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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 28, 1998
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(D)
OF THE EXCHANGE ACT OF 1943
FOR THE TRANSITION PERIOD FROM
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COMMISSION FILE NO. 1-4766
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GATEWAY ENERGY CORPORATION
(Name of small business issuer in its charter)
<TABLE>
<S> <C>
DELAWARE 44-0651207
(State or other jurisdiction (IRS Employer
of Identification Number)
incorporation or
organization)
</TABLE>
10842 OLD MILL ROAD, SUITE 5, OMAHA, NE 68154
(Address and Zip Code of principal executive offices)
(402) 330-8268
(Issuer's telephone number)
--------------------------
Securities registered under Section 12(b) of the Exchange Act:
<TABLE>
<S> <C>
TITLE OF EACH
CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
None None
</TABLE>
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, $0.25 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 ____
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 28, 1998,
were $10,680,700.
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 April 30, 1998 was $14,457,000. The
number of shares outstanding of each of the issuer's classes of common equity,
as of April 30, 1998, was 14,457,400.
DOCUMENTS INCORPORATED BY REFERENCE
The following document is incorporated by reference into the indicated parts
of this Annual Report to the extent specified in such parts:
Part III of this Annual Report incorporates by reference information in the
Proxy Statement for the Annual Meeting of Stockholders of Gateway Energy
Corporation to be held on July 16, 1998.
Transitional Small Business Disclosure Format (check one): Yes ____ No_X_
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To Our Stockholders:
Because Gateway is a company with publicly traded stock, we must annually file
this Form 10-KSB with the Securities and Exchange Commission ("SEC"). It is our
principal annual disclosure document. It contains an overall discussion about
our business, our financial condition and financial prospects and our annual
audited financial statements.
Item 1 contains the general description of our current business and
properties. We direct your particular attention to the caption "Current
Developments" which describes the significant changes we have made during the
year regarding ownership and management of our assets. Item 2 describes our
properties, including our lease arrangements for our executive offices. Item 3
describes any significant legal proceedings in which we were involved. Item 4
shows the matters submitted to the common and preferred stockholders and the
results of the voting. Item 5 contains a two-year report on the high and low
quarterly stock prices of our Common Stock.
Item 6 is a discussion about our results of operations. We are required to
compare the most recent fiscal year results for February 28, 1998 with the
results of a year ago and to do a similar comparison of the results for February
28, 1997 compared with the prior year. In this way, you are provided with a
three-year overview of what occurred financially within your Company. The
discussion also includes our liquidity, or basically how much cash we have and
where we will get the cash needed to operate in the near term. Finally, we
discuss certain factors which may affect the future of your Company and you are
encouraged to read those carefully.
The audited financial statements are contained in Item 7 along with the
report from our auditors, Grant Thornton LLP.
Item 13 describes important documents relating to the Company and where
copies of those may be found. The last part of the form contains the signatures.
The SEC requires that this Form 10-KSB be signed by an executive officer and a
majority of the Board of Directors of your Company.
<PAGE>
PART I.
ITEM 1. BUSINESS
GENERAL
Gateway Energy Corporation (the "Company"), a Delaware corporation, was
incorporated in 1960. The Company's common stock is traded in the
over-the-counter market on the bulletin board section under the symbol GNRG. 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.
CURRENT DEVELOPMENTS
The Company has significantly changed its operating and management
philosophy during the past fiscal year. Previously, the Company had owned
properties through joint ventures which were typically managed and operated by
the Company's joint venture partners. This form of ownership and management was
designed to minimize corporate expenses and utilize the industry experience of
others.
The Company now has determined that such arrangements do not provide the
Company with sufficient control over performance and cash flow. This type of
ownership also restricted the Company's ability to use these properties as
collateral for conventional financing.
Therefore, early in fiscal 1998 the Company initiated plans to dissolve all
significant joint venture and limited partnership relationships. In September
1997, the Company sold its limited partnership interest in Castex Energy 1995 LP
("Castex LP") a partnership which owned interests in producing properties in
Louisiana. The Company sold this interest and other minor gas producing
properties in the same transaction for a total of $3.5 million.
In September 1997, the Company entered into a Settlement Agreement
("Agreement") with Shoreham Pipeline Company ("Shoreham") to dissolve all joint
venture arrangements between the parties and to settle litigation resulting from
the Company's intention, as majority owner, to assert its management and
operating rights over the properties.
Under the Agreement, the Company transferred its interest in six operating
properties to Shoreham in return for $2.7 million; twenty percent (20%) was paid
at closing and the remainder will be paid in twenty-four equal installments with
interest at nine percent (9%) per annum. In addition, Shoreham transferred its
interests in nine other properties, and its twenty percent (20%) interest in
Gateway Offshore Pipeline Company (formerly Shoreham Gathering Company) to the
Company.
In February 1998, the Company acquired the minority interest held by
Ghere-Smith Interests, Inc. ("GSI") in Fort Cobb Irrigation Fuel Authority,
Caddo Gas Gathering Joint Venture and WestOK Gas Marketing Joint Venture and
cancelled the existing management contracts which would have been in effect
until November 1999. Thus, as of February 28, 1998, the company owns, manages
and operates all but two minor systems.
RECAPITALIZATION
Effective March 1, 1997, the Company consummated a recapitalization which
resulted in substantial changes to the Company's capital structure. In January
1997, the holders of the Company's Common Stock were asked to approve a 1-for-25
reverse split of the Common Stock of the Company and to decrease the authorized
Common Stock from 75,000,000 shares to 17,500,000 shares. The holders of the
Common Stock approved this action subject to the completion of other parts of
the recapitalization.
The second and most significant part of the recapitalization was the
solicitation of consents of the holders of the nine series of Preferred Stock of
the Company and its subsidiary, Gateway Pipeline Company. In February 1997, the
consents were solicited from these holders and the required majority vote
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of each class of Preferred Stock was obtained. The holders of the Preferred
Stock were then given a period of time until April 11, 1997 in which to either
convert their Preferred Stock into Common Stock under the original conversion
terms or accept a package of securities consisting of 10% Subordinated Notes,
Common Stock and Common Stock Purchase Warrants. As a result, Preferred Stock
with a stated value of $14,632,600 was converted into 11,422,700 shares of
Common Stock. The holders of the remaining Preferred Stock with a stated value
of $3,098,700 received a total of $1,171,700 of 10% Subordinated Notes, 736,200
shares of Common Stock, and 62,000 Common Stock Purchase Warrants. The 10%
Subordinated Notes carry an additional interest provision equal to a percentage
of any operating cash distribution received from the Company's limited
partnership engaged in the oil and gas development business. As a result,
approximately 4.4% of the Company's total operating cash distributions from
Castex LP will be segregated for an additional interest provision on the Notes.
