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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended February 29, 1996
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D)
OF THE EXCHANGE ACT OF 1943
For the transition period from __________________ to _______________
Commission File No. 1-4766
GATEWAY ENERGY CORPORATION
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(Name of small business issuer in its charter)
Delaware 44-0651207
- ------------------------------- ----------------------------
(State or other jurisdiction of (IRS Employer Identification
incorporation or organization) Number)
10842 Old Mill Road, Suite 5, Omaha, NE 68154
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(Address and Zip Code of principal executive offices)
(402) 330-8268
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(Issuer's telephone number)
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered
None None
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Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.01 Par Value
-----------------------------------
(Title of Class)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes X No
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Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.
Issuer's revenues for the most recent fiscal year ended February 29, 1996,
were: $13,156,700.
The aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and ask prices of such stock, as of May 20, 1996, was $6,906,000.
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
The number of shares outstanding of each of the issuer's classes of common
equity, as of May 20, 1996, was 27,624,590.
DOCUMENTS INCORPORATED BY REFERENCE
None
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Transitional Small Business Disclosure Format (check one): Yes No X
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PART I.
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Gateway Energy Corporation (the "Company"), a Delaware corporation, was
originally incorporated as "Gateway Sporting Goods Company" in 1960. On June 1,
1992, the Company completed a restructuring plan and began acquiring interests
in natural gas gathering, processing, and transmission properties (commonly
known as the gathering, transmission, and marketing segment of the natural gas
industry).
In January 1995, the Company acquired Castex Energy, Inc., a company
engaged in the operating and development of natural gas wells in Texas and
Louisiana. This marked the entry of the Company into the production segment of
the natural gas industry and is discussed in more detail later in this section.
The Company's common stock is traded in the over-the-counter market on the
bulletin board section of NASDAQ under the symbol GECO. The Company's principal
executive offices are located at 10842 Old Mill Road, Suite 5, Omaha, Nebraska
68154, and its telephone number is (402) 330-8268.
DESCRIPTION OF BUSINESS
The Company, through joint ventures with industry partners (the "Joint
Ventures"), owns and operates natural gas gathering pipeline systems and
processing plants and related facilities in the Gulf Coast and Southwestern
states of Texas, New Mexico, Oklahoma and Louisiana, and the Gulf of Mexico.
The Company, through its subsidiary Gateway Pipeline Company ("Pipeline")
acquired the remaining interest in IGT, a delivery system which provides service
to industrial users in Ellis County, Texas. Pipeline also owns and operates a
delivery system in Texas County, Oklahoma and has constructed a gathering system
to provide service to a natural gas well operated by Castex Energy, Inc.
Castex Energy, Inc. ("Castex") a majority owned subsidiary of the Company,
owns interests in several natural gas producing wells in Pennsylvania, Texas and
Louisiana and is also the operator of several of these wells. In December 1995,
Castex formed Castex Energy 1995 LP, a limited partnership which acquired the
interests of Wynn-Crosby, Inc. in the South Lake Arthur Field in Vermillion and
Jefferson Davis Parishes in Louisiana. Castex is the general partner of this
limited partnership and the Company owns directly 66% of the limited partnership
units.
The Company has utilized the net proceeds of its Series N Preferred Stock
Offering to directly acquire ownership interests in natural gas gathering and
delivery systems and oil and gas production and to own, develop, and operate
those properties through Pipeline and Castex.
The gas gathering segment of the natural gas transmission system is that
portion of the transportation system developed and designed to gather natural
gas from producing properties and transport that natural gas to the primary
transmission pipeline. These gathering systems generally have the lowest capital
cost of any segment of the total pipeline system. They are usually installed
underground to service the producing wells
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along their service area. Gathering systems can include connections into other
existing production or leases yet to be developed. Delivery systems provide
natural gas service to end users. These systems may purchase gas for resale to
industrial customers or may provide a transportation service for a tariff.
The gas gatherer contracts with the owner or operator of the producing gas
wells in an area to utilize the gas gathering system to transport the gas from
the wellhead to a transmission line. The producer pays the state severance taxes
and delivers dry gas (that which is stripped of natural gas liquids ("NGLs")).
The gathering system delivers the gas to the transmission line and for that
service receives a "tariff." The gatherer generally has no obligation for
severance taxes or stripping the NGLs. In some cases, the gatherer will install
a separator/dehydrator and thus receives the benefits from the "drip" or the
sale of the extracted NGLs, and in other cases the gatherer may construct and
own gas processing facilities which extract the NGLs under financial
arrangements with the producer from rich BTU gas streams. The gas gatherer may
also take advantage of gas marketing opportunities, whereby the gas gatherer
purchases the gas at the wellhead and takes title to the product. The gas is
then transported from the point of purchase to a point of delivery and then sold
to one or more customers. These purchases and sales are generally transacted
through "back to back" contracts. Currently, approximately 84% of gathering and
processing revenues recorded by the Company are received under "back to back"
contracts, 6% under tariff arrangements, and 10% from sales of NGLs.
The delivery segment of the industry provides service directly to end users
of natural gas, primarily industrial and large commercial companies. Delivery
pipelines are connected to major intra or interstate pipelines and gas supplies
are purchased directly from the pipeline company or others who have access and
capacity on that system. Delivery pipelines provide service directly to end
users and volumes are metered at the plant. Generally, sales are based on
contracts which cover the same period as the supply contract so margins are
secured for the length of the contract. This is an expanding segment of the
industry due to regulations which allowed customers to bypass their local
distribution utility. It is also becoming more competitive as suppliers try to
secure markets for their gas and as local utilities become more aggressive in
retaining large industrial users.
Since January 1995, the Company has also participated in the development
and production segment of the natural gas industry. Through Castex, the Company
owns interests in, and operates, producing gas wells. The production phase is
involved in finding, developing, drilling and producing oil and natural gas.
Castex has historically acquired promising prospects and resold these prospects
to industry partners; usually retaining a working interest and the rights to
develop and operate the wells. This process allows the Company to minimize the
risk associated with development and drilling. The Company also acquires
interests in producing wells and the reserves associated with these wells.
THE COMPANY'S JOINT VENTURE OPERATIONS
The Company operates certain of its gathering systems through joint
ventures. Each joint venture is operated by an operator/manager who is a joint
venture partner. The operator/manager is responsible for the operation,
maintenance, marketing, and accounting for the pipeline system. The
operator/manager receives a monthly fee and, in some instances, an overhead
allowance to cover certain in-office expenses. The joint venture agreements
provide for net operating revenues to be distributed monthly to the joint
venture partners
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in proportion to their ownership interests. Such ownership interest may change
after the Company has received a payout of 125% of its investment in the system.
Effective December 1, 1994, the Company made certain prospective changes to
its future joint venture arrangements essentially providing for (a) a guaranteed
return on the Company's investment before distributions become available for the
Joint Venture operator; (b) a management fee for the operator based on the
performance of the property; and (c) a maximum interest to the operator of up to
20% of the properties' investment, of which 5% of such investment would be
provided by the Joint Venture operator. As of February 29, 1996, only four Joint
Venture agreements included the above provisions.
MAJOR CUSTOMERS AND SUPPLIERS
The Company purchases natural gas from numerous producers and purchased 15%
of its total cost of gas supply from one major oil and gas producing company.
All customers with sales exceeding 10% are in the gas gathering segment.
Gross sales as a percentage of total revenue to non-affiliated major customers
are as follows:
1996 1995
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Customer A 22% 18%
Customer B 9% 18%
Customer C 0% 13%
Although these sales constitute a major portion of total revenues, they do
not represent a significant portion of net operating margin because of back-to-
back purchase contracts to supply these major customers.
COMPETITION
The natural gas industry is highly competitive. The Company competes
against other companies in the production, gathering, delivery, and marketing
business for supplies and for customers. Competition for gas supplies is
primarily based on the availability of transportation facilities and a
satisfactory price. In marketing, there are numerous competitors, including
interstate pipelines, major producers, and local and national gatherers,
brokers, and marketers. Most competitors have capital resources greater than the
Company and control greater supplies of gas. Competition for marketing customers
is primarily based on reliability and the price of delivered gas.
REGULATION
Natural Gas Transmission Industry. The transportation, sale, and marketing
of natural gas in interstate commerce are subject to extensive regulation under
the Natural Gas Act ("NGA"), the Natural Gas Policy Act of 1978 ("NGPA"), and
rules and regulations promulgated by the Federal Energy Regulatory Commission
("FERC"). As discussed below, the Company believes that the gathering and
delivery facilities of the Company are intrastate in nature and not subject to
FERC's jurisdiction. The properties are, however, subject to regulation by
various state agencies.
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In April 1992, the FERC issued Order 636 which generally requires
interstate pipelines to "unbundle" their traditional wholesale services and
create and make available on an open and nondiscrimination basis numerous
constituent services, including gas gathering services. This ruling and
subsequent Orders 636A and 636B are expected to have a significant impact on the
natural gas transportation industry and the cost of acquiring these gathering
systems. Generally, these regulations have made it less attractive for large
interstate pipelines to own and operate the gas gathering systems. This
situation makes available numerous systems at prices which can generate
attractive rates of return for the Company.
The Fort Cobb Fuel and Irrigation Authority ("Fort Cobb") is a local
distribution company subject to the regulations of the Oklahoma Public Service
Commission ("OPSC"). The OPSC regulates the prices to the customer based on the
cost of investment, operating and maintenance expense, cost of purchased gas and
rates of return. Fort Cobb's rates to customers were last approved by the OPSC
in 1993; Fort Cobb has not filed for an increase in rates since that time. The
OPSC also regulates construction and safety of the distribution system.
Environmental and Safety Concerns. The Company's operations are subject to
environmental risks normally incident to the operation and construction of
pipelines, plants, and other facilities for gathering, processing, treating, and
transporting natural gas. In most instances, the regulatory requirements relate
to the discharge of substances into the environment and include controls such as
water and air pollution control measures. Environmental laws and regulations may
require the acquisition of a permit before certain activities may be conducted.
Further, these laws and regulations may limit or prohibit activities on certain
lands lying within wilderness areas, wetlands, areas providing habitat for
certain species, or other protected areas. The properties are also subject to
other federal, state, and local laws covering the handling, storage, or
discharge of materials used by the joint ventures, or otherwise relating to
protection of the environment, safety, and health.
Management believes the Company and its joint venture operators have
obtained and are in current compliance with all necessary and material permits
and that the Joint Ventures are in substantial compliance with applicable
material governmental regulations.
EMPLOYEES
As of February 29, 1996, the Company, excluding the employees of its joint
venture operators, had 23 full-time employees and 5 part-time employees.
ITEM 2. DESCRIPTION OF PROPERTY
JOINT VENTURE OPERATING PROPERTIES
As discussed above, the Company currently operates various properties
through joint ventures with industry partners (the "Joint Venture Systems"). The
Company owns interests in these Joint Venture Systems ranging from 25% to 70%.
The Company does not hold record or
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legal title to any of the joint venture properties. All of the operating
properties are owned by the respective Joint Venture Systems with record or
legal title being held in the name of the Manager/Operator of the joint venture.
The terms of the joint venture agreements provide for undivided ownership
interest in the operating properties.
As of February 29, 1996, the Company owned interests (generally 60% to 70%
after payout) in Joint Venture systems comprising approximately 580 miles of
pipeline with a capacity of 537 million cubic feet per day (MMCFD), currently
handling approximately 58 MMCFD with an investment cost of $6,144,000. Of this
invested cost, $3,816,000 of properties are pledged to secure dividend and
redemption payments on the Company's Series G Preferred Stock. The 31 systems
are operated under 16 Joint Venture Agreements. The pipeline systems are
comprised of 1" to 20" pipe and generally vary in length from 7 miles to 70
miles per system.
The Joint Venture Systems are utilized as gathering systems. A brief
summary of location, miles of pipeline, capacity and size of pipeline is as
follows:
STATE MILES SIZE CAPACITY
----- ----- ---- --------
(MMCFD)
-------
Texas 363 2" to 8" 291
New Mexico 117 3" to 8" 46
Louisiana 37 2 7/8" to 8" 40
Offshore 63 4 1/2" to 20" 160
DELIVERY
The Company owns and operates the following delivery systems:
STATE MILES SIZE CAPACITY
----- ----- ---- --------
Texas 14 6" 25
Oklahoma 15 8" 30
The Company's investment in these systems is $1,965,000 of which $1,170,000
is pledged to secure dividend and redemption payments on the Series G Preferred
Stock. The delivery systems serve industrial customers in and around Waxahachie,
Texas and customers in Guymon, Oklahoma.
FORT COBB FUEL AND IRRIGATION AUTHORITY
The Company owns 99% of the Fort Cobb Fuel and Irrigation Authority ("Ft.
Cobb"), a local distribution company which serves approximately 2,600 rural and
residential customers in Caddo and Washita counties in Oklahoma. Ft. Cobb owns
and operates 594 miles of 1" to 4" pipeline and related meters, regulators,
valves, rights-of-way, easements, etc. normally associated with distribution
systems. The pipeline, rights-of-way and associated assets are pledged as
security to the holders of the Series G Preferred Stock in the amount of
$2,441,000.
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The system is also used as a gathering system to transport natural gas from
low pressure wells in Caddo and Washita counties. As of February 29, 1996,
twelve wells have been connected and two compressors installed. The gas
purchased from these producers is either sold to Fort Cobb or to third parties.
OIL AND GAS PROPERTIES
The Company owns and participates in the development and production of oil
and gas reserves through Castex and Castex Energy 1995, L.P. The working
interests owned by the Company are generally less than 25 %. The following
information summarizes the location of the properties and the net equivalent of
natural gas reserves (MMCF) associated with those working interests as of
February 29, 1996:
STATE PROVED RESERVES
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(MMCF)
------
Texas 309.1
Louisiana 11,986.8
Pennsylvania 32.9
At February 29, 1996, net production was approximately 7 MMCFD compared
with less than one MMCFD at February 28, 1995. During the fiscal year Castex
and Castex Energy 1995, LP participated in the drilling and completion of 5
development wells in Louisiana. At February 29, 1996, the Company had
approximately 1,120 net undeveloped acres under lease and owned interests in
58 producing wells (7 net) of which it operated 23 (5 net).
Substantially all of the Company's sales from oil and gas producing
activities are natural gas sales. For the year ended February, 1996, the
Company's average sales price per equivalent unit produced was $2.73 per mcf;
the average production cost per equivalent unit produced was $.47 mcf. The
estimated quantities of proved oil and gas reserves, the standardized measure
of future net cash flows from proved oil and gas reserves (the "Standardized
Measure") and changes in the Standardized Measure for the year ended February
29, 1996 are included under "Supplemental Financial Data" in the notes to the
consolidated financial statements.
CORPORATE PROPERTY
In addition to the operating properties described above, the Company leases
office space and owns certain office equipment located at 10842 Old Mill Road,
Suite 5, Omaha, NE 68154, the Company's corporate headquarters, and leases
office space in Houston, Texas for Gateway Pipeline Company and Castex Energy,
Inc.
ITEM 3. LEGAL PROCEEDINGS
ENCINITAS JOINT VENTURE LITIGATION. On May 6, 1993, Shoreham, as
operator/manager of the Encinitas Joint Venture, filed a lawsuit against Energy
Assets International Corporation and others for breach of contract for non-
delivery and under-delivery of gas into the joint venture pipeline system as
required pursuant to the parties' contract. Shoreham was seeking approximately
$3,000,000 in claims and damages. Subsequent to the initial filing, one of the
defendants filed a third-party claim against the Company. On May 15, 1996, the
litigation was settled with payment of $115,000 to Shoreham and the Company and
the cancellation of the original September 23, 1986 gas contract.
ROCKDALE SYSTEM LITIGATION. Stanley Rosenthal, a Texas individual, filed
an action, on September 23, 1994, in District Court in Milam County, Texas
against Shoreham Pipeline Company involving the Rockdale System joint venture.
Rosenthal seeks specific performance of an alleged oral contract purportedly
requiring Shoreham to sell gas to Rosenthal. Shoreham filed an answer stating
that no contractual relationship was ever
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entered into between Shoreham and Rosenthal, and that even if oral discussions
occurred, such discussions would not be enforceable under the Texas Statute of
Frauds prohibiting enforcement of certain oral contracts.