As a result of the recapitalization, the Company currently has no Preferred
Stock outstanding.
DESCRIPTION OF BUSINESS
The Company owns and operates natural gas gathering, transportation and
distribution systems and related facilities in Texas, including Texas state
waters, Oklahoma and Louisiana. The gas gathering segment is that portion of the
transportation system developed and designed to gather natural gas from
producing properties and transport that natural gas to a primary transmission
pipeline.
The gas gatherer contracts with the owner or operator of the producing gas
wells to utilize the gas gathering system to transport the gas from the wellhead
to a transmission line. The gathering system delivers the gas to the
transmission line and for that service receives a "tariff." In some cases the
gatherer will install a separator/dehydrator or compressor and thus receives
additional revenue. In other cases the gatherer may construct and own gas
processing facilities which extract the natural gas liquids from 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. In fiscal 1998,
approximately 54% of the Company's natural gas sales were generated under
"back-to-back" contracts.
The transportation segment provides service directly to other pipelines and
end users of natural gas, primarily industrial and large commercial companies.
Distribution 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. Distribution pipelines provide service
directly to end users. 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.
MAJOR CUSTOMERS AND SUPPLIERS
The Company purchases natural gas from numerous producers and purchased 17%
and 10% of its total cost of gas supply from two major oil and gas producing
companies. In 1998, one customer with sales exceeding 10% is in the gas
gathering segment, the other customer is an industrial customer. Gross sales as
a percentage of total revenue to these customers are as follows:
<TABLE>
<CAPTION>
1998 1997
----- -----
<S> <C> <C>
Customer A.................................................. 21% 28%
Customer B.................................................. 2% 16%
Customer C.................................................. 11% 6%
</TABLE>
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.
2
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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, service and 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
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 other rules and regulations
promulgated by the Federal Energy Regulatory Commission ("FERC"). The Company
believes that the gathering, transportation and distribution properties 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.
The Fort Cobb Fuel Authority ("Fort Cobb") is a local distribution company
subject to the regulations of the Oklahoma Corporation Commission ("OCC"). The
OCC 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 OCC in 1993; Fort Cobb has
not filed for an increase in rates since that time. The OCC 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, transporting and distributing
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 has obtained, and is in current compliance
with, all necessary and material permits and that its operations are in
substantial compliance with applicable material governmental regulations.
EMPLOYEES
As of February 28, 1998, the Company had 25 full-time employees.
ITEM 2. DESCRIPTION OF PROPERTY
ONSHORE PROPERTIES
A wholly-owned subsidiary, Gateway Pipeline Company ("GPC") owns 15
operating systems in Texas, Louisiana and Oklahoma. The systems generally gather
and transport natural gas under back-to-back purchase and sales arrangements or
for a tariff fee. One system is a 14 mile delivery system which transports and
sells natural gas to industrial users in Ellis County, Texas. The Company also
owns interests
3
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in two joint ventures located in Louisiana and Texas and a partnership in
Oklahoma which gather and transport natural gas under tariff arrangements.
The systems are properly maintained and are capable of transporting natural
gas under prescribed pressures. At February 28, 1998, the Company's onshore
systems were comprised of approximately 150 miles of 2-inch to 8-inch pipelines
and related compressors, meters, regulators, valves and equipment.
OFFSHORE PROPERTIES
A wholly-owned subsidiary, Gateway Offshore Pipeline Company ("Offshore")
owns pipelines, a related 170' X 40' operating platform, and an onshore terminal
facility servicing producers in Texas offshore waters and Galveston Bay. These
systems and related facilities are in shallow water and provide the Company the
capacity to separate and dehydrate gas in large volumes and to transport the
natural gas and condensate to various markets. The Company's offshore systems
consist of approximately 100 miles of 6-inch to 20-inch pipelines and related
equipment which transport natural gas and condensate primarily under tariff
contracts.
FORT COBB FUEL AND IRRIGATION AUTHORITY
Fort Cobb Fuel Authority ("Fort Cobb"), is owned by the Company and is a
local distribution company which serves approximately 2,600 rural and
residential customers in Caddo and Washita counties in Oklahoma. Fort Cobb owns
and operates approximately 600 miles of 1" to 4" pipeline and related meters,
regulators, valves, rights-of-way, easements, etc. normally associated with
distribution systems.
The system is also used as a gathering system to gather and transport
natural gas from low pressure wells in Caddo and Washita counties. As of
February 28, 1998, nineteen wells have been connected and two compressors
installed. The gas purchased from these producers is either sold to Fort Cobb or
to third parties.
SYSTEM CAPACITY
The capacity of a pipeline is primarily a function of its diameter and
length and its inlet and outlet pressures. Based upon normal operating
pressures, the Company's systems have a daily throughput capacity of over
500,000 MCF per day which significantly exceeds the current daily throughput of
approximately 50,000 MCF per day.
The onshore terminal facility referred to above, with minor modifications,
has a capacity of 5,000 barrels of condensate per day. Additional tankage and
related facilities could be added on adjacent land owned by the Company.
CORPORATE PROPERTY
In addition to the operating properties described above, the Company leases
office space and owns certain office equipment in its corporate office located
at 10842 Old Mill Road, Suite 5, Omaha, NE 68154 and its operating headquarters,
in Houston, Texas at 500 Dallas Street, Suite 2615, Houston, Texas.
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company is involved in litigation concerning its
properties and operations. Management does not deem that any current litigation
will have a material effect on the Company.
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 on the over-the-counter market in the
bulletin board section (OTCBB); its symbol is GNRG. The closing bid prices shown
reflect inter-dealer prices without retail mark-up, mark-down, or commissions
and may not represent actual transactions. The market prices shown for fiscal
1997 have been adjusted for the one for twenty-five reverse split.
<TABLE>
<CAPTION>
QUARTER ENDING HIGH LOW
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<S> <C> <C>
May 31, 1996................................................................ $ 10.15 $4.70
August 31, 1996............................................................. 7.80 3.75
November 30, 1996........................................................... 5.47 1.95
February 28, 1997........................................................... 3.50 1.00
<CAPTION>
QUARTER ENDING HIGH LOW
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<S> <C> <C>
May 31, 1997................................................................ $1.00 $.50
August 31, 1997............................................................. .69 .50
November 30, 1997........................................................... .81 .50
February 28, 1998........................................................... .58 .44
</TABLE>
HOLDERS
As of February 28, 1998, there are approximately 3,500 shareholders of the
Company's Common Stock, Par Value $0.25.
DIVIDENDS
There have been no dividends declared on the Company's Common Stock during
the last two fiscal years. 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.
RESULTS OF OPERATIONS
The following table sets forth information for each of the years in the
three-year period ended February 28, 1998:
<TABLE>
<CAPTION>
1998 1997 1996
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<S> <C> <C> <C>
Operating Revenues........................................ $ 10,680,700 $ 18,136,900 $ 13,131,400
Operating Margin.......................................... 1,364,800 3,189,300 3,492,900
Depreciation and Amortization............................. 743,200 995,500 1,089,900
General and Administrative Expense........................ 2,037,400 1,670,800 2,315,100
Other Income (Expense).................................... 251,000 (231,600) (146,600)
Net Earnings (Loss)....................................... (1,176,800) 225,400 (92,700)
Loss Applicable to Common Stock........................... (1,176,800) (1,283,300) (2,415,700)
</TABLE>
5
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YEAR ENDED FEBRUARY 28, 1998 COMPARED TO YEAR ENDED FEBRUARY 28, 1997
GENERAL. In fiscal 1998, the Company took several significant actions which
adversely affected revenues and operating margins. Since 1992, the Company had
operated its gas gathering properties through several joint venture partners.
This approach was initially taken to minimize corporate overhead and utilize the
industry expertise of others.
After the Recapitalization, and upon the advice of its investment banker,
the Company initiated action to dissolve the joint ventures owned in partnership
with Shoreham Pipeline Company ("Shoreham"). This dissolution of the joint
ventures was accomplished on September 3, 1997 and resulted in the sale of the
Company's interest in six operating systems to Shoreham and the acquisition of
Shoreham's minority interest in nine other systems ("the Shoreham Transaction").
The Company hired Mr. Michael Fadden as President and Chief Operating
Officer effective August 1, 1997 to manage these properties and to pursue the
termination of other joint venture arrangements. Additional operating personnel
were added in October 1997 to improve the performance of the properties acquired
in the transactions and to actively seek additional gas gathering and
transportation opportunities.
Natural gas prices as represented by the NYMEX Henry Hub index averaged
$2.36 in fiscal 1998 compared to $2.70 in the prior year. The natural gas
industry is generally optimistic about long term prospects based on expected
demand, the cost of developing prospects and the sales price of natural gas. The
Company's operating margins are not significantly affected by the price of
natural gas since gas gathering is generally based on a "tariff" arrangement.
However, long-term depression of prices can affect exploration and development
and result in lower volumes available for transportation.
OPERATING REVENUES. Operating revenues decreased $7,456,200 from the prior
year. The decrease was largely the result of the Shoreham Transaction which
reduced revenues by $4.2 million, the revenue in the last six months of fiscal
1997 from the properties sold. In addition to this loss of revenue, operating
revenues decreased $2.4 million due to the loss of a major producer in July 1997
on one of the systems sold to Shoreham. The loss of this customer did not
significantly affect operating margins due to the low margin on these volumes.
Operating revenues decreased an additional $1.2 million as a result of the
discontinuance of gas marketing activities. This also had little effect on the
operating margins of the Company due to the low margins available on the volume
marketed.
OPERATING MARGINS. Operating margins are defined as revenue less gas
purchases and operating and maintenance expenses. Operating margins decreased
significantly in 1998 from the prior year. The primary cause is the Shoreham
Transaction discussed above which reduced operating margins by $1.0 million. In
addition to the loss of operating margins attributable to the properties sold,
the Company incurred significant additional operating costs including i) costs
associated with winding up the joint ventures which substantially reduced
distributions in the last three months of operation, ii) repair and maintenance
costs which had been deferred by Shoreham and, iii) operating fees paid to third
parties to maintain our offshore facilities in the proper manner and consulting
fees to review and analyze properties retained in the Shoreham Transaction.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased
$252,300 as a result of the sale of natural gas properties in connection with
the Shoreham transaction in September 1997. The effect of the sale of certain
properties was offset slightly by capital additions made throughout the year and
the additional value of the property interests received in the Shoreham
Transaction.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expenses
increased $366,600 from the prior period. Salaries and wages and related
employee costs increased $.2 million due to the addition of
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the president and chief operating officer in August 1997 and the addition of
other operating and clerical personnel for the Houston office in late 1997.
In addition, general and administrative expense includes $125,000 of costs
associated with the termination of the GSI management agreements related to Fort
Cobb and Caddo Gas Gathering. Also, the Company incurred additional consulting
fees to analyze the potential of certain joint ventures which provided a basis
for our negotiations with joint venture partners and legal fees to obtain an
accounting of the final joint operating statements in the Shoreham Transaction.
OTHER INCOME (EXPENSE). Other income and expense includes gains of $398,000
in 1998 recognized from the sale of properties compared to a loss of $344,000 in
1997.
Interest expense includes conversion costs of approximately $383,000
associated with securities which had conversion privileges for common stock at
prices which were less than the market price at the date the conversion
privileges were established. This charge does not affect total stockholders'
equity since the offsetting credit is to paid-in capital.
Interest income increased in 1998 over 1997 due to the investment of
proceeds from the sale of the Company's limited partnership interest in
September 1997 and the note received in the Shoreham Transaction.
NET EARNINGS (LOSS). The net loss in 1998 was $1,176,800 compared to net
earnings of $225,400 in 1997, a reduction of $1,402,200. This decrease is the
result of the reduction in operating margin from the Shoreham Transaction in
September and higher operating expenses associated with operating the properties
including deferred repair and maintenance expense, operating fees for offshore
properties and management fees paid to operate some of the Company's systems
during fiscal 1998. The net loss for 1998 also includes $383,000 of conversion
costs as discussed above. The reduction in net earnings was partially offset by
lower depreciation and amortization and gains on sales of assets.
LOSS APPLICABLE TO COMMON STOCK. As a result of the Recapitalization, the
Company eliminated the preferred dividend requirement effective March 1, 1997.