While the Milam County action was still pending, Rosenthal filed an
administrative action before the Texas Railway Commission. No decision has been
rendered yet by the hearing officer. The Company is advised that the hearing
officer can only require that Rosenthal be served by Shoreham through the
Rockdale system and cannot award damages or penalties. Counsel to Shoreham
continues to believe that an unfavorable outcome to Shoreham is unlikely under
either the Milam County, Texas matter or the Texas Railway Commission
administrative proceeding.
CONSOLIDATED FUELS BANKRUPTCY. Shoreham filed a claim in the United States
Bankruptcy Court in Dallas, Texas seeking to recover a joint venture receivable
in the amount of $399,567 from Consolidated Fuels Corporation. The claim was
allowed and $199,000 of the claim has been paid. The bankruptcy trustee is to
make the remaining payments out of available cash flow.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's common stock is traded in the over-the-counter market on the
bulletin board section of NASDAQ. The bid prices shown reflect inter-dealer
prices without retail mark-up, mark-down, or commissions and may not represent
actual transactions.
QUARTER ENDING HIGH LOW
May 31, 1994 $.50 $.375
August 31, 1994 .50 .375
November 30, 1994 .9375 .48
February 28, 1995 .80 .50
QUARTER ENDING HIGH LOW
May 31, 1995 $.6875 .4375
August 31, 1995 .75 .50
November 30, 1995 .625 .375
February 28, 1996 .50 .375
HOLDERS
As of February 29, 1996, there are approximately 3,500 shareholders of the
Company's Common Stock, Par Value $0.01.
DIVIDENDS
There have been no dividends declared on the Company's Common Stock during
the last two fiscal years. The Company is restricted from paying any dividends
on its Common Stock unless all cumulative dividends on all outstanding series of
preferred stock have been paid. As of February 29, 1996, the Company had met all
preferred stock dividend requirements. The Company does not intend to pay
dividends on its common stock in the near future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following management's discussion and analysis contains trend analysis
and other forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. Actual results could differ materially from those
projected in the forward-looking statements throughout this document as a result
of the risk factors set forth below in the section entitled "Factors Affecting
Future Results" and elsewhere in this document.
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RESULTS OF OPERATIONS
The following table sets forth information for each of the years in the
three-year period ended February 29, 1996:
<TABLE>
<CAPTION>
1996 1995 1994
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<S> <C> <C> <C>
Operating Revenues $13,156,721 $8,107,559 $8,345,937
Operating Margin 3,689,156 1,876,471 631,949
Depreciation, Depletion and Amortization 1,089,916 345,528 106,251
General and Administrative Expense 2,491,405 979,026 283,655
Other Income (Expense) (166,526) 69,978 (21,947)
Net Earnings (Loss) (92,691) 575,258 216,096
Loss Applicable to Common Stock (2,415,721) (705,662) (223,470)
</TABLE>
YEAR ENDED FEBRUARY 29, 1996 COMPARED TO YEAR ENDED FEBRUARY 28, 1995.
GENERAL. Natural gas prices as represented by the monthly NYMEX index
prices were about 4% higher in fiscal 1996 as compared to fiscal 1995. A
significant portion of the Company's properties and gas revenues are made based
on monthly El Paso index prices which actually decreased $.12 per BTU or 8%.
Both indexes reflected substantially lower prices from March 1995 to August
1995. Lower gas prices during the early months of the fiscal year resulted in a
slowdown of producer rework and drilling activity which curtailed some expected
volume increases on certain of the Company's systems. Natural gas prices
rebounded strongly in late fall of 1995 and at February 29, 1996, were $2.34 for
March deliveries which was $.92 higher than the previous year. Prices have
remained steady during the first quarter of fiscal 1997 and were $2.36 for June
1996 deliveries. These higher gas prices have increased producer interest in
maximizing production of natural gas through rework and new drilling activities.
OPERATING REVENUES. Operating revenues increased $5.0 million or 62% over
the prior year. The revenue increase was largely due to acquisitions made during
fiscal 1996 and 1995. Revenues from gathering and delivery systems increased
$2.3 million because of systems acquired throughout 1995. Distribution revenues
from Fort Cobb Fuel Authority increased $1.2 million with the purchase of this
utility in November 1994. Production revenue increased $1.0 million due to the
acquisition of interests in the South Lake Arthur field in January 1996 and
revenues generated from successful wells drilled during the current fiscal year.
Revenues from systems acquired prior to March 1, 1994, declined 6% due to
reductions in volumes on several systems.
OPERATING MARGIN. Operating margins are defined as revenues less gas
purchases, and operation and maintenance expense. Operating margins for
fiscal 1996 increased by $1.8 million, almost double, over fiscal 1995 due
almost entirely to acquisitions made during the period. Gathering system
margins increased $.5 million primarily due to the addition of volumes on the
Caddo System and other acquisitions in 1995. Distribution operating margins
from Fort Cobb increased $.3 million due to the timing of the acquisition in
November 1994. Production operating margins increased $.8 million due
primarily to the acquisition of interests in the South Lake Arthur field in
January 1996. Castex also drilled several successful wells in fiscal 1996.
Other increases in operating margins from acquisitions were offset by higher
operating expenses and reduced volumes transported by several gathering
systems. Volumes and expenses on these systems are expected to return to
normal levels in the second quarter of fiscal 1997.
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DEPRECIATION, DEPLETION & AMORTIZATION. Depreciation depletion and
amortization increased $.7 million over fiscal 1995 due primarily to $400,000
of depletion of gas reserves acquired in January 1996 and increases due to
gathering system assets acquired during fiscal 1995. Depletion related to
production is approximately 50% of production revenues.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expenses
increased $1.5 million in fiscal 1996 over fiscal 1995. In January 1995, the
Company acquired certain production properties and in connection therewith
opened an operating office in Houston, Texas. This office is focusing on
making larger acquisitions for the Company, owning and operating systems to
avoid joint venture operating fees, developing gas producing prospects, and
drilling low risk wells. In fiscal 1996, total general and administrative
expenses of Gateway Pipeline Company and Castex were $896,000 compared to
only $119,000 for the two months in fiscal 1995. These costs included start
up costs, costs of pursuing several significant acquisitions which were not
consummated, and costs to position the companies to operate properties.
General and administrative expenses are not expected to increase in fiscal
1997 even though revenues may increase due to acquisitions.
Administrative expenses at Fort Cobb increased $280,000 over fiscal 1995
due to including twelve months in 1996 as contrasted to four months in 1995.
Corporate administrative expenses increased $429,000 over fiscal 1995.
This increase was due primarily to fees paid to an investment advisory firm
to assist the Company in obtaining institutional funds. In August 1994, the
Company entered into a contract with an investment advisory firm to assist in
obtaining a minimum of $15.0 million of institutional funds. The Company was
unable to locate the somewhat narrowly defined qualified investment prospects
and therefore was obligated to pay certain minimum annual financing fees in
addition to monthly retainer fees of $313,000 which are included in expense.
The contract was terminated in April 1996. Increases in professional fees
(legal and accounting), salaries and wages and shareholder-related costs
accounted for the balance of the increase. Legal and accounting fees continue
to increase as the Company pursues larger and more complex transactions,
especially those involving oil and gas production.
OTHER INCOME (EXPENSE). The majority of the change in other income
(expense) is related to interest expense which increased $272,000 over the
previous year. This increase was due to $119,000 of expense associated with
the credit facility used to acquire interests in the South Lake Arthur field
and $153,000 for bridge loans necessary to acquire properties before funds
from the Series N Preferred Stock Offering were available. The interest
expense for bridge loans includes the issuance of common stock valued at
$60,000 in consideration of commitment fees.
NET EARNINGS (LOSS). The fiscal 1996 net loss of $93,000 represents a
$668,000 decrease from fiscal 1995 net earnings. Although revenues and net
operating margins increased significantly, this increase was offset primarily
by higher general and administrative costs associated with the Company's
Houston operations, fees paid to the investment advisory firm and increased
interest expense.
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LOSS APPLICABLE TO COMMON STOCK. Net loss applicable to common stock
increased $1.7 million over 1995 due to net earnings decreasing $668,000 and
the provision for preferred dividends increasing $1.0 million. The increase in
the provision for dividends is due to $842,000 of additional dividend payments
resulting from additional preferred stock issuances in 1996 and 1995 and
increased amortization of Series G offering costs of $200,000.
YEAR ENDED FEBRUARY 28, 1995 COMPARED TO FEBRUARY 28, 1994.
GENERAL. Natural gas prices declined significantly in April 1994 and did
not completely recover before year end. Although lower prices in the summer are
expected, gas prices normally rebound in the fall and winter months as demand
increases. However, three factors contributed to the soft prices for natural
gas. First, the weather was unusually mild throughout the Midwest and Northeast
with heating degree days about 85% of normal. Second, large amounts of gas
available from storage depressed prices and third, increased export of gas from
Canada to the lower United States. Lower gas prices affect the Company's
revenues and earnings in two ways. First, substantially all of the gas purchased
and resold is based on a percentage of various index prices. Therefore, the
contribution to net margin is less when gas prices are lower. Second, lower gas
prices resulted in some producers shutting in wells and other producers not
drilling new wells or reworking old wells which actions directly affect volumes
on the Company's systems.
OPERATING REVENUES. Operating revenues decreased $238,000 or 3% from the
prior year. Operating revenues increased from acquisitions made during fiscal
1995 and 1994 by $3,500,000. These increases from acquisitions were offset by a
loss of revenue of $2,695,000 from a major customer and a reduction in revenue
of $1,056,000 from a reduction in gathering system volumes. The combined net
operating margin loss from these two customers was only $42,000 due to the low
margins associated with these sales.
OPERATING MARGIN. Net operating margins increased $1,244,000 due to
margins from properties acquired during 1995 and 1994 of $1,059,000 and
improved margins on additional gas connected to a system and a reduction in
operating costs.
DEPRECIATION, DEPLETION AND AMORTIZATION. Depreciation, depletion and
amortization increased $239,000 due to acquisitions acquired during 1995 and
1994.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expenses
increased by $695,000 from 1994 to 1995. This increase was due to an increase
in salaries, wages and employee benefits of $399,000 including $172,000 for
entities which were acquired in fiscal 1995. Wages and salaries also reflect
staff additions, including the chief financial officer in January 1994, merit
and cost of living adjustments, and accruals for stock options and warrants
granted.
In fiscal 1995, the Company also paid outside consultants $106,000 to
assist in finding properties for acquisition and to assist in the conversion of
various series of preferred stock. All of these consulting agreements have been
terminated. The Company also incurred costs of $21,000 in connection with
prospective acquisitions which were not successful. These costs are included in
general and administrative costs.
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In addition, the Company increased its efforts in reporting to stockholders
and investors and published an annual report along with three quarterly reports
and wrote off costs associated with a terminated potential public offering of
$24,000.
OTHER INCOME (EXPENSE). Other income (expense) increased $92,000 over
the previous year. Interest income increased $54,000 due to higher invested
balances from the proceeds of Series G Preferred Stock. Interest expense
decreased $47,000 because bridge loans required in fiscal 1994 were not
necessary because of the availability of Series G funds.
NET EARNINGS (LOSS). Net earnings increased $359,000 to $575,000 as a
result of the improvement in operating margins of $1.2 million offset by
increased depreciation, depletion and amortization of $239,000 and general and
administrative expenses of $695,000.
LOSS APPLICABLE TO COMMON STOCK. The loss applicable to common stock
increased $482,000 in fiscal 1995 to $706,000. An increase in net earnings of
$359,000 was offset by $597,000 of additional preferred stock dividends paid as
a result of additional preferred stock issuances during 1995 and 1994 and
$244,000 of additional amortization of Series G offering costs included in the
provision for preferred stock dividends.
LIQUIDITY AND CAPITAL RESOURCES
During 1996 and 1995, the Company generated net cash flows from operating
activities of $637,000 and $460,000 respectively. The Company utilized the
net cash flows from operating activities plus proceeds from the sale of
non-core properties, payments of notes receivables, an operating bridge loan
and dividend reserves from Series G and N Preferred Stock and a portion of a
subsidiary's preferred stock to meet its dividend obligations of $1.8 million
in fiscal 1996 and $1.0 million in fiscal 1995.
During fiscal 1996, the Company raised $3,902,000 from the sale of Series
N Preferred Stock, $1,225,000 from acquisition bridge loans and $9.5 million
through a $15.0 million credit facility from Bank of America. This credit
facility is available to Castex Energy 1995, L.P., a limited partnership in
which the Company and its subsidiaries own a 71% interest, to purchase oil
and gas reserves in Louisiana.
The Company used the proceeds of the above financings to invest $2.8
million in natural gas gathering and delivery systems and $10.7 million in
oil and gas reserves and producing wells. At February 29, 1996, the Company
had $1,385,000 of funds available for future acquisitions or to repay
outstanding bridge loans.
As of February 29, 1996, the Company has a working capital deficit of $1.3
million which includes bridge loans and an acquisition line of credit totalling
$1.4 million. The bridge loans and line of credit are expected to be refinanced
or repaid by the use of cash escrowed for acquisitions, by the additional
issuance of Series N Preferred Stock through May 31, 1996, and the issuance of
$750,000 of Series P Preferred Stock.
Subsequent to year end, the Company purchased Venture Resources, Inc. for
$1.3 million which was funded by the issuance of additional Series N
Preferred Stock and bridge loans. Castex
12
<PAGE>
Energy 1995, L.P. purchased additional interests in the South Lake Arthur field
for $3.3 million using the credit facility.
Prospectively, the Company anticipates that cash flows from operating
activities after meeting debt service requirements related to long-term debt
will not be sufficient to fund all of its preferred stock dividend
requirements. The Company is currently evaluating its alternatives which
include issuing additional common equity, reducing preferred stock dividends
through conversion of a portion of the preferred stock, improving the
operating performance of its systems and properties and refinancing or
extending the maturity dates of the acquisition line of credit and bridge
loans. The Company believes a combination of the above will permit the
Company to meets its preferred dividend requirements. Alternatively, the
Company has the option to suspend the payment of dividends on all series of
preferred stock, except Series G, without default.
FACTORS AFFECTING FUTURE RESULTS
As described in Item 1 above, approximately 85% of the Company's gathering
and processing revenues are received under "back to back" contracts where the
Company, or its joint venture partners, purchase gas at the wellhead, transport
the gas and sell it to one or more customers. Accordingly, a substantial
majority of the Company's revenues are affected by the price of natural gas.
During times where warm winter weather conditions prevail, manufacturing needs
are down or the supply of natural gas in the market is up, prices will be lower
and the Company's revenues will be adversely effected. Additionally,
approximately 41% of the Company's properties are managed by joint venture
partners or other third parties. The ability of such parties to manage the
properties efficiently effects operating costs and therefore the revenues that
flow through to the Company.
Over the next twelve to eighteen months, the Company also needs to
generate additional capital to continue to make payment of preferred stock
dividends. As discussed above under "Liquidity and Capital Resources", the
Company believes that it has sources and methods to obtain such capital
resources. There can be no assurances, however, that the Company will be
successful in any or all of these activities. The state of the natural gas
market, the general economic and stock market conditions and the long-term
investment value of the Company's operating properties will have a
significant impact upon the Company's ability to raise capital and generate
funds.
The ability of the holders of common stock of the Company to derive
long-term value for their investment is dependent upon the profitable
operation of the Company's properties, the long-term investment value of the
Company's properties, and the ultimate ability of the Company to cause the
redemption or conversion of a substantial portion of the outstanding
preferred stock. The ability of the Company to derive such long term value
for the holders of the common stock is dependent upon a number of factors,
many of which are outside of the control of the Company, including the
ability of third parties to operate the Company's properties efficiently and
profitably, continued strong demand for natural gas, new natural gas wells
drilled and adequate reserves for existing wells within the purview of the
Company's gathering system properties, the ability of the third party
operators to secure new gas supply and distribution contracts on profitable
terms, the availability of new properties at prices that make profitable
operation possible and the availability of appropriately-priced financing to
secure new properties.