All of the costs associated with the Recapitalization were recorded in fiscal
1997; therefore the provision for preferred dividends was zero in 1998 and the
loss applicable to common stock is equal to the net loss. In fiscal 1997, the
Company recognized a provision for preferred dividends of $1,508,700.
YEAR ENDED FEBRUARY 28, 1997 COMPARED TO YEAR ENDED FEBRUARY 29, 1996
GENERAL. Monthly natural gas prices as represented by the NYMEX Henry Hub
index averaged $2.70 in fiscal 1997, compared to $1.86 in the preceding fiscal
year, an increase of 45%. Monthly gas prices represented by the EPNG Permian
Basin index increased from $1.43 in 1996 to $2.32 in 1997. The Company's gas
gathering revenues are based both on "back-to-back" contracts and tariff
contracts. Increases in natural gas prices directly affect the revenues under
the 'back-to-back' contracts but do not significantly impact operating margins
as gas gathering is generally based on "tariff" arrangements. Higher prices also
affect the overall production of natural gas as producers are encouraged to
invest larger amounts in exploration, development and rework. Liquids prices
were also higher than in prior years particularly in the third and fourth
quarter of fiscal 1997.
OPERATING REVENUES. Operating revenues increased $5,005,500 or 38% over the
prior year. Revenues from gas gathering activities increased $4.8 million. New
acquisitions in 1997 added $.9 million to revenue, and higher gas prices on
existing joint ventures increased revenue by approximately $2.7 million.
Additional volumes transported on gas gathering systems increased revenues by
$1.2 million. Revenues from marketing activities increased $.7 million as a
result of higher gas prices and additional volume. Revenues from Caddo Gas
increased $.6 million as a result of an 86% increase in volumes and additional
sales made
7
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to third parties. All other activities including the Company's oil and gas
production, delivery and other miscellaneous income increased revenue by $.2
million over 1996.
The above increases in revenues were offset by $.7 million as a result of
the change in accounting for Castex LP from consolidation to the equity method
of accounting. Also, revenues at Fort Cobb decreased $.2 million as a result of
a decrease in volumes of 20%. Weather in Caddo County, Oklahoma was wet during
the irrigation season and dry during the fall drying season. The decrease in
volumes was somewhat offset by higher gas purchase prices which were passed
through to customers.
OPERATING MARGIN. Operating margins decreased $303,600 in 1997 from 1996.
Operating margins from properties owned throughout the periods increased
approximately $500,000 due largely to higher gas prices. Also, operating margins
from Venture, purchased in March 1996, were $167,000 in 1997. These increases
were offset by reduced operating margins from Fort Cobb of $203,700 due to
reductions in sales related to weather, the sale of Castex Energy, Inc. in
October 1996, and the change in accounting for Castex LP. Operating margins from
Castex LP were $630,000 in 1996.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased
$94,400. The acquisition of Venture Resources, Inc. in March 1996, additions and
expansions to existing properties, and additional depletion on certain producing
properties due to redefining the full cost pools increased depreciation by
$349,000. These increases were offset by the decrease in depletion from Castex
LP due to the change in method of accounting for the investment in this
partnership.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense
decreased $644,300 in 1997 from 1996. This decrease was due primarily to the
effect of closing the Houston office of GPC ($72,000); reduction in corporate
expenses, ($321,200) and the change in accounting for Castex LP ($345,000).
Corporate expense decreased because of the termination in April 1996 of services
provided under an agreement for investment banking services and a decrease in
salaries and wages due to bonuses and incentives provided for in 1996. These
decreases were offset by increases in accounting and legal fees due to the
addition of Castex LP and the complexities involved in financial and tax
reporting.
OTHER INCOME (EXPENSE). Other income and expense includes interest income
and expense, loss on disposal of assets, income from equity investment in
partnership and minority interest. Interest expense increased $140,300 in 1997
over 1996 as a result of promissory notes of $759,600 issued in fiscal 1997,
interest and commitment fees on the Guarantee Notes issued in July 1996 and
interest and commitment fees relating to the extension of certain bridge loans.
Interest expense decreased $119,600 due to the change in accounting for Castex
LP.
The loss on the disposal of assets of $344,800 in 1997 includes the loss on
the sale of the Guymon Pipeline, the sale of the Company's interest in CEI and
the loss on assets associated with the Houston office of GPC. These losses were
offset by the gain on a pipeline system which was included in the purchase of
Venture Resources, Inc. in March 1996.
Income from equity in partnerships includes the Company's share of the net
income of $295,500 from Castex LP for 1997. This investment was made in January
1996 and, because the Company had a majority interest in the general partner,
was consolidated in 1996. Income, net of minority interest, was $53,000 for the
two months Castex LP was owned in the year ended February 29, 1996. Equity
investments in partnerships acquired with Venture in March 1996 contributed
$170,300 in 1997.
NET EARNINGS (LOSS). Net earnings increased $318,100 in fiscal 1997 over
fiscal 1996. Earnings increased approximately $80,000 from properties owned
during 1997 and 1996 and $644,000 from a reduction in general and administrative
expenses. Earnings also increased $242,000 and $243,000 with the purchase of an
equity interest in Castex LP in January 1996 and all of the common stock of
Venture Resources, Inc. in March 1996, respectively. These increases in earnings
were offset by an increase in
8
<PAGE>
interest expense of $260,000 due to additional borrowings and commitment fees
and net losses on the disposal of assets which were $393,000 more than in fiscal
1996.
LOSS APPLICABLE TO COMMON STOCK. The loss applicable to common stock
decreased to $1,283,300 from $2,415,700 in 1996. This change in the net loss
applicable to common stock was due to an increase in net earnings of $318,100
and decrease in the provision for preferred dividends of $814,300. Increases in
preferred dividends and amortization of offering costs, and the charge for
redemption of Series C were offset by gains resulting from the revaluation of
preferred stock due to the Recapitalization.
LIQUIDITY AND CAPITAL RESOURCES.
The Company has substantially improved its financial condition through the
implementation of the Recapitalization. The Company's percent of debt to total
capital, after the results of the Recapitalization, is approximately 14%. The
net working capital has improved from $.4 million in 1997 to $3.0 million in
1998. The increase is due to the sale of the Castex LP limited partnership and
the sale and exchange of properties in connection with terminating certain joint
venture arrangements.
The Company has in place an operating line of credit agreement with a bank
with maximum borrowings of $500,000. As of February 28, 1998, the amount
available to the Company under this operating line of credit was $162,000.
The Company has retained the services of an investment banker with
experience in helping growth-oriented companies in the oil and gas industry. The
investment advisor is expected to assist the Company in obtaining reasonably
priced long-term debt or equity capital to finance its acquisition strategies.
The Company has approximately $2.0 million in cash and short-term investments
which it expects to invest in natural gas properties.
Payments for debt service in fiscal 1999 are estimated to be about $800,000.
The Company believes that cash generated from operations and the payments
received on notes receivable will be sufficient to meet these debt service
requirements and fund expected system additions (estimated to be less than
$200,000) required to maintain the competitive position of the gas gathering and
processing assets. In addition, the Company expects to acquire additional
systems which complement its strategy of developing core geographic areas. The
Company expects to be able to finance these acquisitions with existing cash
reserves and additional long-term debt supported by cash flows from acquired
properties.
FACTORS AFFECTING FUTURE RESULTS.
As discussed in Item 1, the Company completed a Recapitalization which
converted its previously existing preferred stocks into subordinated notes,
common stock and common stock warrants. The Recapitalization reduced the cash
requirements for preferred dividends from approximately $2.2 million annually to
$.1 million for interest. One of the principal objectives of the
Recapitalization was to facilitate access to reasonably priced capital to enable
the Company to build enhanced stockholder value through the execution of certain
strategies. These strategies include, among other things, i) focusing on
gathering, processing , transporting and marketing of natural gas, ii) expanding
the Company's asset base in core geographic areas, iii) developing a niche that
will create demand for our services, and iv) acquiring or constructing
properties in one or more new core areas.
The Company must provide services to its customers, primarily producers, at
a competitive price. Therefore, in order to be successful the Company must
contain its costs in line with industry competitors. The Company's access to
reasonably priced long-term capital will have a significant effect on its
ability to acquire additional properties which will increase operating margins
to enable us to spread our fixed overhead costs over a larger asset base. The
Company believes that the Recapitalization, the retention of an investment
advisor with experience in growing middle market oil and gas companies and
experienced operating management will allow the Company to access capital and
find properties which can provide attractive returns. However, there can be no
assurance that the Company will be successful in this endeavor.
9
<PAGE>
The Company's ability to generate long-term value for the common stockholder
is dependent upon the successful acquisition of additional mid-stream assets
which compliment the Company's core business at costs which provide for
reasonable returns. There are many companies participating in the midstream
segment of the natural gas industry, many with resources greater than the
Company. Greater competition for profitable operations can increase prices and
make it more difficult to acquire assets at reasonable multiples of cash flow.
The Company believes that it will be able to compete in this environment and
will be able to find attractive investments which compliment its existing
properties; however, it is not possible to predict competition or the effect
this will have on the Company's operations.
The Company's operations are also significantly affected by factors which
are outside the control of the Company. Gas gathering and processing is
dependent on throughput volume. Throughput on the Company's systems is dependent
on natural gas production which is significantly affected by natural gas prices
as prices affect the willingness of producers to invest the required capital to
obtain geological and geophysical information, drill development or exploratory
wells, and to rework or maximize production on existing wells. Natural gas
prices have recently stabilized at levels which should provide adequate
incentive to producers; however, there is no assurance that such prices will
remain at current levels, and that producers will continue to react positively
to the current prices.
The Company's revenues, particularly in its retail operations, are also
affected by weather. Much of the retail demand is for crop irrigation and
drying. Favorable precipitation in the growing season and hot, dry weather in
the fall can significantly reduce demand for natural gas.
YEAR 2000 ISSUES
The "year 2000 issue" is the result of computer programs being written using
two digits, rather than four digits, to identify the year in a date field. Any
computer programs using such a system, and which have date sensitive software,
will not be able to distinguish between the year 2000 and the year 1900. This
could result in miscalculations or an inability to process transactions, send
invoices or engage in similar normal business activities.
The Company has in place Year 2000 compliant systems for its financial and
accounting functions. The Company does not have computer systems in place in
other areas which would require modification. Therefore, the Company believes
that the financial impact of the "Year 2000 issue" will not be significant.
ITEM 7. FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Certified Public Accountants............................ F-1
Consolidated Balance Sheets as of February 28, 1998 and 1997.................. F-2
Consolidated Statements of Operations for the years ended February 28, 1998
and February 28, 1997........................................................ F-3
Consolidated Statement of Stockholders' Equity for the years ended February
28, 1998 and February 28, 1997............................................... F-4
Consolidated Statements of Cash Flows for the years ended February 28, 1998
and February 28, 1997........................................................ F-5
Notes to Consolidated Financial Statements.................................... F-6
</TABLE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
None.
10
<PAGE>
PART III.
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference from the Gateway Energy Corporation Proxy
Statement for Annual Meeting of Stockholders to be held July 16, 1998, under the
captions ELECTION OF DIRECTORS, LIST OF CURRENT EXECUTIVE OFFICERS OF THE
COMPANY, and ADDITIONAL INFORMATION--Compliance with Section 16(a) of the
Securities Exchange Act of 1934.
ITEM 10. EXECUTIVE COMPENSATION
Incorporated by reference from the Gateway Energy Corporation Proxy
Statement for Annual Meeting of Stockholders to be held July 16, 1998, under the
caption EXECUTIVE COMPENSATION.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from the Gateway Energy Corporation Proxy
Statement for Annual Meeting of Stockholders to be held July 16, 1998, under the
captions GENERAL and ELECTION OF DIRECTORS.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the Gateway Energy Corporation Proxy
Statement for Annual Meeting of Stockholders to be held July 16, 1998, under the
captions CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
The following index sets forth the documents and schedules filed with this
annual report on Form 10-KSB.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF DOCUMENT
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
3(a) Restated Certificate of Incorporation, filed as Exhibit 3.1 to Registrant's Form 8 dated October 17,
1991.*
3(b) Certificate of Amendment of Restated Certificate of Incorporation dated March 3, 1997.*
3(c) Certificate of Amendment of Restated Certificate of Incorporation dated July 29, 1996.*
3(d) Certificate of Amendment of Restated Certificate of Incorporation dated July 29, 1995.*
3(e) Certificate of Amendment of Restated Certificate of Incorporation dated January 12, 1995 filed as Exhibit
3.8 to Annual Report on Form 10-KSB for the year ended February 29, 1996.*
10(a) 1994 Incentive and Nonqualified Stock Option Plan filed as part of the Gateway Energy Corporation 1994
Proxy Statement, Schedule 14-A.*
10(b) Employment agreement with Donald L. Anderson.*
11 Statement Regarding Computation of Earnings Per Share.**
21 Subsidiaries**
27 Financial Data Schedule**
</TABLE>
- ------------------------
* Incorporated by reference.