13
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants
as of February 29, 1996 and February 28, 1995
and for the years then ended . . . . . . . . . . . . . . . . . F-1
Consolidated Balance Sheets as of
February 29, 1996 and February 28, 1995. . . . . . . . . . . . F-2
Consolidated Statements of Operations for the years
ended February 29, 1996 and February 28, 1995. . . . . . . . . F-4
Consolidated Statement of Stockholders' Equity for the years
ended February 29, 1996 and February 28, 1995. . . . . . . . . F-5
Consolidated Statements of Cash Flows for the years
ended February 29, 1996 and February 28, 1995. . . . . . . . . F-6
Notes to Consolidated Financial Statements . . . . . . . . . . . F-8
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Not applicable.
14
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS
The names and ages of the directors as of February 29, 1996, are set forth
below. All directors serve until the next annual stockholder meeting.
NAME AGE DIRECTOR SINCE
---- --- --------------
Donald L. Anderson 64 February 1993
John B. Ewing 74 June 1988
Charles A. Holtgraves 31 June 1988
L. J. Horbach 54 January 1990
James W. Vickers* 67 February 1993
*Mr. Vickers resigned as a director effective April 1, 1996.
Officers of the Company serve for a one-year term. The names and ages of
officers are listed below.
NAME AGE POSITION OFFICER SINCE
- ---- --- -------- -------------
L. J. Horbach 54 Chairman of the Board, June 1990
President and Chief
Executive Officer
Neil A. Fortkamp 50 Executive Vice President, January 1994
Treasurer and Chief
Operating Officer
Donald L. Anderson 64 Vice President and Secretary September 1992
Roger L. Pfeifer 47 Assistant Secretary October 1993
L. J. HORBACH has been a director of the Company since January 1990 and
Chairman of the Board, President and Chief Executive Officer since June 1990.
For the past five years Mr. Horbach has also been associated with L. J. Horbach
& Associates, a firm specializing in reorganizations and financial consulting.
Mr. Horbach is currently a director of Regency Affiliates, Inc., a public
company, and Templeton Savings Bank.
NEIL A. FORTKAMP was appointed Vice President, Treasurer, and Chief
Financial Officer in January 1994 and Executive Vice President and Chief
Operating Officer in November 1995. Mr. Fortkamp was president of Data
Duplicating Corporation, a software manufacturing company, from August 1991 to
January 1994. From 1989 to 1991 he was Vice President and Treasurer of KVI
Associates, a real estate development company. Mr. Fortkamp currently serves as
a director of Data Duplicating Corporation.
DONALD L. ANDERSON has served on the Board since February 1993 and has been
a Vice President since September 1992. Mr. Anderson has been involved in
investment banking activities for over 30 years and
15
<PAGE>
has significant experience in the energy business. For the past five years Mr.
Anderson has served as a private consultant to the investment banking industry
and is affiliated with Pipeline Capital, Inc.
JAMES W. VICKERS has been a director of the Company since February 1993.
For the past five years he has been a consultant to several oil and gas
companies and is also very active in several charitable and philanthropic
endeavors. Previous to that time Mr. Vickers was an officer and director of
Vickers Petroleum Company, Inc., a director of the Marketing Division of the
American Petroleum Institute, and a member of the Young Presidents
Organization. Mr. Vickers resigned as a director of the Company for personal
reasons on April 1, 1996.
JOHN B. EWING has been a director since June 1988. For the past five years
Mr. Ewing has been an attorney in private practice.
COMPLIANCE WITH SECTION 16(A) OF EXCHANGE ACT
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires the Company's officers and directors and persons who
own more than 10% of a registered class of the Company's equity securities to
file reports of ownership on Form 3 and changes in ownership on Form 4 or Form 5
with the Securities and Exchange Commission (the "SEC"). Such officers,
directors, and 10% stockholders are also required by the SEC rules to furnish
the Company with copies of all Section 16(a) forms they file. Charles A.
Holtgraves, a Director of the Company, failed to timely file two Form 4
ownership reports involving two transactions.
ITEM 10. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE. Individual executive officer compensation for
the fiscal year ended February 29, 1996, included base salary, bonuses based
upon financial objectives accomplished for the year ended February 28, 1995,
certain expense allowances provided by the Company and matching contributions of
the Company to its 401(k) savings plan. As of February 29, 1996, the Company had
no bonus or long-term incentive programs in effect and no bonuses were payable
for the year then ended. The following Summary Compensation Table includes
compensation paid in cash and notes.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
SECURITIES
UNDERLYING
OPTIONS/SARS
(#)
---------------------------------------------
NAME AND PRINCIPAL POSITION YEAR SALARY ($) OTHER BONUS
($) ($)
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Larry J. Horbach,
President and Chief
Executive Officer 1994 $ 65,000 0 0 0
1995 95,933 11,264 0 175,000 shares (1)
1996 108,137 9,422 10,617
- ----------------------------------------------------------------------------------------------------------
Neil A. Fortkamp, Executive 1994 10,833 (3) 0 0 0
Vice President and Chief 1995 66,667 5,486 0 162,500 shares (1)(2)
Operating Officer 1996 76,250 7,200 8,009
- ----------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE>
(1) On December 1, 1994, Messrs. Horbach and Fortkamp were granted incentive
stock options coupled with tandem stock appreciation rights under the
Company's 1994 Incentive and Nonqualified Stock Option Plan. Messrs.
Horbach and Fortkamp were granted options and tandem stock appreciation
rights on 175,000 shares and 150,000 shares, respectively, each at an
exercise price of $0.25 per share. The options vest at the rate of 50% per
year commencing December 1, 1994. Under the stock appreciation rights,
holders may exercise such SARs for cash, common stock or any combination
thereof in an amount equal to the difference between the market price of
the Company's common stock on the date of exercise and the option price at
the date of grant. Mr. Fortkamp also received warrants to purchase 12,500
shares of common stock. See Footnote 2 below.
(2) As a part of 1995 compensation to Company employees, Mr. Fortkamp received
warrants to purchase 12,500 shares of Company common stock exercisable at
$0.16 per share through February 28, 2000.
(3) Mr. Fortkamp joined the Company on January 3, 1994.
OPTION/SAR GRANTS IN LAST FISCAL YEAR. The Company made no grants of stock
options or stock appreciation rights during the year ended February 29, 1996.
AGGREGATE OPTION/SARS EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END
VALUES. No executive officers exercised options during the fiscal year ended
February 29, 1996. The following table sets forth the year-end value of
unexercised options/SARs for officers of the Company:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES VALUE (1) OF UNEXERCISED IN-THE-
UNDERLYING UNEXERCISED MONEY OPTIONS/SARS AT YEAR-
OPTIONS/SARS AT YEAR-END: (#) END: ($)
NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Larry J. Horbach 0/175,000 0/$27,300
- -------------------------------------------------------------------------------------------------
Neil A. Fortkamp (2) 0/150,000 0/$23,400
- -------------------------------------------------------------------------------------------------
</TABLE>
(1) The value of unexercised, in-the-money options has been calculated by
determining the difference between the fair market value of the Company's
common stock on February 29, 1996 and the exercise price of the options,
multiplied by the number of options held.
(2) Mr. Fortkamp also received warrants to purchase 12,500 shares of Company
common stock as described in Footnote 2 to the Summary Compensation Table.
DIRECTOR COMPENSATION. Directors who are not officers receive $500 per day
for Board and committee meetings attended plus expenses of meetings.
17
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS. The table below sets
forth the persons who are known to the Company to be beneficial owners of more
than five percent (5%) of the Company's voting common stock.
- --------------------------------------------------------------------------------
NAME AND ADDRESS OF AMOUNT AND NATURE OF
TITLE OF CLASS BENEFICIAL OWNER BENEFICIAL OWNER PERCENT OF CLASS
- --------------------------------------------------------------------------------
Common Stock Harry N. and Betty Davis 1,477,747 5.48%
3760 Martin Road
Smithville, MO 64089
- --------------------------------------------------------------------------------
Common Stock John J. Buterin 1,513,570 5.61%
P.O. Box 375
Mission, KS 66201
- --------------------------------------------------------------------------------
(b) SECURITY OWNERSHIP OF MANAGEMENT. The following table sets forth
information concerning the shares of Common and Preferred Stock beneficially
owned by (i) each director of the Company; (ii) each of the executive officers
of the Company; and (iii) all directors and executives as a group.
- --------------------------------------------------------------------------------
NAME AND ADDRESS OF AMOUNT AND NATURE OF
TITLE OF CLASS BENEFICIAL OWNER BENEFICIAL OWNER PERCENT OF CLASS
- --------------------------------------------------------------------------------
Common Stock L. J. Horbach 615,116 2.28%
10842 Old Mill Road #5
Omaha, NE 68154
- --------------------------------------------------------------------------------
Common Stock Neil A. Fortkamp 37,500 .14%
13011 Lafayette Avenue
Omaha, NE 68154
- --------------------------------------------------------------------------------
Common Stock Charles A. Holtgraves 1,297,500 4.81%
6510 Indian Lane
Mission Hills, KS 66208
- --------------------------------------------------------------------------------
Common Stock Donald L. Anderson 449,064 1.66%
48-505 Via Encanto
La Quinta, CA 92253
- --------------------------------------------------------------------------------
Common Stock James W. Vickers 402,065 1.49%
75-650 Alta Mira
Indian Wells, CA 92210
- --------------------------------------------------------------------------------
Common Stock John B. Ewing, Jr. 144,000 .53%
1621 Bay Point Court
Sarasota, FL 34236
- --------------------------------------------------------------------------------
All executive officers and directors
as a group 2,945,245 10.92%
18
<PAGE>
- --------------------------------------------------------------------------------
NAME AND ADDRESS OF AMOUNT AND NATURE OF
TITLE OF CLASS BENEFICIAL OWNER BENEFICIAL OWNER PERCENT OF CLASS
- --------------------------------------------------------------------------------
Preferred Stocks
Series B Charles A. Holtgraves 2.5 .14%
John B. Ewing, Jr. 25.0 1.45%
Series L,M,K,J Charles A. Holtgraves 10.0 .44%
Series C Donald L. Anderson 56.25 100%
James W. Vickers 56.25 100%
- --------------------------------------------------------------------------------
All executive officers and directors as a group:
Series B 27.5 1.59%
Series K 10.0 .44%
Series C 56.25 100%
- --------------------------------------------------------------------------------
(c) CHANGES IN CONTROL. None.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In fiscal year 1992, the Company entered into an agreement, as amended
February 28, 1993, and October 28, 1994, with Pipeline Capital, Inc. ("PCI")
whereby PCI, through a sponsorship arrangement, was to raise up to $50,000,000
for the Company over a five-year period through arranging private placements and
public offerings of the Company's securities. Under the Agreement, PCI received
a commission and finder's fees for properties acquired by the Company. PCI was
also issued common stock for successful efforts in raising funds used to
purchase the operating properties. To date, $18,595,000 of capital has been
raised.
In addition, PCI will receive an Exit Amount upon expiration of the
sponsorship agreement to be based on fifty percent (50%) of the fair market
value of the properties acquired during the period plus 10% of defined net
operating income of the properties to the extent such Exit Amount exceeds
finder's fees and commissions paid to PCI. a portion of such 10% amounts have
been advanced to PCI. The Exit Amount due PCI has been evidenced by the Series C
Preferred Stock which can only be issued to PCI. Upon payment of the Exit
Amount, the agreement provides that the Series C Preferred Stock will be
returned to the Company and canceled.
Donald L. Anderson and James W. Vickers, directors and shareholders of the
Company, are shareholders of PCI. Each has a one-third interest in the capital
and in all profits and losses of PCI. The following table sets forth the cash
payments, excluding amounts with respect to the 10% net operating income and
stock issued to PCI during the periods indicated:
2/28/94 2/28/95 2/28/96
-------------------------------------------------------
Cash $323,000 $630,000 $231,400
Common Stock 232,445 shares 490,000 shares 120,000 shares
Series C Preferred 18.0 shares 9.75 shares 0 shares
In addition, as of May 6, 1996, the Company had advanced $278,728 to PCI.
The amount bears interest at 7% (and was due not later than February 20, 1999).
To the extent that the Exit Amount as
19
<PAGE>
described above is paid to PCI, all remaining principal and interest on the
advances will be deducted from such amounts payable.
Over the past year, disagreements had arisen between the Company and PCI as
to the proper method of determining the fair market value of the Company's
properties for purposes of determining the Exit Amount. The agreement, its
various amendments and other correspondence and documents between the parties
provided a basis for widely varying interpretations of how to calculate the Exit
Amount. PCI's position was that the Exit Amount was equal to the greater of 50%
of the fair market value of the properties less any indebtedness against the
properties, or the total of the commissions, finder's fees advances and common
stock paid to PCI. The position of the Company was that the Exit Amount was
based upon the after tax proceeds upon a sale, or assumed sale, of the
properties, reduced by all commissions, finder's fees, expense advances and the
value of any common stock received by PCI during the term of the agreement.
Further, concerns had also arisen about the continued involvement of PCI in
obtaining capital and securing properties in light of changes in the Company's
operations.
As a result of the ongoing disagreements, the Company and PCI determined to
terminate all prior agreements and the parties entered into a Settlement and
Purchase Agreement effective May 6, 1996. The Settlement and Purchase Agreement
provides as follows:
- The Company repurchased the 56.25 shares of Series C Preferred Stock
owned by PCI, representing its right to receive the Exit Amount and
the 10% interest in defined net operating cash flows for $480,000
represented by a promissory note requiring payments of $10,000 per
month commencing July 1, 1996 and ending June 1, 2000. The Company
may, at its option, prepay all of the note at a discount rate of 8%.
- PCI executed a new promissory note in the amount of $278,728 plus
interest at 7% per annum representing all advances to PCI to date. All
principal and interest on this note will be offset against the amounts
which are payable to PCI upon a "Payment Event" under the Series O
Preferred Stock, described below.
- The Company issued to PCI one share of its Series O Preferred Stock
which is non-voting and has no dividend rights. Upon the following
described events, the following payments will be made to PCI:
A. In the event of the merger of the Company where it is not
the surviving corporation, the sale of all, or substantially all,
of its assets or the sale or exchange of a majority or more of
the outstanding common stock, PCI shall be entitled to receive
10% of the consideration paid in the transaction.
B. In the event of the liquidation and dissolution of the
Company after payment of all debts and obligations senior to the
Series O Stock and any distributions required to be made to the
holders of the Series G Preferred Stock, PCI shall receive a
payment equal to 10% of the remaining assets of the Company.
20
<PAGE>
C. If neither of the events described in A or B above have
occurred by July 1, 2000, the Company and PCI will agree upon an
investment banking or appraisal firm to value the Company and PCI
shall receive an amount equal to 10% of the fair market value
appraisal. The Company must pay $250,000 at closing, any
remaining balance up to $500,000 within twelve (12) months after
closing, and if there is any remaining balance, half will be paid
within eighteen (18) months of closing and the remaining half
will be paid within twenty-four (24) months of closing. Any
balances bear interest at the rate of 8% per annum.
In the event the Company pays less than $5,000 on any monthly
payment under the $480,000 promissory note described above and
has failed to pay any remaining amount within thirty (30) days,
PCI may either accelerate all remaining payments under the note
or shall have a one time right to increase the 10% amounts
described in subparagraphs A, B and C above to 20%. Each of the
events in subparagraph A, B and C above constitute a Payment
Event and all principal and interest remaining due under the
$278,728 PCI note shall be offset against those amounts.
- The Company has entered into an Employment Agreement with Donald L.
Anderson to employ him as Vice President-Shareholder Relations until
July 1, 2000 unless the Agreement is otherwise terminated. Mr.
Anderson shall receive compensation of $6,000 per month. In the event
the employment is terminated as a result of Mr. Anderson's death or
permanent disability or because of a sale of change of control of the
Company, Mr. Anderson or his estate shall be entitled to all remaining
salary under the Agreement reduced to present value at a discount rate
equal to 8%.
- The Company has agreed to consider on a property-by-property basis,
engaging PCI to act as a finder and complete all reasonable and
necessary due diligence on future property acquisitions and to pay to
PCI a so-called Lehman formula (5-4-3-2-1) fee on all such properties
actually acquired.