** Included in SEC 10-KSB filing only.
(b) REPORTS ON FORM 8-K None
11
<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)
By: /s/ L. J. HORBACH
-----------------------------------------
L. J. Horbach
CHAIRMAN & CEO
By: /s/ NEIL A. FORTKAMP
-----------------------------------------
Neil A. Fortkamp
EXECUTIVE VICE PRESIDENT &
CHIEF FINANCIAL OFFICER
Date: May 28, 1998
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.
NAME TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ L. J. HORBACH
- ------------------------------ Director May 28, 1998
L. J. Horbach
/s/ NEIL A. FORTKAMP
- ------------------------------ Director May 28, 1998
Neil A. Fortkamp
/s/ MICHAEL T. FADDEN
- ------------------------------ Director May 28, 1998
Michael T. Fadden
/s/ JOHN B. EWING
- ------------------------------ Director May 28, 1998
John B. Ewing
/s/ CHARLES A. HOLTGRAVES
- ------------------------------ Director May 28, 1998
Charles A. Holtgraves
/s/ DONALD L. ANDERSON
- ------------------------------ Director May 28, 199
Donald L. Anderson
/s/ NIC PILGER
- ------------------------------ Director May 28, 1998
Nic Pilger
/s/ ABE YEDDIS
- ------------------------------ Director May 28, 1998
Abe Yeddis
12
<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 28,
1998 and 1997, 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 28, 1998 and 1997, and the
consolidated results of their operations and their consolidated cash flows for
the years then ended in conformity with generally accepted accounting
principles.
GRANT THORNTON LLP
Lincoln, Nebraska
May 22, 1998
F-1
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
FEBRUARY 28,
--------------------------
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents........................................................... $ 439,800 $ 329,500
Certificate of deposit.............................................................. 2,750,000 --
Trade accounts receivable, less allowance for doubtful accounts of $15,100 in
1997.............................................................................. 906,800 2,834,700
Notes receivable--current portion................................................... 1,370,900 --
Inventories......................................................................... 121,700 55,200
Prepaid expenses and other assets................................................... 311,200 367,500
------------ ------------
Total current assets.............................................................. 5,900,400 3,586,900
Property and Equipment, at cost
Gas gathering, processing and transportation........................................ 9,425,200 11,857,100
Office furniture and other equipment................................................ 539,100 317,300
------------ ------------
9,964,300 12,174,400
Less accumulated depreciation and amortization...................................... 1,858,800 1,839,000
------------ ------------
8,105,500 10,335,400
Other Assets
Assets held for sale................................................................ -- 3,024,900
Notes receivable, less current portion.............................................. 868,600 --
Equity investment in partnership.................................................... 326,300 370,000
Note receivable--related party...................................................... -- 298,700
Other............................................................................... 185,200 499,900
------------ ------------
1,380,100 4,193,500
------------ ------------
$ 15,386,000 $ 18,115,800
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Notes payable....................................................................... $ 915,300 $ 379,300
Current maturities of long-term debt................................................ 671,200 199,100
Accounts payable.................................................................... 1,057,300 2,357,000
Accrued expenses and other liabilities.............................................. 243,700 300,000
------------ ------------
Total current liabilities......................................................... 2,887,500 3,235,400
Preferred dividends payable........................................................... -- 960,700
Long-term debt, less current maturities............................................... 1,184,500 1,173,600
Minority interests.................................................................... -- 184,500
Preferred stock of subsidiary (liquidation value of $537,500 at February 28, 1997).... -- 358,500
Mandatory redeemable preferred stock (liquidation value of $8,336,900 at February 28,
1997)................................................................................ -- 6,394,700
Stockholders' Equity
Preferred stock (liquidation value of $9,400,000 at February 28, 1997).............. -- 9,400
Common stock--authorized, 17,500,000 shares of $.25 par value; issued and
outstanding 14,457,400 shares in 1998 and 1,929,800 shares in 1997................ 3,614,400 482,500
Additional paid-in capital.......................................................... 15,896,500 12,334,900
Accumulated deficit................................................................. (8,196,900) (7,018,400)
------------ ------------
11,314,000 5,808,400
------------ ------------
$ 15,386,000 $ 18,115,800
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-2
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
----------------------------
1998 1997
------------- -------------
<S> <C> <C>
Operating revenues
Natural gas sales................................................................ $ 9,736,600 $ 16,190,000
Transportation and processing.................................................... 930,500 1,869,800
Other............................................................................ 13,600 77,100
------------- -------------
10,680,700 18,136,900
Operating costs and expenses
Cost of natural gas purchased.................................................... 7,213,000 12,630,000
Operation and maintenance........................................................ 2,102,900 2,317,600
Depreciation and amortization.................................................... 743,200 995,500
General and administrative....................................................... 2,037,400 1,670,800
------------- -------------
12,096,500 17,613,900
------------- -------------
Operating profit (loss)........................................................ (1,415,800) 523,000
Other income (expense)
Equity in earnings of partnerships............................................... 406,900 465,800
Gain (loss) on disposal of assets................................................ 398,000 (344,800)
Interest and other income........................................................ 222,300 73,000
Interest expense and conversion costs............................................ (776,200) (425,600)
------------- -------------
251,000 (231,600)
------------- -------------
Earnings (loss) before income taxes............................................ (1,164,800) 291,400
Income taxes....................................................................... 12,000 66,000
------------- -------------
Net earnings (loss)............................................................ (1,176,800) 225,400
Provision for preferred dividends.................................................. -- 1,508,700
------------- -------------
Loss applicable to common stock................................................ $ (1,176,800) $ (1,283,300)
------------- -------------
------------- -------------
Basic and diluted loss per common share............................................ $ (0.08) $ (0.95)
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<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, 1996.................... $ 7,900 26,976,100 $ 269,800 $9,275,600 $(4,984,500) $4,568,800
Redemption of mandatory redeemable Series C
preferred stock............................ -- -- -- (693,000) -- (693,000)
Issuance of stock for cash and services (net
of issuance costs of $502,300)............. 1,700 2,662,600 26,600 1,732,600 -- 1,760,900
Amortization of issue costs on mandatory
redeemable preferred stock................. -- -- -- (482,100) -- (482,100)
Compensation under stock award plans........ -- -- -- (34,800) -- (34,800)
Preferred stock dividends................... -- -- -- -- (2,259,300) (2,259,300)
Preferred stock conversions to common
stock...................................... (200) 18,606,600 186,100 1,467,300 -- 1,653,200
Revaluation of preferred stock due to
Recapitalization........................... -- -- -- 1,069,300 -- 1,069,300
Net earnings................................ -- -- -- -- 225,400 225,400
Reduction in shares, one for twenty-five
reverse stock split........................ -- (46,315,500) -- -- -- --
----------- ---------- --------- ---------- ------------ ----------
Balance at February 28, 1997................ 9,400 1,929,800 482,500 12,334,900 (7,018,400) 5,808,400
Preferred stock conversions to common
stock...................................... (9,400) 12,372,900 3,093,200 3,301,500 -- 6,385,300
Recapitalization costs...................... -- 10,000 2,500 (342,400) -- (339,900)
Net loss.................................... -- -- -- -- (1,176,800) (1,176,800)
Conversion of promissory note............... -- 120,000 30,000 20,000 -- 50,000
Purchase and retirement of common stock..... -- (1,300) (300) -- (1,700) (2,000)
Issuance of warrants and options to
non-employees.............................. -- -- -- 132,200 -- 132,200
Issuance of stock for dividends............. -- 26,000 6,500 45,500 -- 52,000
Debt conversion costs....................... -- -- -- 404,800 -- 404,800
----------- ---------- --------- ---------- ------------ ----------
Balance at February 28, 1998................ $ -- 14,457,400 $3,614,400 $15,896,500 $(8,196,900) $11,314,000
----------- ---------- --------- ---------- ------------ ----------
----------- ---------- --------- ---------- ------------ ----------
</TABLE>
The accompanying notes are an integral part of this statement.
F-4
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
Cash flows from operating activities
Net earnings (loss).................................................................. $(1,176,800) $ 225,400
Adjustments to reconcile net earnings (loss) to net cash provided by (used in)
operating activities
Equity in undistributed earnings of partnerships................................... (290,000) (288,500)
Depreciation, depletion and amortization........................................... 743,200 995,500
(Gain) loss on disposal of assets.................................................. (398,000) 344,800
Noncash interest expense, net...................................................... 516,200 85,000
Other.............................................................................. 19,800 45,600
Increase (decrease) in cash and cash equivalents, net of businesses acquired,
resulting from changes in:
Trade accounts receivable........................................................ 1,927,900 (911,700)
Inventories...................................................................... (66,500) 15,600
Prepaid expenses and other current assets........................................ 73,200 (368,900)
Accounts payable................................................................. (1,299,700) 1,003,500
Accrued expenses and other liabilities........................................... (56,300) (60,500)
----------- -----------
Net cash provided by (used in) operating activities............................ (7,000) 1,085,800
----------- -----------
Cash flows from investing activities
Capital expenditures................................................................. (819,800) (697,600)
Proceeds from sale of property and partnership interests............................. 3,423,300 841,500
Purchase of certificate of deposit................................................... (2,750,000) --
Acquisitions of businesses, net of cash acquired of $134,200 in 1997................. (40,800) (1,265,600)
Payments on notes receivable......................................................... 270,500 --
Decrease in cash and cash equivalents as a result of the deconsolidation
of Castex LP....................................................................... -- (1,172,800)
Other................................................................................ (12,500) (155,000)
----------- -----------
Net cash provided by (used in) investing activities.................................. 70,700 (2,449,500)
----------- -----------
Cash flows from financing activities
Decrease in restricted and escrowed cash............................................. 2,100 803,700
Proceeds from borrowings............................................................. 2,672,000 3,478,700
Payments on borrowings............................................................... (2,608,700) (3,761,400)
Proceeds from sale of preferred stock................................................ -- 1,438,000
Proceeds from issuance of common stock............................................... -- 30,100
Preferred dividends paid............................................................. -- (1,523,800)
Other................................................................................ (18,800) (344,700)
----------- -----------
Net cash provided by financing activities............................................ 46,600 120,600
----------- -----------
Net change in cash and cash equivalents................................................ 110,300 (1,243,100)
Cash and cash equivalents at beginning of year......................................... 329,500 1,572,600
----------- -----------
Cash and cash equivalents at end of year............................................... $ 439,800 $ 329,500
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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") and all its wholly-owned and majority-owned subsidiaries and
joint venture investments. The Company's investments in joint ventures are
accounted for using the proportional consolidation method. All significant
intercompany transactions have been eliminated in consolidation.
In October 1996, the Company sold a majority-owned subsidiary, Castex
Energy, Inc. ("CEI"). CEI, among other things, served as the general partner for
Castex Energy 1995 L.P. ("Castex LP"). The sale of CEI resulted in the Company
no longer controlling the general partner of Castex LP; therefore, in 1997 the
Company deconsolidated its 66% limited partner interest in Castex LP and
reported such interest using the equity method as of the beginning of fiscal
year 1997. The Castex LP investment was included in assets held for sale through
September 1997 (See Note B).
The Company purchases, develops, owns, and operates natural gas gathering
and pipeline systems and related facilities in the Gulf Coast and Southwestern
states of Texas, Oklahoma, Louisiana and in offshore Texas state waters. The
Company also operates a natural gas distribution company in Oklahoma.
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 costs 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 6 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.
Impairment losses are 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, based on presently available estimates and current circumstances, has
determined that no impairment loss should be recognized at February 28, 1998.
F-6
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
3. ASSETS HELD FOR SALE
Assets held for sale are stated at the lower of cost or market.
4. 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.
5. 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 expected to
apply 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.
6. STOCK-BASED COMPENSATION
Compensation for stock-based awards to employees is measured using the
intrinsic method. This method recognizes compensation when the fair value of the
underlying common stock exceeds the exercise price of the instrument.