OTHER TRANSACTIONS
As of February 29, 1996, the Company owed Mr. Horbach $17,129 which was the
amount remaining on a Promissory Note issued in 1992. During fiscal years 1995
and 1996, the Company paid Donald L. Anderson $27,000 and $15,100 respectively,
plus 1,190 shares of common stock in fiscal 1995 as fees for administrative
services performed in connection with private placement of the Company's
securities.
Effective January 1, 1995, Gateway Pipeline Company, ("GPC"), a subsidiary
of the Company, acquired all of the common stock of Castex Energy, Inc., a
Houston based exploration production company. Cash payments of $267,000, notes
payable totaling $243,500, 200,000 shares of Company common stock and 5,000
shares of GPC common stock were paid or issued, respectively, to the sellers who
are now executive officers and/or directors of GPC.
21
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
Exhibit 11 - Statement Regarding Computation of Per Share Earnings
Exhibit 21 - Subsidiaries
Exhibit 27 - Financial Data Schedule
(B) REPORTS ON FORM 8-K
(1) Form 8-K-Item 2, Acquisition of Assets, February 7, 1996.
(2) Form 8-K/A1-Item 2, Acquisition of Assets, April 5, 1996.
Audited Statements of Revenue and Direct Operating Expenses of
Certain Acquired Property Interests of Castex Energy 1995, L.P.
Pro Forma Balance Sheet as of November 30, 1995.
Pro Forma Statement of Operations for the Nine Months Ended
November 30, 1995.
22
<PAGE>
FINANCIAL STATEMENTS AND
REPORT OF INDEPENDENT
CERTIFIED PUBLIC ACCOUNTANTS
GATEWAY ENERGY CORPORATION
AND SUBSIDIARIES
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Gateway Energy Corporation
We have audited the accompanying consolidated balance sheets of Gateway Energy
Corporation (a Delaware corporation) and subsidiaries as of February 29, 1996
and February 28, 1995, and the related consolidated statements of operations,
stockholders' equity and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Gateway Energy
Corporation and subsidiaries as of February 29, 1996 and February 28, 1995, and
the consolidated results of their operations and their consolidated cash flows
for the years then ended in conformity with generally accepted accounting
principles.
/s/ GRANT THORNTON LLP
GRANT THORNTON LLP
Lincoln, Nebraska
June 10, 1996
F-1
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS February 29, February 28,
1996 1995
------------- -------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 1,572,549 $ 337,897
Restricted cash 148,055 258,240
Trade accounts receivable, less allowance for
doubtful accounts of $34,410 in 1996
and $16,680 in 1995 4,041,807 2,623,799
Note receivable - 150,000
Inventories 71,193 23,546
Prepaid expenses and other assets 92,441 26,415
------------ ------------
Total current assets 5,926,045 3,419,897
------------ ------------
PROPERTY AND EQUIPMENT - AT COST
Oil and gas properties, using full cost accounting 11,813,937 662,498
Gas gathering, processing and transportation 11,678,483 9,625,928
Office furniture and other equipment 435,391 158,195
------------ ------------
23,927,811 10,446,621
Less accumulated depreciation, depletion
and amortization 1,538,198 490,667
------------ ------------
22,389,613 9,955,954
------------ ------------
OTHER ASSETS
Cash escrowed for acquisitions 657,704 858,815
Note receivable - related party 278,728 168,268
Other 469,085 253,375
------------ ------------
1,405,517 1,280,458
------------ ------------
$ 29,721,175 $ 14,656,309
------------ ------------
------------ ------------
</TABLE>
F-2
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
<TABLE>
<CAPTION>
LIABILITIES February 29, February 28,
1996 1995
------------- -------------
<S> <C> <C>
CURRENT LIABILITIES
Notes payable $ 1,389,986 $ -
Note payable to officer 17,129 41,775
Current maturities of long-term debt 1,606,687 52,341
Accounts payable 3,622,402 2,161,908
Accrued expenses and other liabilities 360,453 247,899
Preferred dividends payable 225,102 205,912
------------ ------------
Total current liabilities 7,221,759 2,709,835
------------ ------------
Long-term debt, less current maturities 8,094,985 191,159
Minority interests 1,029,661 138,108
Preferred stock of subsidiary (liquidation value
of $537,500 at February 29, 1996) 470,519 -
Mandatory redeemable preferred stock (liquidation
value of $9,749,150 at February 29, 1996) 8,335,486 8,133,944
STOCKHOLDERS' EQUITY
Preferred stock (liquidation value of $7,905,000 at
February 29, 1996) 7,905 4,040
Common stock - authorized, 30,000,000 shares
of $.01 par value; issued and outstanding,
26,976,149 shares in 1996 and 25,735,781
shares in 1995 269,761 257,358
Additional paid-in capital 9,275,647 6,247,786
Accumulated deficit (4,984,548) (3,025,921)
------------ ------------
4,568,765 3,483,263
------------ ------------
$ 29,721,175 $ 14,656,309
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year ended
---------------------------
February 29, February 28,
1996 1995
------------ -------------
<S> <C> <C>
Operating revenues
Natural gas and oil sales $11,357,383 $ 7,431,703
Transportation 1,647,266 675,856
Other 152,072 -
----------- -----------
13,156,721 8,107,559
----------- -----------
Operating costs and expenses
Cost of natural gas purchased 7,113,486 4,919,655
Operation and maintenance 2,354,079 1,311,433
Depreciation, depletion and amortization 1,089,916 345,528
General and administrative 2,491,405 979,026
----------- -----------
13,048,886 7,555,642
----------- -----------
Operating profit 107,835 551,917
----------- -----------
Other income (expense)
Gain on sale of property and equipment 47,977 -
Interest income 77,939 64,593
Interest expense (285,290) (12,631)
Other expense (14,623) -
Minority interests 7,471 18,016
----------- -----------
(166,526) 69,978
----------- -----------
Earnings (loss) before income taxes (58,691) 621,895
Income taxes 34,000 46,637
----------- -----------
NET EARNINGS (LOSS) (92,691) 575,258
Provision for preferred dividends 2,323,030 1,280,920
----------- -----------
Loss applicable to common stock $(2,415,721) $ (705,662)
----------- -----------
----------- -----------
Loss per common share $ (.09) $ (.03)
----------- -----------
----------- -----------
Weighted average common shares outstanding 26,152,882 21,214,479
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEARS ENDED FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
<TABLE>
<CAPTION>
Common stock Additional
Preferred ------------------------- paid-in Accumulated
stock Shares Amount capital deficit Total
---------- ---------- ---------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at March 1, 1994 $2,963,419 17,339,740 $173,397 $2,090,291 $(2,577,001) $ 2,650,106
Issuance of stock for cash and
services (net of issuance costs
of $62,303) 684,836 4,227,041 42,271 554,204 - 1,281,311
Issuance of stock for acquisition - 200,000 2,000 48,000 - 50,000
Issuance of stock for preferred
stock of subsidiary 172,780 100,000 1,000 (1,000) - 172,780
Amortization of issue costs on
mandatory redeemable preferred
stock - - - (256,742) - (256,742)
Compensation under stock award
plans - - - 21,728 - 21,728
Preferred stock dividends - 52,000 520 12,480 (1,024,178) (1,011,178)
Preferred stock conversions and
changes in par values (3,816,995) 3,817,000 38,170 3,778,825 - -
Net earnings - - - - 575,258 575,258
---------- ---------- ---------- ---------- ----------- -----------
Balance at February 28, 1995 4,040 25,735,781 257,358 6,247,786 (3,025,921) 3,483,263
Issuance of stock for cash and
services (net of issuance costs
of $707,476) 3,902 611,650 6,116 3,319,244 - 3,329,262
Amortization of issue costs on
mandatory redeemable preferred
stock - - - (457,094) - (457,094)
Compensation under stock award
plans - - - 34,804 - 34,804
Preferred stock dividends - - - - (1,865,936) (1,865,936)
Preferred stock conversions (37) 628,718 6,287 130,907 - 137,157
Net loss - - - (92,691) (92,691)
---------- ---------- ---------- ---------- ----------- -----------
Balance at February 29, 1996 $ 7,905 26,976,149 $ 269,761 $9,275,647 $(4,984,548) $ 4,568,765
---------- ---------- ---------- ---------- ----------- -----------
---------- ---------- ---------- ---------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of this statement.
F-5
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended
---------------------------
February 29, February 28,
1996 1995
------------ -------------
<S> <C> <C>
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS
Cash flows from operating activities
Net earnings (loss) $ (92,691) $ 575,258
Adjustments to reconcile net earnings (loss) to
net cash provided by operating activities
Provision for losses on accounts receivable 26,378 17,176
Depreciation, depletion and amortization 1,089,916 345,528
Gain on sale of property and equipment (47,977) -
Amortization of deferred income (32,199) (42,932)
Compensation accrued under stock award plans 34,804 21,728
Stock issued for interest, fees and services 110,121 -
Minority interests in net losses of subsidiaries (7,471) (18,016)
Other - 9,148
Increase (decrease) in cash and cash
equivalents, net of businesses acquired,
resulting from changes in:
Trade accounts receivable (1,444,386) (1,354,866)
Inventories (47,647) (23,546)
Prepaid expenses and other current assets (66,026) 8,178
Accounts payable 969,580 814,390
Accrued expenses and other liabilities 144,753 107,920
----------- -----------
Net cash provided by operating activities 637,155 459,966
----------- -----------
Cash flows from investing activities
Capital expenditures (1,909,099) (1,352,434)
Proceeds from sale of property and equipment 228,416 -
Acquisitions of businesses, net of cash acquired
of $128,337 in 1995 (11,097,579) (6,136,839)
Advances on notes receivable (110,460) (230,782)
Payments on notes receivable 150,000 -
Other (199,710) (116,692)
----------- -----------
Net cash used in investing activities (12,938,432) (7,836,747)
----------- -----------
</TABLE>
F-6
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
<TABLE>
<CAPTION>
Year ended
---------------------------
February 29, February 28,
1996 1995
------------ -------------
<S> <C> <C>
Cash flows from financing activities
Decrease in restricted and escrowed cash $ 311,296 $ 48,232
Proceeds from borrowings 11,389,986 -
Payments on borrowings (461,000) -
Payments on note payable to officer (24,646) (30,778)
Proceeds from sale of preferred stock 3,620,865 7,936,468
Retirement of preferred stock (95,850) -
Proceeds from issuance of common stock - 188,000
Preferred dividends paid (1,876,699) (959,664)
Minority shareholder contributions 671,977 -
----------- -----------
Net cash provided by financing activities 13,535,929 7,182,258
----------- -----------
Net change in cash and cash equivalents 1,234,652 (194,523)
Cash and cash equivalents at beginning of year 337,897 532,420
----------- -----------
Cash and cash equivalents at end of year $ 1,572,549 $ 337,897
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-7
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies consistently applied in
the preparation of the accompanying consolidated financial statements
follows.
1. PRINCIPLES OF CONSOLIDATION AND NATURE OF BUSINESS
The consolidated financial statements include the accounts of Gateway
Energy Corporation ("GEC" - formerly Gateway Gathering Systems, Inc.), its
joint venture investments, its majority owned subsidiaries, Gateway
Pipeline Company ("GPC"), Fort Cobb Oklahoma Irrigation Fuel Authority
L.L.C. ("Fort Cobb"), Shoreham Gathering Company ("SGC" - newly formed in
fiscal 1996), Castex Energy, Inc. ("CEI" - formerly a wholly-owned
subsidiary of GPC - see below), Castex Energy 1995, L.P. ("Castex LP" -
newly formed in fiscal 1996 - see below) and wholly-owned Ozark Natural Gas
Company ("Ozark" - acquired in 1996), all collectively referred to as
the "Company". The Company's investments in its joint ventures are
accounted for using the proportional consolidation method. All significant
intercompany transactions have been eliminated in consolidation.
In December 1995, GPC distributed 100% of its wholly-owned subsidiary, CEI,
to its shareholders. Concurrently, CEI formed a new limited partnership,
Castex LP, which is 5% owned by CEI and 66% owned by GEC, with the
remaining minority interests owned by certain officers of CEI and other
individuals. Castex LP was formed for the purpose of acquiring ownership
interests in oil and gas producing properties located in the South Lake
Arthur field. CEI also issued additional shares to certain of its officers
for services associated with the acquisition effective February 29, 1996.
As a result of the GPC distribution and issuance of additional shares of
CEI, GEC's ownership of CEI was reduced to 60% at March 1, 1996.
The Company purchases, develops, owns, and operates natural gas gathering
pipeline systems and processing plants and related facilities in the Gulf
Coast and Southwestern states of Texas, New Mexico, Oklahoma and Louisiana,
both internally and through joint ventures with industry partners. In
addition, the Company operates a local natural gas distribution company in
Oklahoma and conducts oil and gas exploration and production activities,
primarily in Louisiana.
F-8
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
2. PROPERTY AND EQUIPMENT
The Company accounts for its investment in oil and gas producing activities
using the full cost method of accounting. Under this method of accounting,
all costs, including indirect costs related to exploration and development
activities, are capitalized as oil and gas property costs. These costs,
and estimated future development costs, are accumulated in a single cost
center and are amortized on an equivalent unit-of-production basis using
total estimated proved oil and gas reserves. No gains or losses are
recognized on the sale or disposition of oil and gas reserves, except for
sales which include a significant portion of the total remaining reserves.
Property and equipment, other than oil and gas properties, are stated at
cost, including capitalization of interest cost on funds used to finance
major pipeline projects during their construction period. Additions and
improvements that add to the productive capacity or extend the useful life
of the asset are capitalized. Expenditures for maintenance and repairs are
charged to expense as incurred. Depreciation is provided using the
straight-line method over estimated useful lives of 15 to 30 years for
pipeline systems, gas plant and processing equipment and over 2 to 10 years
for office furniture and other equipment. Upon disposition or retirement
of pipeline components or gas plant components, any gain or loss is charged
or credited to accumulated depreciation. When entire pipeline systems, gas
plants or other property and equipment are retired or sold, any gain or
loss is credited to or charged against operations.
In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND
FOR LONG-LIVED ASSETS TO BE DISPOSED OF, which requires impairment losses
to be recognized for long-lived assets used in operations when indicators
of impairment are present and the undiscounted cash flows are not
sufficient to recover the assets' carrying value. The amount of impairment
is measured by comparing the fair value of the asset to its carrying
amount. The Company has elected early adoption of Statement No. 121 and,
based on presently available estimates and current circumstances, has
determined that no impairment loss should be recognized at February 29,
1996.
F-9
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
3. CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid debt instruments purchased with original
maturities of three months or less to be cash equivalents.
4. INCOME TAXES
Deferred tax assets and liabilities are recognized for the expected future
tax consequences of events that have been included in the financial
statements or income tax returns. Under this method, deferred tax assets
and liabilities are determined based on the difference between the
financial statement and tax bases of assets and liabilities as measured by
the enacted tax rates in effect when these differences reverse. Deferred
tax assets are reduced by a valuation allowance when it is more likely than
not that they will not be realized. Deferred tax expense is the result of
changes in deferred tax assets and liabilities.
5. GAS BALANCING
The Company uses the sales (cash) method of accounting for gas imbalances.
Under the sales method the Company recognizes revenue on the amount of gas
sold to purchasers, which may differ from the amount the Company is
entitled based on its working interest. A liability is recognized for
overproduction only when the estimated reserves on a property are not
sufficient to repay the overproduction quantities "in-kind". Gas
imbalances at February 29, 1996 are as follows:
<TABLE>
<CAPTION>
MCF Amount
--- ------
<S> <C> <C>
Total overproduction 119,116 $ 220,365
Total underproduction (151,274) (279,857)
---------- ----------
Total net underproduction (32,158) $ (59,492)
---------- ----------
---------- ----------
</TABLE>
F-10
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
6. EARNINGS PER COMMON SHARE
Earnings per common share are based upon the average number of shares
outstanding during each period after giving effect to dividend requirements
of the various preferred stock issues and shares issuable upon exercise of
outstanding stock options and warrants in periods in which such options and
warrants have a dilutive effect. The fully diluted per share computation
reflects the effect of common shares issuable upon the conversion of
preferred stock in periods in which such exercise would cause dilution.
For 1996 and 1995, the loss per common share, assuming full dilution, is
considered to be the same as primary since the effect of the common stock
equivalents and other potentially dilutive securities would be
antidilutive.
7. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
NOTE B - LIQUIDITY CONSIDERATIONS
The Company is highly leveraged, with approximately $17,800,000 in long-
term debt and mandatory redeemable preferred stocks outstanding at February
29, 1996. Also, other cumulative preferred stock with a liquidation value
of $7,905,000 is issued and outstanding. Certain of these instruments
carry high interest or dividend rates, large debt issue costs, and obligate
a percentage of the future net profits to the lenders. In addition, as
reflected in the accompanying financial statements, the Company is in a
deficit working capital position of $1,295,714 at February 29, 1996 and has
realized losses applicable to common stock of $2,415,721 and $705,662 for
the years ended February 29, 1996 and February 28, 1995, respectively. To
meet its liquidity requirements and attain profitable operations, the
Company must restructure its debt obligations.
Prospectively, the Company anticipates that cash flows from operating
activities after meeting debt service requirements related to long-term
debt will not be sufficient to fund all its preferred stock dividend
requirements. The Company is currently evaluating its alternatives
which include the issuance of additional common equity, the reduction of
preferred stock dividends through conversion of a portion of the
preferred stock, sale of operating properties, refinancing or extending
the maturity dates of the acquisition line of credit and bridge loans,
and improving the operating performance of its systems and properties.
The Company believes a combination of the above alternatives will enable
the Company to meet its preferred dividend requirements. Alternatively,
the Company has the option to suspend the payment of dividends on all
series of preferred stock, except Series G, without default.
F-11
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE C - ACQUISITIONS
All acquisitions have been accounted for as purchases; operations of the
companies and businesses acquired have been included in the accompanying
consolidated financial statements from their respective dates of
acquisition.
Effective January 1996, Castex LP acquired numerous oil and gas producing
interests for approximately $9,500,000 and assumed certain liabilities of
approximately $500,000. The purchase was financed with proceeds from the
credit facility described in Note G. The acquisition cost was equal to the
fair value of the net assets acquired.
In January 1996, GPC acquired all the outstanding shares of Ozark for
$30,000. Ozark owns natural gas franchises for the cities of Branson and
Hollister, Missouri. Additional contingent consideration of $70,000 will
be paid upon successful financing of planned development of natural gas
transmission and distribution systems in the franchise areas.
On December 15, 1995, SGC acquired eight separate offshore gathering
systems. The systems were purchased for cash of $753,000 and consist of
approximately 49 miles of pipeline. Six of the eight systems are inactive
but are located in areas where there is considerable lease and drilling
activity.
Effective June 30, 1995, GPC acquired a 15 mile pipeline. The purchase
price of $795,000 was financed with proceeds from the Series N preferred
stock and short-term bank financing which has subsequently been repaid.
During the year ended February 28, 1995, the Company entered into various
purchase agreements with individuals or with entities owned or partially
owned or controlled by individuals who, as a result of the agreements,
became officers and partial owners of GPC, as follows:
1) Effective April 15, 1994, the Company entered into a joint venture
agreement to acquire an 80% interest in a gas gathering system in
Ellis County, Texas. GPC acquired the remaining 20% interest in the
system effective January 1, 1995. Such interests were acquired for
$1,090,000 in cash. In addition, the Company will be required to pay
up to an additional $523,000 over the next ten years, assuming
specified cumulative levels of net revenues from the acquired
properties are attained. No asset, liability or expense has been
recorded for such contingent consideration as the specified net
revenue levels are not currently being attained.
F-12
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE C - ACQUISITIONS - CONTINUED
2) Effective January 1, 1995, GPC purchased all the common stock of
Castex Energy, Inc., a Houston based exploration and production
company. The purchase price of approximately $510,500 included cash
payments of approximately $267,000 and notes payable of $243,500.
3) Effective February 28, 1995, the Company acquired 49% of the common
stock of Eclipse Energy, Inc., a company which will market natural gas
on the West Coast, Texas and Louisiana, for cash of $75,000.
In addition to the above, 200,000 shares of the Company's common stock and
20% of GPC's common stock were issued to the sellers at a recorded value of
approximately $182,000. Cost in excess of the fair value of the net assets
acquired of approximately $92,000 will be amortized on the straight-line
method over 15 years.
The sellers' 20% interest in GPC must be reacquired by the Company at
appraised value no later than February 28, 2000. The sellers can require
the Company to reacquire their stock in GPC any time after February 29,
1996 and the Company can elect to reacquire the stock in GPC any time after
February 28, 1997, both at appraised value. At the election of the
sellers, payment may be made in cash or common stock of the Company.
Effective November 1, 1994, the Company acquired substantially all the
assets of Fort Cobb Irrigation Fuel Authority, a local natural gas
distribution company in Caddo County, Oklahoma for approximately $2,660,000
in cash. Concurrent with the acquisition, the Company entered into two
joint ventures to market and transport natural gas and acquire natural gas
pipeline and gathering systems.
During the year ended February 28, 1995, the Company acquired seven
natural gas gathering systems through newly formed joint
ventures. Total cash payments of approximately $2,430,000 were made for
the Company's investments in such systems.
F-13
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE C - ACQUISITIONS - CONTINUED
The following unaudited pro forma consolidated results of operations assume
all purchases occurred at the beginning of 1995, as follows:
<TABLE>
<CAPTION>
Year ended
---------------------------
February 29, February 28,
1996 1995
------------ -------------
<S> <C> <C>
Revenues $16,490,000 $16,090,000
Net earnings 134,000 1,062,000
Loss applicable to common stock (2,299,000) (418,000)
Loss per common share (.09) (.02)
</TABLE>
NOTE D - OIL AND GAS OPERATIONS
Capitalized costs related to the Company's oil and gas producing activities
and the related amounts of accumulated depreciation, depletion and
amortization at February 29, 1996 are shown below:
<TABLE>
<CAPTION>
<S> <C>
Proved properties $11,731,474
Unproved properties 82,463
-----------
11,813,937
Accumulated depreciation, depletion and amortization (413,000)
-----------
Net property costs $11,400,937
-----------
-----------
</TABLE>
The following reflects the costs incurred during 1996 in oil and gas
producing activities:
<TABLE>
<CAPTION>
<S> <C>
Property acquisition costs:
Proved $10,221,489
Unproved 82,463
Exploration and development costs 847,487
-----------
$11,151,439
-----------
-----------
</TABLE>
The following table includes revenues and expenses associated directly with
the Company's oil and gas producing activities. It does not include any
allocation of the Company's interest costs or general corporate overhead
and, therefore, is not necessarily indicative of the contribution to
F-14
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE D - OIL AND GAS OPERATIONS - CONTINUED
net earnings of the Company's oil and gas operations. Income tax expense
has been calculated by applying statutory income tax rates to oil and gas
sales after deducting costs, including depreciation, depletion and
amortization and after giving effect to permanent differences. Prior year
information is not presented as oil and gas producing activities were not
significant.
<TABLE>
<CAPTION>
Year ended
February 29, 1996
-----------------
<S> <C>
Oil and gas sales $1,051,674
Production and operating expenses (181,789)
Depreciation, depletion and amortization (414,741)
Income tax expense (155,000)
----------
Results of operations for oil and gas producing
activities $ 300,144
----------
----------
</TABLE>
NOTE E - JOINT VENTURE OPERATIONS
The Company participates in 20 joint ventures, 18 of which are natural gas
gathering or delivery systems, one of which is a natural gas processing
plant and one of which conducts natural gas marketing activities. All but
two of the joint ventures are operated by the Company's joint venture
partners. Management fees to the joint venture partners are a base fee
plus a percentage of qualifying expenditures or a percentage of net
operating income, as defined. The joint venture agreements contain
provisions for increased income participation by the Company until
specified payout levels are attained. The agreements have terms of one to
ten years, with provision for earlier termination, along with buy-sell
agreements in the event of termination. Fees paid to the joint venture
partners were approximately $237,000 in 1996 and $138,000 in 1995.
NOTE F - NOTES PAYABLE
Notes payable consist of the following at February 29, 1996:
<TABLE>
<CAPTION>
<S> <C>
Acquisition line of credit $ 575,000
Operating line of credit 29,986
Bridge loans 785,000
----------
$1,389,986
----------
----------
</TABLE>
F-15
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE F - NOTES PAYABLE - CONTINUED
ACQUISITION LINE OF CREDIT
On December 15, 1995, the Company entered into a revolving line of credit
agreement with a bank with maximum available borrowings of $750,000.
Interest is payable monthly at 2.5% above the bank's base rate (the
effective rate was 10.75% at February 29, 1996). All outstanding principal
is due October 31, 1996. Interests in certain of the Company's joint
venture properties and all deposit and escrow accounts at the bank
collateralize the line.
OPERATING LINE OF CREDIT
On July 15, 1995, Fort Cobb entered into a revolving line of credit with a
bank with maximum available borrowings of $40,000. Interest is payable
quarterly at 1.25% above the New York Prime rate (the effective rate was
9.75% at February 29, 1996) beginning October 1, 1995. All outstanding
principal is due July 15, 1996. The line is collateralized by
substantially all Fort Cobb assets and is guaranteed by the Company and the
remaining 1% owner of Fort Cobb.
BRIDGE LOANS
On September 28, 1995, the Company issued a promissory note due December
28, 1995, for $235,000 in cash. The proceeds were used for working capital
purposes due to delays in collecting funds from a customer. The note was
extended to March 28, 1996. The note bears interest at 11% per annum which
may, at the option of the holder, be paid with common stock of the Company
at $.25 per share. As part of the commitment to the holder for the initial
and extension terms, the Company issued 50,000 shares of restricted common
stock and warrants to purchase an additional 150,000 shares at $.25 per
share. The balance outstanding at February 29, 1996 was $135,000 and was
reduced to $35,000 in May 1996.
On November 30, 1995, the Company issued promissory notes due February 28,
1996 for a total of $650,000 in cash. The proceeds from the notes were
used to acquire the Company's interest in the South Lake Arthur properties
and are intended to be repaid from the proceeds of Series P Preferred
Stock. The notes have been extended to May 28, 1996. The notes bear
interest at 11% per annum which may, at the option of the holders, be paid
with common stock of the Company at $.35 per share. As part of the
commitment to the holders for the initial and extension terms, the Company
issued 150,000 shares of common stock and warrants to purchase 331,500
shares of common stock at $.35 per share. The notes are collateralized by
the properties acquired.
F-16
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE G - LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
February 29, February 28,
1996 1995
------------ ------------
<S> <C> <C>
Bank credit agreement $9,500,000 $ -
Notes payable to directors and officers 201,672 243,500
------------ ------------
9,701,672 243,500
Less current maturities 1,606,687 52,341
------------ ------------
$8,094,985 $191,159
------------ ------------
------------ ------------
</TABLE>
BANK CREDIT AGREEMENT
In January 1996, the Company entered into a bank credit agreement which
provides for commitments totaling $15,000,000 to finance the acquisition
and development of certain oil and gas producing properties and other
properties in Louisiana and Texas. The first $10,000,000 of commitments is
available through December 31, 1996. The remaining $5,000,000 of
commitments is available through January 24, 1997. Commitment availability
is reduced by amounts borrowed and can be further reduced by the Company
and the bank under certain circumstances as defined in the agreement. A
commitment fee of 0.125% per annum on the average commitment availability
is payable quarterly.
Borrowings under the bank credit agreement have a final stated maturity
date of January 24, 2001 but can be retired earlier. Principal and
interest payments are made monthly. Borrowings bear interest primarily at
floating interest rates based on the higher of the bank's base rate or the
Federal Funds Rate plus 0.25% (the effective rate was 7.375% at February
29, 1996). Provisions in the bank credit agreement also require up front
closing fees of $250,000, annual engineering fees of $25,000, the use of
interest rate swaps and production price hedges and the assignment of a
permanent overriding royalty interest ("ORRI") initially equivalent to a
6.5% interest in certain oil and gas producing properties acquired with the
loan proceeds. The bank agreement provides for a reduction of the ORRI to
2% when the payments of principal, interest, fees, interest rate hedges and
the 6.5% ORRI produce an internal rate of return to the bank of 13% on
amounts borrowed and payments made under the ORRI exceed $500,000. As a
result of these provisions, the value of the ORRI will be amortized using
the interest method and included in interest expense.
F-17
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE G - LONG-TERM DEBT - CONTINUED
BANK CREDIT AGREEMENT - CONTINUED
The bank credit agreement contains covenants which require that Castex LP
maintain defined levels of tangible net worth, cash equivalents, current
assets to current liabilities, debt to capitalization, and interest
coverage. The covenants also limit, among other things, the subsidiary's
ability to sell or acquire oil and gas interests, incur additional
indebtedness, make investments or pay dividends or distributions.
Borrowings under this bank credit agreement are collateralized by the
properties acquired and developed. At February 29, 1996, Castex LP was in
compliance with such covenants.
NOTES PAYABLE TO DIRECTORS AND OFFICERS
Notes payable to officers and directors of one of the Company's
subsidiaries were incurred as part of the 1995 acquisition of CEI and for
the purchase of office equipment. The notes bear interest at 15% and are
payable in monthly installments of principal and interest through December
1998. The notes are collateralized by the properties acquired. Principal
and interest payments are subject to adequate cash flows being realized
from the properties acquired. Should cash flows not be sufficient, any
remaining obligations at February 28, 1999 will be forgiven. As all such
payments are expected to be made, such notes have been included as
liabilities in the consolidated financial statements.
Aggregate future maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
<S> <C>
1997 $1,606,687
1998 2,231,653
1999 2,223,332
2000 2,160,000
2001 1,480,000
----------
$9,701,672
----------
----------
</TABLE>
NOTE H - SPONSORSHIP AGREEMENTS
The Company has agreements with a related company, Pipeline Capital, Inc.
("PCI"), whereby PCI attempts to raise funds for the Company through
private placements and public offerings of the Company's securities. PCI
is to receive 40,000 shares of restricted common stock for each $1,000,000
of funds raised under private placements or public offerings, up to a
maximum of 2,000,000 shares, with provisions for increasing such maximum
should additional offerings be consummated. The agreements also provide
for an "Exit Amount" due PCI of a 10% cumulative participation in the net
operating income, as defined, from the
F-18
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE H - SPONSORSHIP AGREEMENTS - CONTINUED
properties acquired with funds raised by PCI and a residual interest in the
acquired properties based on a buyout formula between five to seven years
from the inception of the various joint venture programs. Series C
preferred stock was issued to PCI to evidence the residual interest.
Payments due under the above agreement are reduced by cumulative prior cash
payments and stock issued to PCI. No liability was recorded at February
29, 1996 or February 28, 1995 as payments and stock issued to PCI exceeded
amounts due under the above agreement.
Over the past year, disagreements had arisen between the Company and PCI as
to the proper method of determining the fair market value of the Company's
properties for purposes of determining the Exit Amount. The agreement,
its various amendments and other correspondence and documents between the
parties provided a basis for widely varying interpretations of how to
calculate the Exit Amount. PCI's position was that the Exit Amount was
equal to the greater of 50% of the fair market value of the properties
less any indebtedness against the properties, or the total of the
commissions, finder's fees, expense advances and common stock paid to PCI.
The position of the Company was that the Exit Amount was based upon the
after-tax proceeds upon a sale, or assumed sale, of the properties,
reduced by all commissions, finder's fees, expense advances and the value
of any common stock received by PCI during the term of the agreement.
Further, concerns had also arisen about the continued involvement of PCI
in obtaining capital and securing properties in light of changes in the
Company's operations.
As a result of the ongoing disagreements, the Company and PCI determined
to terminate all prior agreements and the parties entered into a
Settlement and Purchase Agreement effective May 6, 1996. The Settlement
and Purchase Agreement provided for the following:
- The Company repurchased the 56.25 shares of Series C Preferred Stock
owned by PCI, representing its right to receive the Exit Amount and
the 10% interest in defined net operating cash flows for $480,000
represented by a promissory note requiring payments of $10,000 per
month commencing July 1, 1996 and ending June 1, 2000. The Company
may, at its option, prepay all of the note at a discount rate of 8%.
- PCI executed a new promissory note in the amount of $278,728 plus
interest at 7% per annum representing all advances to PCI to date.
All principal and interest on this note will be offset against the
amounts which are payable to PCI upon a "Payment Event" under the
Series O Preferred Stock, described below.
F-19
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE H - SPONSORSHIP AGREEMENTS - CONTINUED
- The Company issued to PCI one share of its Series O Preferred Stock
which is non-voting and has no dividend rights. Upon the following
described events, payments will be made to PCI as described below:
1) In the event of the merger of the Company where it is not the
surviving corporation, the sale of all, or substantially all,
of its assets or the sale or exchange of a majority or more
of the outstanding common stock, PCI shall be entitled to
receive 10% of the consideration realized in the transaction.
2) In the event of the liquidation and dissolution of the
Company after payment of all debts and obligations senior to
the Series O Stock and any distributions required to be made
to the holders of the Series G Preferred Stock, PCI shall
receive a payment equal to 10% of the remaining assets of
the Company.
3) If neither of the events described in (1) or (2) above have
occurred by July 1, 2000, the Company and PCI will agree upon
an investment banking or appraisal firm to value the Company
and PCI shall receive an amount equal to 10% of the fair
market value appraisal. The Company must pay $250,000 at
closing, any remaining balance up to $500,000 within 12 months
after closing, and if there is any remaining balance, half
will be paid within 24 months of closing. Any balances bear
interest at the rate of 8% per annum.
In the event the Company pays less than $5,000 on any monthly
payment under the $480,000 promissory note described above and
has failed to pay any remaining amount within 30 days, PCI may
either accelerate all remaining payments under the note or
shall have a one time right to increase the 10% amounts
described in subparagraphs (1) through (3) above to 20%. Each
of the events in subparagraphs (1) through (3) above
constitute a Payment Event and all principal and interest
remaining due under the $278,728 PCI note shall be offset
against those amounts.
- The Company has agreed to consider on a property-by-property basis,
engaging PCI to act as a finder and complete all reasonable and
necessary due diligence on future property acquisitions and to pay
fees based on a formula for all such properties actually acquired.
As a result of this settlement, during the first quarter of fiscal 1997,
the Company will record a charge to earnings of approximately $700,000.
No external appraisal of the Company has been performed; therefore, it
is possible that the Company's estimate of the value of the Series O
preferred stock will change. Prospectively, the Company will adjust
the Series O preferred stock value through periodic charges to earnings
for future changes in the estimated fair value of Company.
NOTE I - PREFERRED STOCK OF SUBSIDIARY COMPANY
During the year ended February 29, 1996, the Company's subsidiary, GPC,
authorized 750 shares and issued 537.5 shares of Series A 10% cumulative
participating convertible preferred stock, $1,000 stated value per share,
par value $.01. The recorded amount at February 29, 1996 was net of issue
costs of $66,981. Dividends accrue at the 10% minimum rate, plus a
participating rate of 3% based upon an earnings return to GPC from certain
natural gas properties over a base threshold return of 25% of total funds
invested. Upon exceeding the annual 25% return, the participating dividend
shall be increased on a percent-by-percent pro-rata basis over the 25%
threshold up to a total of 3% participation for a total return of 13%.
Holders of the preferred stock have the right, commencing on the second
anniversary from the date of issuance of the shares, to convert any or all
shares into the number of shares of common stock of GEC determined by
dividing $1,000 plus any accrued and unpaid dividends
F-20
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE I - PREFERRED STOCK OF SUBSIDIARY COMPANY - CONTINUED
for each preferred share to be converted by the then effective conversion
price. The conversion price is equal to 90% of the average bid price of
the common stock determined from the price reports of the market on which
the Company's common stock is then trading for the ninety days previous to
the date the preferred stock is surrendered for conversion. The conversion
privileges expire five years from the date of issuance.
The Company has the option at any time after the second anniversary of the
dates of issuance to redeem such shares at the redemption price of $1,000
per share plus any accrued and unpaid dividends. The Company, also at its
option after the second anniversary of the dates of issuance, may call for
mandatory conversion to GEC common stock, if the preferred shareholder has
received cumulative 13% average annual dividend payments for such periods.
The conversion price is equal to 85% of the average bid price of the common
stock determined from the price reports of the market on which the
Company's common stock is then trading for the ninety days previous to the
date the preferred stock is called for conversion. The stock has a
liquidation preference to common and junior stock of GPC equal to the
stated value of $1,000 per share plus any accrued and unpaid dividends.
NOTE J - MANDATORY REDEEMABLE PREFERRED STOCK
Redeemable preferred stock was as follows:
<TABLE>
<CAPTION>
February 29, February 28,
1996 1995
------------ ------------
<S> <C> <C>
Series C
Authorized, 1,000 shares; issued, 56.25 shares $ 562 $ 562
Series G
Authorized, 10,000 shares; issued, 9,749.15
shares in 1996 and 10,000 shares in 1995, net
of unamortized issue costs of $1,414,226 in
1996 and $1,866,618 in 1995 8,334,924 8,133,382
---------- ----------
$8,335,486 $8,133,944
---------- ----------
---------- ----------
</TABLE>
F-21
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE J - MANDATORY REDEEMABLE PREFERRED STOCK - CONTINUED
1. SERIES C NONVOTING PREFERRED STOCK
Series C redeemable preferred stock has a stated value of $1,000 per share
and was issued to PCI in exchange for services and to reflect PCI's
residual interest in various gas properties acquired. The stock was issued
to this related entity pursuant to the sponsorship agreements discussed in
Note H and was recorded at the estimated value of the services rendered.
The stock has been designated as $1 par value, contingent, cumulative,
convertible junior preferred stock. The annual dividend rate is $500 per
share, with quarterly dividend periods to commence one day following the
date all holders of senior issues of preferred stock have received
cumulative dividends of $1,000 per share. The shares are redeemable at the
option of the holder on the fifth anniversary date of issuance at a
specified redemption rate based on a formula price related to 50% of the
then fair market value (as defined) of gas properties of the joint ventures
reduced by applicable income taxes. Payments due under the above formula
are reduced by cumulative prior cash payments and stock issued to PCI. The
recorded value of the Series C stock will be increased by periodic charges
to earnings sufficient to reflect the estimated redemption value of the
stock. No additional increase of the stock over its original recorded
amount was required during 1996 or 1995 as payments and stock issued to PCI
exceeded the estimated redemption value of the stock. If the holder does
not exercise its redemption rights, the Company must redeem the shares on
the seventh anniversary date under the same redemption formula. Series C
shares, subject to certain defined conditions relating to accumulated
earnings or the passage of time, are convertible into common stock at a
conversion rate of 2,500 shares of common stock for each share of Series C
preferred stock.
The stock has a liquidation preference to common stock equal to 50% of the
gas properties described above, up to $1,000 per share plus any accrued and
unpaid dividends. The stock also has a preference to common stock as to
distributions in the event of the sale of the gas properties described
above based on a defined formula price. The above preferences are junior
to required distributions to or redemptions of other preferred stock
issues.
As more fully described in Note H, the Company and PCI entered into a new
agreement in May 1996 which terminates the sponsorship agreements and
redeems the above preferred stock.
F-22
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE J - MANDATORY REDEEMABLE PREFERRED STOCK - CONTINUED
2. SERIES G NONVOTING PREFERRED STOCK
Series G preferred stock, issued February 1994 through February 1995, is
designated as $1 par value, 12% secured cumulative convertible preferred
stock, $1,000 stated value per share, with dividends payable at $10 per
share per month from funds derived solely from revenue distributions from
properties acquired with the proceeds of the Series G offering. Holders of
the Series G preferred stock have the right, commencing on the second
anniversary from the date of issuance of the shares, to convert any or all
shares into the number of shares of common stock of the Company determined
by dividing $1,000 plus any accrued and unpaid dividends for each preferred
share to be converted by the then effective conversion price. The
conversion price is equal to 70 percent of the average bid price of the
common stock determined from the price reports of the market on which the
Company's common stock is then trading for the ninety days previous to the
date the Series G preferred stock is surrendered for conversion.
The shares are redeemable at the option of the holders on the second and
third anniversaries following the dates of issuance of the shares, subject
to limitations on maximum aggregate stock redemptions, at the redemption
price of $1,000 per share plus any accrued and unpaid dividends. The
Company has the option at any time after the second anniversary of the
dates of issuance to redeem such shares at the above redemption price and
must redeem such shares at such price by the fourth anniversary of issuance
unless prior notice of extension is given by the Company. The extended
redemption period provides for an increase in the redemption price of $50
per share per year plus any additional accrued and unpaid dividends. All
Series G stock must be redeemed or converted no later than six years after
issuance. Redemption of Series G preferred stock shall be funded from
operating revenue distributions and any sales proceeds from properties
acquired with the Series G offering proceeds. The stock also has a
liquidation preference to common and junior preferred stock equal to the
stated value of $1,000 per share plus any accrued and unpaid dividends.
The Series G preferred stock is collateralized by properties and joint
venture interests which are purchased with the proceeds from the Series G
offering. A bank serving as an independent trustee (the "Trustee") holds a
first security interest in those properties in favor of the holders of
Series G preferred stock. The Trustee is empowered to liquidate or sell
properties in the event that dividends are not paid or the stock is not
redeemed as required.
F-23
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE J - MANDATORY REDEEMABLE PREFERRED STOCK - CONTINUED
2. SERIES G NONVOTING PREFERRED STOCK - CONTINUED
The Company shall, to the extent operating revenues from the properties
permit, deposit with the Trustee amounts on each anniversary date which, in
the aggregate, will be sufficient to redeem the preferred stock on the
fourth anniversary date from the date of issuance at $1,000 per share. At
February 29, 1996 restricted cash of $37,587 is designated for future
redemptions.
Issue costs are being amortized to the initial mandatory date and are
reflected as preferred dividends in the accompanying statements of
operations using the interest method. The provisions for preferred
dividends include $457,094 and $256,742 of such amortization in 1996 and
1995, respectively. Maximum redemption requirements at February 29, 1996,
are as follows:
1997 $1,500,000
1998 2,175,950
1999 6,073,200
The Company, as part of the terms of the Series G preferred stock issuance,
maintained unused funds from the offering in a trust account to be used
only for property acquisitions and operations. These funds were fully
expended during the year ended February 29, 1996. In addition, a separate
trust account is maintained for future Series G dividend payments. The
balances in the dividend payment trust account were $98,914 at February 29,
1996 and $258,240 at February 28, 1995 and are reflected as part of
restricted cash included in current assets.
NOTE K - PREFERRED STOCK
Preferred stock was as follows at:
<TABLE>
<CAPTION>
February 29, February 28,
1996 1995
------------ ------------
<S> <C> <C>
Series B
Authorized, 4,000 shares; issued, 1,750
shares in 1996 and 1,787.5 shares in
1995 $1,750 $1,787
Series J
Authorized, 750 shares; issued, 747.5
shares 748 748
</TABLE>
F-24
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE K - PREFERRED STOCK - CONTINUED
<TABLE>
<CAPTION>
February 29, February 28,
1996 1995
------------ ------------
<S> <C> <C>
Series K
Authorized and issued, 750 shares $ 750 $ 750
Series L
Authorized and issued, 255 shares 255 255
Series M
Authorized and issued, 500 shares 500 500
Series N
Authorized, 21,000 shares; issued, 3,902
shares in 1996 3,902 -
------ ------
$7,905 $4,040
------ ------
------ ------
</TABLE>
1. SERIES B NONVOTING PREFERRED STOCK
Series B preferred stock, issued August 1992 through October 1993,
is designated as $1 par value, $1,000 stated value, 12% cumulative
convertible preferred stock, with dividends payable quarterly.
As part of a redesignation and amendment process in 1995, Series B
stockholders received 715,000 shares of restricted common stock of the
Company. Holders of the Series B preferred stock have the right,
commencing on the second anniversary from the date of issuance of the
shares, to convert any or all shares into the number of shares of common
stock of the Company determined by dividing $1,000 for each preferred share
to be converted by the then effective conversion price. The conversion
price is equal to 89% of the average bid price of the common stock
determined from the price reports of the market on which the Company's
common stock is then trading for the ninety days previous to the date the
preferred stock is surrendered for conversion. Such conversion privileges
expire five years from the date of issuance.
The Company has the option at any time after the fourth anniversary of the
date of issuance to redeem such shares at the redemption price of $1,000
per share plus any accrued and unpaid dividends. The stock has a
liquidation preference to common and junior preferred stock equal to the
stated value of $1,000 per share plus any accrued and unpaid dividends.
F-25
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE K - PREFERRED STOCK - CONTINUED
2. SERIES D, E, F AND H NONVOTING PREFERRED STOCK
During 1995, all Series D, E and F preferred stock was exchanged for Series
M, K and L, respectively, of the Company's preferred stock. As part of the
exchange process, Series D, E and F stockholders received a total of
200,000 shares, 200,000 shares and 102,000 shares, respectively, of
restricted common stock of the Company. Also during 1995, all Series H
preferred stock was exchanged for 2,600,000 shares of restricted common
stock.
3. SERIES J NONVOTING PREFERRED STOCK
Series J preferred stock, issued August 1994 through November 1994,
is designated as $1 par value, $1,000 stated value, 10% cumulative
convertible preferred stock, with dividends payable quarterly. Dividends
accrue at the 10% minimum rate plus a participating rate of up to 5% based
on the Company's share of earnings (as defined) from specified joint
venture properties. Holders of the preferred stock have the right,
commencing on the second anniversary from the date of issuance
of the shares, to convert any or all shares into the number of shares of
common stock of the Company determined by dividing $1,000 for each
preferred share to be converted by the then effective conversion price.
The conversion price is equal to 90% of the average bid price of the common
stock determined from the price reports of the market on which the
Company's common stock is then trading for the ninety days previous to the
date the preferred stock is surrendered for conversion. Such conversion
privileges expire five years from the date of issuance.
The Company has the option at any time after the fourth anniversary of the
date of issuance to redeem such shares at the redemption price of $1,000
per share plus accrued and unpaid dividends. In addition, the Company also
has the option after the second anniversary of the date of issuance to
redeem such shares by issuing the number of shares of common stock of the
Company determined by dividing $1,000 plus any accrued and unpaid dividends
for each preferred share to be redeemed by the then effective conversion
price. The conversion price is equal to 85% of the average bid price of
the common stock determined from the price reports of the market on which
the Company's common stock is then trading for the ninety days previous to
the date the preferred stock is redeemed. This redemption option is
available to the Company only if the Series J preferred stockholders have
previously received 15% cumulative annual preferred dividends. The stock
has a liquidation preference to common and junior preferred stock equal to
the stated value of $1,000 per share plus any accrued and unpaid dividends.
F-26
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE K - PREFERRED STOCK - CONTINUED
4. SERIES K, L AND M PREFERRED STOCK
Series K, L and M preferred stock, issued October 1993 through November
1994, is designated as $1 par value, $1,000 stated value, 12% cumulative
convertible preferred stock, with dividends payable quarterly. Holders
of the preferred stock have the right, commencing on the second anniversary
from the dates of issuance of the shares, to convert any or all shares
into the number of shares of common stock of the Company determined by
dividing $1,000 plus any accrued and unpaid dividends for each preferred
share to be converted by the then effective conversion price. The
conversion price is equal to 88% of the average bid price of the common
stock determined from the price reports of the market on which the
Company's common stock is then trading for the ninety days previous to
the date the Series K or L preferred stock is surrendered for conversion,
with the Series M preferred stock containing an 89% conversion ratio.
Series K conversion privileges expire five years from the date of issuance.
The Company has the option at any time after the fourth anniversary of the
dates of issuance to redeem such shares at the redemption price of $1,000
per share plus any accrued and unpaid dividends. The stock has a
liquidation preference to common and junior preferred stock equal to the
stated value of $1,000 per share plus any accrued and unpaid dividends.
5. SERIES N PREFERRED STOCK
Series N preferred stock, issued March 1995 through May 1996, is designated
as $1 par value, 12% cumulative convertible preferred stock with dividends
payable monthly. Holders of the preferred stock have the right, commencing
on the second anniversary from the date of issuance of the shares, to
convert any or all shares into the number of shares of common stock of the
Company determined by dividing $1,000 plus any accrued and unpaid dividends
for each preferred share to be converted by the then effective conversion
price. The conversion price is equal to a percentage of the average bid
price of the common stock determined from the price reports of the market
on which the Company's common stock is then trading for the ninety days
previous to the date the preferred stock is surrendered for conversion.
Such percentage is 80% for the first $5,000,000 of preferred stock sold,
82% for the second $5,000,000 sold, 83% for the third $5,000,000 sold and
85% for any additional preferred stock sold.
F-27
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE K - PREFERRED STOCK - CONTINUED
5. SERIES N PREFERRED STOCK - CONTINUED
The Company has the option at any time after the second anniversary of the
dates of issuance to redeem such shares. Should the Company elect
redemption, preferred stockholders may elect to receive a redemption price
of $1,000 per share plus any accrued and unpaid dividends or receive common
stock under the conversion formula described above. The stock has a
liquidation preference to common and junior preferred stock equal to the
stated value of $1,000 per share plus any accrued and unpaid dividends.
At February 29, 1996, restricted cash includes $11,554 held for payment of
Series N dividends and escrowed cash represents Series N stock issuance
proceeds which are being held for property acquisitions.
6. SERIES P PREFERRED STOCK
Effective November 30, 1995, the Company authorized a $750,000 private
offering of 75 units consisting of Series P preferred stock, common stock
and common stock purchase warrants. Each unit consists of 10 shares of
Series P preferred stock, 5,600 shares of common stock and warrants to
purchase 14,000 shares of common stock at $.25 per share. This offering
terminates November 30, 1996. The net proceeds of this offering will be
used to repay certain bridge loans.
Series P preferred stock is designated as nonvoting, $1 par value, $1,000
stated value, 11% cumulative convertible preferred stock, with dividends
payable quarterly. Each share of preferred stock may be converted at any
time into 1,000 shares of common stock. The exercise period will expire 36
months from the date of issuance of the preferred stock. If at any time
after issuance of the preferred stock, the bid price of the common stock
for ten consecutive days is $1.25 or higher, each share of stock will
automatically convert. The preferred stock may be called for redemption at
the option of the Company at any time after the first anniversary date of
issuance. The holder will have 30 days in which to exercise the conversion
right. Preference in liquidation equals the $1,000 stated value per share
plus accumulated unpaid dividends at 11%. The warrants may be exercised at
any time and will expire 18 months from issuance.
At June 7, 1996, no funds have been raised under this offering.
F-28
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE K - PREFERRED STOCK - CONTINUED
7. RIGHTS OF PREFERRED STOCKHOLDERS
If, for any class of preferred stock, the Company (i) is in arrears on
dividends, (ii) has failed to pay or set aside any amounts required to be
paid or set aside for any sinking funds, or (iii) is in default on any of
its redemption obligations, then no dividends shall be paid or declared on
any common stock nor shall any common stock be purchased or redeemed by the
Company.
8. AUTHORIZED SHARES AND PAR VALUES
During 1995, the Company increased its authorized preferred stock from
250,000 shares to 1,750,000 shares, including Series C and G redeemable
preferred stock. In addition, during 1995 all preferred stock was changed
from a no par value to $1 par value designation.
NOTE L - INCOME TAXES
The provision for income taxes for the years ended February 29, 1996 and
February 28, 1995 consisted of the following:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Current $ 45,000 $ 279,637
Benefit of tax net operating loss
carryforwards (11,000) (233,000)
--------- ---------
Total $ 34,000 $ 46,637
--------- ---------
--------- ---------
</TABLE>
The differences between income taxes computed using the average statutory
federal income tax rates of 17% and 34%, respectively, and the provision
for income taxes for the years ended February 29, 1996 and February 28,
1995 follow:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Taxes at statutory rate $ (10,000) $ 211,000
State income taxes, net of federal tax
benefit 34,000 22,000
Benefit of net operating loss carryforwards - (194,000)
Other 10,000 7,637
--------- ---------
$ 34,000 $ 46,637
--------- ---------
--------- ---------
</TABLE>
F-29
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE L - INCOME TAXES - CONTINUED
The tax effects of the temporary differences that give rise to deferred tax
assets and liabilities follow:
<TABLE>
<CAPTION>
February 29, February 28,
1996 1995
------------ ------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward $ 2,648,000 $ 2,923,000
Deferred income on sale/leaseback
transaction - 11,000
Deferred compensation 19,000 7,000
Other 22,000 17,000
---------- -----------
2,689,000 2,958,000
Deferred tax liability - excess financial
over tax basis of property and equipment (2,000) (60,000)
Valuation allowance (2,687,000) (2,898,000)
---------- -----------
$ - $ -
---------- -----------
---------- -----------
</TABLE>
The decrease in the valuation allowance was $211,000 and $666,000 during
1996 and 1995, respectively.
At February 29, 1996, the Company had federal net operating loss
carryforwards which may be applied against future taxable income and which
expire as follows:
<TABLE>
<CAPTION>
Year ending
February 28,
------------
<S> <C>
1997 $6,292,000
1998 through 2006 1,497,000
----------
$7,789,000
----------
----------
</TABLE>
F-30
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE M - EMPLOYEE BENEFITS
The Company offers various benefits to its employees, as follows:
1. 401(K) SAVINGS PLAN
The Company has a 401(k) savings plan covering substantially all employees
at least 21 years of age with at least one year of service. The Company
can make discretionary contributions with Board of Directors' approval.
Total Company contributions to the plan were $7,739 and $7,074 for the
years ended February 29, 1996 and February 28, 1995, respectively.
2. STOCK OPTION PLAN
During 1995, the Company adopted an "incentive and nonqualified stock
option plan" which provides for the granting of (1) incentive stock
options, (2) nonqualifying stock options and (3) stock appreciation rights
(SAR's) to key officers and employees. A total of 500,000 shares of common
stock has been reserved for issuance under the plan. Under the terms of
the plan, the exercise price, determined by a committee of the Board of
Directors ("the Committee"), shall be determined at the time of grant but
shall not be less than 100% of the common stock fair market value (as
defined) for incentive stock options and not less than 75% of the fair
market value for nonqualified stock options. The term of each option shall
be fixed by the Committee but may not exceed ten years. The above options
may be issued with SAR's attached as described below.
SAR's permit the holder to exercise such SAR's for cash, common stock or
any combination thereof in an amount equal to the difference between the
market price (as defined) on the date of exercise and the option price at
the date of grant.
On December 1, 1994, incentive stock options with attached SAR's for
325,000 shares of common stock were issued to two officers of the Company
at an exercise price of $.25 per share. Up to 50% of the options may be
exercised one year following the date of grant and 50% may be exercised two
years following the date of grant, with the options and SAR's expiring ten
years from the date of grant.
Compensation expense of $34,804 and $14,600 has been recorded during 1996
and 1995, respectively, with a corresponding credit to additional paid-in
capital, representing the portion of the increase in value of the SAR's at
February 29, 1996 and February 28, 1995, which has been earned by the
officers.
F-31
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE M - EMPLOYEE BENEFITS - CONTINUED
3. COMMON STOCK WARRANTS
Stock purchase warrants for 29,700 shares of common stock were issued to
selected employees as part of their 1995 compensation. Such warrants are
exercisable at $.16 per share through February 2000. During 1995,
compensation expense of $7,128 was recorded with a corresponding credit to
additional paid-in capital, representing the excess of the fair market
value of Company's stock over the warrant exercise price at the date of
grant.
4. STOCK-BASED COMPENSATION PLANS
In October 1995, the FASB issued Statement No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION, which requires adoption in fiscal 1997. The new
standard defines a fair value method of accounting for stock options and
similar equity instruments. Under the fair value method, compensation cost
is measured at the grant date based on the fair value of the award and is
recognized over the service period, which is usually the vesting period.
Pursuant to the new standard, companies are encouraged, but not required,
to adopt the fair value method of accounting for employee stock-based
transactions. Companies are also permitted to continue to account for such
transactions under Accounting Principles Board Opinion No. 25 ("APB 25"),
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, but would be required to disclose
pro-forma net income and, if presented, earnings per share as if the
companies had applied the new method of accounting. The accounting
requirements of the new method are effective for all employee awards
granted after the beginning of the fiscal year of adoption, whereas the
disclosure requirements apply to all awards granted subsequent to December
31, 1994. The Company will adopt the disclosure requirements of Statement
No. 123 in fiscal year 1997 but will continue to recognize and measure
compensation for its restricted stock and stock option plans in accordance
with the existing provisions of APB 25.
NOTE N - LEASES
The Company leases office space and certain equipment under operating
leases expiring at various times through March 2000. The majority of the
equipment leases are month-to-month leases.
F-32
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE N - LEASES - CONTINUED
Rent expense totaled $643,313 and $541,266 during 1996 and 1995,
respectively. Future minimum lease rentals on noncancellable operating
leases at February 29, 1996 were as follows:
<TABLE>
<CAPTION>
<S> <C>
1997 $102,616
1998 102,616
1999 88,802
2000 67,264
2001 4,630
--------
$365,928
--------
--------
</TABLE>
NOTE O - RELATED PARTY TRANSACTIONS
During the year ended February 29, 1996, PCI, a company controlled by two
Company directors, received cash payments of approximately $231,400 and a
director received cash payments of approximately $15,100 for services
relating to various preferred stock fundraising activities, for due
diligence and other services relating to property acquisitions. PCI also
received 120,000 shares of restricted common stock related to Series G
offering costs at a total recorded value of $28,880.
Included in accounts payable at February 29, 1996 are amounts due PCI and
members of Company management and joint venture operators totaling
approximately $56,600. The $278,728 note receivable to a related party
represents a note due from PCI for advances to and expenses paid on its
behalf relating to fundraising activities. The note is collateralized by
all Series C preferred stock, bears interest at 7% and is due no later than
February 1999. The note payable to officer represents a demand promissory
note, with interest payable quarterly at the national prime rate. In
addition, GPC has notes payable totaling $201,672 relating to certain
business acquisitions and office equipment purchases with certain officers
and directors of GPC and CEI. Interest expense on these notes was $33,517
for the year ended February 29, 1996. GPC and CEI also paid approximately
$61,500 in consulting fees to a director of GPC and CEI during 1996.
During the year ended February 28, 1995, PCI received cash payments of
approximately $630,000 and a director received cash payments of
approximately $27,000 for services relating to various preferred stock
fundraising activities and for due diligence and other services relating to
property acquisitions. PCI also received 490,000 shares of restricted
F-33
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE O - RELATED PARTY TRANSACTIONS - CONTINUED
common stock and 9.75 shares of Series C preferred stock and a director
received 1,190 shares of restricted common stock for services related to
various preferred stock fundraising activities at a total recorded value of
approximately $52,000. In addition, the Company issued 200,000 shares of
restricted common stock and 5,000 shares of GPC common stock as part of a
business acquisition with individuals or with entities owned or partially
owned or controlled by individuals who, as a result of the agreements,
became officers and partial owners of GPC. The stock was issued at a
recorded value of approximately $182,000.
Included in accounts payable at February 28, 1995 are amounts due PCI and
members of Company management totaling approximately $74,000. The $168,268
note receivable to a related party represents a note due from PCI for
advances to and expenses paid on its behalf relating to fundraising
activities. The note is collateralized by all Series C preferred stock,
bears interest at 7% and is due no later than February 1999. The note
payable to officer represents a demand promissory note, with interest
payable quarterly at the national prime rate. In addition, GPC paid
cash of $267,000 and entered into notes payable totaling $243,500
relating to certain business acquisitions with current officers
and directors of GPC. The Company also paid approximately $19,000
in consulting fees to directors and officers of the Company and
its subsidiaries.
NOTE P - COMMITMENTS, CONTINGENCIES AND UNCERTAINTIES
During 1995, the Company entered into a compensation agreement with several
GPC officers whereby such officers will receive warrants to acquire the
Company's common stock for $.01 per share, with the number of such warrants
determined by a formula based on GPC's earnings and the market value of the
Company's common stock. No warrants were issued during 1996 or 1995.
In connection with the acquisition of Ozark, GPC has an agreement to pay
the former owner a project development fee equal to 2% of the gross
investment to develop natural gas transmission and distribution systems in
a defined area of the Ozarks over a ten year period beginning in 1997. In
addition, GPC will pay a marketing fee not to exceed $0.15 per dekatherm
for all gas sold to residential and commercial customers in the defined
area. No amounts are due as of February 29, 1996 as development has not
commenced.
The Company's policy is to depreciate gas gathering, processing and
transportation properties over their remaining useful lives using the
straight-line method and to evaluate the remaining lives and recoverability
of such properties in light of current conditions.
F-34
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE P - COMMITMENTS, CONTINGENCIES AND UNCERTAINTIES- CONTINUED
As discussed at Note C, effective June 30, 1995, the Company acquired a 15
mile pipeline in Guymon, Oklahoma. Shortly after acquisition, the
Company's contract for gas delivery was terminated by the pipeline's only
customer. The Company is seeking to develop alternative sources of revenue
through agreements with a number of a small customers; however, at February
29, 1996, no sales were as yet consummated. Given the early stage of
development of new customer relationships and additional capital investment
that will be necessary to generate adequate revenue, it is reasonably
possible that the Company's estimate that it will recover the carrying
amount of the pipeline from future operations will change in the near term.
The Company and its subsidiaries are parties to litigation and claims
arising in the normal course of business. Management, after consultation
with legal counsel, believes that the liabilities, if any, arising from
such litigation and claims will not be material to the consolidated
financial statements.
NOTE Q - SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest was $108,344 and $6,770 in 1996 and 1995,
respectively. Cash paid for income taxes was $62,865 and $24,437 in 1996
and 1995, respectively.
NONCASH INVESTING AND FINANCING ACTIVITIES
During 1996, 447,012 shares of restricted common stock were issued as part
of various preferred stock conversion activities and for offering costs.
Additionally, 100 shares of Series A preferred stock of GPC were issued to
a stockholder of GEC for a $100,000 reduction of a short-term promissory
note. The Company also entered into a promissory note with an officer of
GPC for $19,172 for the purchase of office equipment. During the formation
of Castex LP in 1996, the minority owners contributed $203,250 of oil and
gas producing properties. Certain stockholders also converted 155 shares
of Series G mandatory redeemable preferred stock with a carrying value of
$137,157, which included $17,843 of issue costs that was charged to
additional paid-in capital, to 527,506 shares of common stock. Also during
1996, the carrying value of Series G preferred stock was increased by
$457,094 through a charge to additional paid-in capital, representing
amortization of issue costs.
F-35
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE Q - SUPPLEMENTAL CASH FLOW INFORMATION - CONTINUED
As described in Note C, during 1996 the Company acquired assets and assumed
certain liabilities in connection with business acquisitions, as follows:
<TABLE>
<CAPTION>
<S> <C>
Fair value of assets acquired $ 11,588,493
Cash paid (11,097,579)
------------
Liabilities assumed $ 490,914
------------
------------
</TABLE>
During 1995, 7,396,041 shares of restricted common stock, 9.75 shares of
Series C preferred stock and 1,505 shares of other preferred stock were
issued as part of various preferred stock issuance and conversion
activities and certain preferred stock dividends. Also during 1995, the
carrying value of Series G preferred stock was increased by $256,742
through a charge to additional paid-in capital, representing amortization
of issue costs. In addition, see Note K regarding conversion of preferred
stock to other preferred stock.
As described in Note C, during 1995 the Company issued 200,000 shares of
restricted common stock and 5,000 shares of GPC common stock and assumed
certain liabilities in connection with business acquisitions, as follows:
<TABLE>
<CAPTION>
<S> <C>
Fair value of assets acquired $ 7,073,969
Common stock issued (182,125)
Cash paid (6,265,176)
------------
Liabilities assumed $ 626,668
------------
------------
</TABLE>
NOTE R - FINANCIAL INSTRUMENTS
The following estimated fair value information at February 29, 1996,
pertains to the Company's financial instruments and is based on the
requirements set forth in FASB Statement No. 107, DISCLOSURES ABOUT FAIR
VALUE OF FINANCIAL INSTRUMENTS, and does not purport to represent the
aggregate net fair value of the Company.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to
estimate that value:
CASH AND CASH EQUIVALENTS, OTHER CASH AND NOTE RECEIVABLE: The carrying
amounts of cash and cash equivalents, restricted cash and cash escrowed for
acquisitions and the note receivable - related party approximate fair value
because of the short maturity of those instruments.
F-36
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE R - FINANCIAL INSTRUMENTS - CONTINUED
NOTES PAYABLE AND NOTE PAYABLE TO OFFICER: The estimated fair values of
notes payable are based on the borrowing rates currently available to the
Company for bank loans with similar terms and average maturities.
LONG-TERM DEBT: The fair values of the Company's long-term debt are
estimated using discounted cash flow analyses based on the Company's
current incremental borrowing rates for similar types of borrowing
arrangements.
MANDATORY REDEEMABLE PREFERRED STOCK: The estimated fair values of
mandatory redeemable preferred stock are estimated using a discounted cash
flow calculation that applies interest rates currently being offered to a
schedule of aggregated expected maturities. The carrying amount of accrued
dividends approximates its fair value.
DERIVATIVE FINANCIAL INSTRUMENTS: Estimated fair values for derivative
financial instruments used by the Company (interest rate and commodity
price swaps and collars) are based on pricing models or formulas using
current assumptions.
The estimated fair values of the Company's financial instruments at
February 29, 1996, are as follows:
<TABLE>
<CAPTION>
Carrying Estimated
amount fair value
of assets of assets
(liabilities) (liabilities)
----------- -----------
<S> <C> <C>
Financial assets:
Cash and cash equivalents $ 1,704,936 $ 1,704,936
Restricted cash and cash escrowed
for acquisitions 673,372 673,372
Note receivable - related party 278,728 278,728
Financial liabilities:
Notes payable and note payable
to officer (1,407,115) (1,407,115)
Long-term debt (9,701,672) (9,709,755)
Mandatory redeemable preferred stock (8,335,486) (10,028,150)
Derivative financial instruments:
Interest rate swap - (100,303)
Commodity price swaps and collars - (524,450)
</TABLE>
F-37
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE R - FINANCIAL INSTRUMENTS - CONTINUED
The Company uses derivative financial instruments to reduce exposures to
market risks resulting from fluctuations in interest rates and gas prices.
The Company does not enter into financial instruments for trading or
speculative purposes. The counter-party to these contracts is a major
financial institution. Management believes that risk of loss is remote and
would not be material.
INTEREST RATE RISK MANAGEMENT
The Company uses interest rate swaps to manage interest rate risk related
to certain borrowings. Interest rate swap agreements are used to hedge
bank debt and mature with these borrowings. The swaps convert the debt to
fixed rate U.S. dollar liabilities. Interest expense under these
agreements, and the respective debt instruments that they hedge, are
recorded at the net effective interest rate of the hedged transactions.
At February 29, 1996, the Company has outstanding one interest rate swap
agreement, with a total notional principal amount of $9,500,000 whereby it
receives the LIBOR rate in exchange for paying a fixed rate of 6.075%. The
swap effectively converts the agreement's floating rate to a fixed rate of
approximately 8%. The interest rate swap agreement, which matures January
26, 2000, provides that the notional principal amount will decrease as
principal payments are made on the related debt.
FUTURES CONTRACTS RISK MANAGEMENT
The Company enters into natural gas swap and collar contracts to reduce its
exposure to price risk in the spot market for natural gas. These contracts
settle monthly through December 1998 and are scheduled to coincide with
monthly gas production equivalent to approximately 100,000 MMBTU per month
during that period. The contracts represent agreements between the Company
and a third party to exchange cash based on a designated price, or a
designated range of prices for collars. Prices are referenced to natural
gas futures contracts traded on the New York Mercantile Exchange. Cash
settlement occurs 120 days subsequent to the production month. The Company
accounts for gains and losses as an adjustment of oil and gas sales in the
period of the hedged production. At February 29, 1996, the Company had the
following open swap and collar positions associated with anticipated
production during the next three fiscal years:
F-38
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE R - FINANCIAL INSTRUMENTS - CONTINUED
<TABLE>
<CAPTION>
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Notional MMBTU's 1,230,000 1,200,000 1,000,000
Weighted average fixed price
to receive $2.01 $1.75 $1.75
</TABLE>
NOTE S - FOURTH QUARTER ADJUSTMENTS
Aggregate year end adjustments recorded in the fourth quarter reduced net
earnings by approximately $201,000.
NOTE T - SEGMENTS AND MAJOR CUSTOMERS
The Company operates in two major lines of business. Information
concerning operations in these businesses is presented below. Prior year
segment information is not presented as oil and gas producing activities
were not significant.
<TABLE>
<CAPTION>
Gas gathering,
Oil and gas processing
producing and
activities transportation Corporate Consolidated
----------- -------------- --------- ------------
<S> <C> <C> <C> <C>
Sales $ 1,051,674 $12,105,047 $ - $13,156,721
Depreciation, depletion
and amortization $ 414,741 $ 667,509 $ 7,666 $ 1,089,916
Operating profit (loss) $ 71,104 $ 1,218,493 $(1,181,762) $ 107,835
Identifiable assets $14,341,968 $14,079,582 $ 1,299,625 $29,721,175
Capital expenditures $11,163,375 $ 2,513,527 $ 13,112 $13,690,014
</TABLE>
F-39
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE T - SEGMENTS AND MAJOR CUSTOMERS - CONTINUED
All customers with sales exceeding 10% of total revenue are in the gas
gathering segment. Gross sales as a percentage of total revenue to these
customers are as follows:
<TABLE>
<CAPTION>
Year ended
---------------------------
February 29, February 28,
1996 1995
------------ ------------
<S> <C> <C>
Customer A 22% 18%
Customer B 9% 18%
Customer C - 13%
</TABLE>
The Company's natural gas pipeline operations have a concentration of
customers in the natural gas transmission, distribution and petrochemical
industries. These concentrations of customers may impact the Company's
overall exposure to credit risk, either positively or negatively, in that
the customers may be similarly affected by the changes in economic or other
conditions. The Company's accounts receivable are generally not
collateralized.
NOTE U - SUBSEQUENT EVENTS
In addition to the new agreement the Company entered into with PCI in May
1996 as discussed in Note H, the Company had the following significant
subsequent events:
ACQUISITION OF VENTURE RESOURCES, INC.
Effective March 1996, GPC acquired all of the outstanding shares of Venture
Resources, Inc., a company with interests in natural gas gathering,
processing and transmission properties located in Texas, for approximately
$1,300,000. The acquisition cost approximates the fair value of the net
assets acquired.
The purchase was financed with $650,000 of proceeds from the Series N
Preferred Stock and new bridge loans totaling $650,000. A payment of
$275,000 on the bridge loans is due in June, 1996. Beginning July 1, 1996,
the remainder of the bridge loan promissory notes is payable in quarterly
installments of $93,750. The notes also provide for interest to accrue at
11% per annum. Interest is payable on the maturity date of the notes in
cash or, at the election of the holders, shares of GEC common stock valued
at $.35 per share. As part of the commitment, the Company also issued
168,750 shares of common stock and warrants to purchase 1,500,000 shares of
common stock at $.25 per share. In the event the Company fails
F-40
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
NOTE U - SUBSEQUENT EVENTS - CONTINUED
ACQUISITION OF VENTURE RESOURCES, INC. - CONTINUED
to pay the principal and interest or fulfill the warrant obligation, then
upon demand of the noteholders, the Company will transfer to the
noteholders up to 87% of the outstanding common stock of Venture Resources,
Inc.
AGREEMENT TO ACQUIRE TRAVERSE/TRANSCO GROUP OIL AND GAS INTERESTS
During April 1996, the Company signed a letter of intent to acquire oil and
gas working and revenue interests owned by the Traverse/Transco Group for
approximately $3,300,000. The purchase will be financed from borrowings
under the Company's bank credit facility. Closing is expected to occur in
July 1996.
PRIVATE OFFERING PROCEEDS
The Company raised net proceeds of $1,190,000 in connection with its Series
N preferred stock private offering subsequent to year end through the
closing of the offering on May 31, 1996.
F-41
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
SUPPLEMENTAL FINANCIAL DATA
(UNAUDITED)
The following 1996 supplemental unaudited information regarding the
Company's proved oil and gas reserves, all of which are located in the
United States, is presented pursuant to the disclosure requirements
prescribed by the Securities and Exchange Commission and Statement of
Financial Accounting Standards No. 69, DISCLOSURES ABOUT OIL AND GAS
PRODUCING ACTIVITIES. Information for prior years is not presented as oil
and gas producing activities were not significant.
The reserve estimates are based primarily on reports prepared by an
independent petroleum engineer and, to a lesser extent, an internally
prepared reserve study. There are numerous uncertainties inherent in
estimating quantities of proved reserves and projecting future rates of
production and timing of development activities. Revision of prior year
estimates can have a significant impact on the results. Also, exploration
costs in one year may lead to significant discoveries in later years and
may significantly change previous reserves and their valuation. Values of
unproved properties and anticipated future price and cost increases or
decreases are not considered. Therefore, the Standardized Measure should
be viewed with caution and not construed as a "best estimate" of the fair
value of the Company's oil and gas properties or of future net cash flows.
ESTIMATED QUANTITIES OF OIL AND GAS RESERVES
<TABLE>
<CAPTION>
Year ended
February 29, 1996
-----------------
(Oil) (Gas)
<S> <C> <C>
Proved developed and undeveloped reserves
Beginning of period 45,109 434,348
Revision of previous estimates 2,153 (25,020)
Purchase of reserves 32,465 11,640,150
Extensions and discoveries - 186,254
Production (4,871) (355,891)
-------- -----------
End of period 74,856 11,879,841
-------- -----------
-------- -----------
Proved developed reserves
Beginning of period 45,109 434,348
End of period 72,956 11,066,641
</TABLE>
The above includes reserves of approximately 22,000 bbls and 3,534,000 MCF
attributable to minority interest ownership in a consolidated subsidiary.
F-42
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
SUPPLEMENTAL FINANCIAL DATA - CONTINUED
(UNAUDITED)
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
<TABLE>
<CAPTION>
Year ended
February 29, 1996
-----------------
<S> <C>
Future oil and gas revenues $23,547,000
Future production and development costs (5,665,000)
Future income tax expense (1,468,000)
-----------
Future net cash flows 16,414,000
Discounted at 10% for estimated timing
of cash flows (4,596,000)
-----------
Standardized measure of discounted future
net cash flows $11,818,000
-----------
-----------
</TABLE>
The above estimated future income taxes are computed by applying the
appropriate statutory tax rates to the future pretax net cash flows of
proved reserves, net of the tax basis of the oil and gas properties and
estimated statutory depletion.
The above total standardized measure of discounted future cash flows
includes $3,515,000 which is attributable to minority interest ownership in
a consolidated subsidiary.
CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
<TABLE>
<CAPTION>
Year ended
February 29, 1996
-----------------
<S> <C>
Sales and transfers of oil and gas produced,
net of production costs $ (736,000)
Net changes in prices and production costs 56,000
Extensions and discoveries, less related costs 264,000
Costs incurred during the period which reduced
future development costs 70,000
Revisions of previous quantity estimates (4,000)
Accretion of discount 64,000
Purchases of reserves 12,205,000
Net change in income taxes (924,000)
Other 322,000
-----------
Net increase 11,317,000
Balance at beginning of period 501,000
-----------
Balance at end of period $11,818,000
-----------
-----------
</TABLE>
F-43
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
GATEWAY ENERGY CORPORATION
(Registrant) Date
----
By: /s/ L. J. Horbach June 13, 1996
-----------------------------------------
L. J. Horbach, President
By: /s/ Neil A. Fortkamp June 13, 1996
-----------------------------------------
Neil A. Fortkamp, Executive Vice President and
Chief Financial Officer
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Date
----
/s/ L. J. Horbach June 13, 1996
- ----------------------------------------------
L. J. Horbach, Director
/s/ John B. Ewing June 13, 1996
- ----------------------------------------------
John B. Ewing, Director
/s/ Charles Holtgraves June 13, 1996
- ----------------------------------------------
Charles Holtgraves, Director
/s/ Donald L. Anderson June 13, 1996
- ----------------------------------------------
Donald L. Anderson, Director
24
<PAGE>
EXHIBIT 11
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
YEAR ENDED
-------------------------------
February 29 February 28
1996 1995
------------ -----------
<S> <C> <C>
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING 26,152,882 21,214,479
ADD SHARES ISSUABLE PURSUANT TO WARRANT
AGREEMENTS LESS SHARES ASSUMED
REPURCHASED AT THE AVERAGE MARKET PRICE 61,127 (1) 213,812 (1)
ADD SHARES ISSUABLE ASSUMING CONVERSION
OF SERIES C PREFERRED STOCK INTO
COMMON STOCK 140,625 (1) 130,469 (1)
ADD SHARES ISSUABLE PURSUANT TO STOCK
OPTIONS LESS SHARES ASSUMED REPURCHASED
AT THE AVERAGE MARKET PRICE 180,964 (1) 50,964 (1)
------------ -----------
TENTATIVE NUMBER OF SHARES FOR COMPUTATION
OF PRIMARY EARNING PER SHARE 26,535,598 21,609,724
ADD ADDITIONAL SHARES ISSUABLE PURSUANT TO
WARRANT AGREEMENTS LESS SHARES ASSUMED
REPURCHASED AT THE HIGHER OF THE PERIOD
END OR AVERAGE MARKET PRICE 1,132 10,371
ADD ADDITIONAL DILUTIVE SHARES ISSUABLE
ASSUMING CONVERSION OF SERIES B, G, J,
K, L, M, N & A PREFERRED STOCK INTO
COMMON STOCK 38,479,361 18,172,691
------------ -----------
TENTATIVE NUMBER OF SHARES FOR COMPUTATION
OF FULLY DILUTED EARNINGS PER SHARE 65,016,091 39,792,786
============ ===========
LOSS APPLICABLE TO COMMON STOCK FOR
PURPOSES OF COMPUTING PRIMARY EARNINGS
PER SHARE $ (2,415,721) $ (705,662)
ADD PROVISION FOR PREFERRED DIVIDENDS
RELATING TO CONVERTIBLE PREFERRED STOCK 2,323,030 1,280,920
------------ -----------
NET EARNINGS (LOSS) FOR COMPUTATION OF FULLY
DILUTED EARNINGS PER SHARE $ (92,691) $ 575,258
============ ===========
LOSS PER COMMON SHARE - PRIMARY,
EXCLUDING COMMON STOCK EQUIVALENTS $ (0.09) $ (0.03)
============ ===========
EARNING (LOSS) PER COMMON SHARE - FULLY
DILUTED $ (0.00) $ 0.01
============ ===========
</TABLE>
(1) NOT USED IN PRIMARY EARNINGS PER SHARE
CALCULATION AS EFFECT WOULD BE ANTIDILUTIVE.
<PAGE>
EXHIBIT 21
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
SUBSIDIARIES
Company State Percent Owned
------- ----- -------------
Gateway Pipeline Co. Missouri 80%
Castex Energy, Inc. Texas 80%
Fort Cobb Oklahoma Irrigation
Fuel Authority Oklahoma 99%
Shoreham Gathering Company Nebraska 80%
Ozark Natural Gas Company Missouri 100%
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> FEB-29-1996
<PERIOD-END> FEB-29-1996
<CASH> 1,720,604
<SECURITIES> 0
<RECEIVABLES> 4,041,807
<ALLOWANCES> 34,410
<INVENTORY> 71,193
<CURRENT-ASSETS> 5,926,045
<PP&E> 23,927,811
<DEPRECIATION> 1,538,198
<TOTAL-ASSETS> 29,721,175
<CURRENT-LIABILITIES> 7,221,759
<BONDS> 8,094,985
8,335,486
7,905
<COMMON> 269,761
<OTHER-SE> 4,291,099
<TOTAL-LIABILITY-AND-EQUITY> 29,721,175
<SALES> 13,156,721
<TOTAL-REVENUES> 13,156,721
<CGS> 7,113,486
<TOTAL-COSTS> 10,557,481
<OTHER-EXPENSES> 2,491,405
<LOSS-PROVISION> 26,378
<INTEREST-EXPENSE> 285,290
<INCOME-PRETAX> (58,691)
<INCOME-TAX> 34,000
<INCOME-CONTINUING> (92,691)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (92,691)
<EPS-PRIMARY> (.09)
<EPS-DILUTED> (.09)
</TABLE>