7. EARNINGS PER COMMON SHARE
In 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
128, EARNINGS PER SHARE. Basic earnings per share is computed by dividing the
loss applicable to common stock (net earnings or loss less provision for
preferred dividends) by the weighted average number of common shares outstanding
during the period. Diluted earnings per share is computed by dividing net
earnings or loss applicable to common stockholders by the weighted average
number of common shares outstanding after giving effect to all potentially
dilutive common shares that were outstanding during the period. Potential
dilutive common shares are not included in the computation of diluted earnings
per share if they are anti-dilutive. For 1998 and 1997, the diluted loss per
common share is the same as basic since the effect of potentially dilutive
common shares arising from convertible debt and outstanding stock options and
warrants was anti-dilutive.
The weighted average number of common shares outstanding used in the
computation of basic and diluted earnings per share for 1998 and 1997 were
14,318,900 and 1,351,000, respectively.
8. REVERSE STOCK SPLIT
All references in the consolidated financial statements referring to common
shares, options and warrants, and loss per common share amounts have been
adjusted to give retroactive effect to a one for twenty-five reverse split
effected on March 4, 1997, to holders of record on that date.
F-7
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
9. 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.
10. RECENT ACCOUNTING PRONOUNCEMENTS
The FASB has issued two new standards which are effective for reporting
periods beginning after December 15, 1997. SFAS No. 130, REPORTING COMPREHENSIVE
INCOME, requires additional disclosures with respect to certain changes in
assets and liabilities that previously were not required to be reported as
results of operations for the period. The Company will begin making the
additional disclosures required by SFAS No. 130 in the first quarter of fiscal
1999. SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION, requires financial and descriptive information with respect to
"operating segments" of an entity based on the way management makes internal
operating decisions. The Company will begin making the disclosures required by
SFAS No. 131 with financial statements for the period ending February 28, 1999.
NOTE B--RECAPITALIZATION
Effective March 1, 1997, the Company's preferred stockholders approved the
restructuring of all nine series of its preferred stock. As part of the
restructuring the Company's common stockholders authorized a one for twenty-five
reverse split and a reduction of authorized common shares from 75,000,000 to
17,500,000 (collectively the "Recapitalization").
The significant components of the Recapitalization, together with the
applicable accounting effects, are as follows:
- Pursuant to elections by the Series G preferred stockholders, the Company
exchanged $7,769,800 stated value of the Series G mandatory redeemable
preferred stock plus accrued dividends of $505,200 for $585,900 of 10%
subordinated notes, 5,866,500 shares of common stock and 29,700 common
stock purchase warrants and cancelled all Series G preferred stock.
- The Company exchanged the Series O preferred stock held by Pipeline
Capital, Inc. ("PCI") for 214,000 shares of common stock and cancelled the
promissory note of $298,700 due to the Company from PCI.
- Pursuant to elections by all other preferred stockholders, the Company
exchanged $9,961,500 stated value of Series A (GPC), B, J, K, L, M, & N
preferred stock plus accrued dividends of $403,400, for $585,800 of 10%
subordinated notes, 6,292,400 shares of common stock and 32,300 common
stock purchase warrants and cancelled all preferred stock of these series.
The subordinated notes are dated March 1, 1997, with an interest rate of
10%, payable quarterly. Annual equal principal payments begin on March 1, 2000,
and continue through March 1, 2004. The aggregate subordinated notes have a
4.36% interest in the cash distributions and liquidation proceeds of Castex LP
after recovery of the Company's investment and the payment of any related income
taxes.
F-8
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--RECAPITALIZATION (CONTINUED)
Payments totaling $20,000 will be paid to holders of the subordinated notes in
June 1998, representing their interest in the net after-tax proceeds from the
sale of Castex LP.
As a result of the Recapitalization, the carrying value of each series of
preferred stock outstanding at February 28, 1997 was adjusted to fair value,
resulting in a decrease in the provision for preferred dividends and loss
applicable to common stock of approximately $2,393,000 for the year ended
February 28, 1997.
NOTE C--ACQUISITIONS AND DIVESTITURES
All acquisitions have been accounted for as purchases; operations of the
companies and businesses acquired or disposed have been included in the
accompanying consolidated financial statements from their respective dates of
acquisition or through their respective dates of disposal.
FISCAL YEAR 1998
In September 1997, the Company sold its limited partnership interest in
Castex LP and other oil and gas producing properties for $3,152,000 in cash and
a note receivable of $350,000 that was paid in full in April 1998. These assets
had been classified as of February 28, 1997 as Assets Held For Sale. The
transaction resulted in a gain of $180,100 which is reflected as gain on
disposal of assets in the accompanying statement of operations.
In September 1997, the Company entered into a Settlement Agreement with
Shoreham Pipeline Company ("Shoreham"), a former joint venture partner, to
dissolve all of the joint ventures between the Company and Shoreham and to
settle litigation between the parties. Under the Agreement the Company
transferred its interest in six operating joint ventures to Shoreham in exchange
for $2,700,000 and Shoreham's interest in nine joint venture properties with an
approximate fair value of $450,000. The Company also acquired Shoreham's 20%
minority interest in Gateway Offshore Pipeline Company (formerly Shoreham
Gathering Company) and transferred an offshore pipeline system to Shoreham as
part of the settlement. Of the $2,700,000, $540,000 was paid at closing. The
remaining balance is a note receivable of $2,160,000 which is payable in 24
equal monthly payments beginning December 1, 1997, with interest at 9% per
annum. The note is without collateral. The Company recognized a gain on the
transaction of $220,300, net of closing costs and legal fees. The net gain is
reflected in gain (loss) on disposal of assets in the accompanying statement of
operations.
In January 1998, the Company reached an agreement with Ghere-Smith Interest,
Inc. ("GSI") to purchase their 1% minority interest in Fort Cobb Fuel Authority,
Caddo Gas Gathering Company and WestOK Marketing Company and terminate the
management agreements between the parties which would have expired October 31,
1999. The Company paid GSI $169,500 which included $125,600 for the termination
of the management agreements. The termination cost has been included in general
and administrative expense in the accompanying statement of operations.
FISCAL YEAR 1997
Effective March 1, 1996, GPC acquired all of the outstanding common stock of
Venture Resources, Inc. ("Venture"), a company with interests in natural gas
gathering and transmission properties located in Texas, Louisiana and Oklahoma
for approximately $1,305,000. The acquisition cost was equal to the fair
F-9
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C--ACQUISITIONS AND DIVESTITURES (CONTINUED)
value of the net assets acquired. In April 1996, Venture acquired the remaining
50% partnership interest in MV Pipeline for $100,000.
In October 1996, the Company sold its sixty percent interest in CEI to its
minority shareholders in exchange for the cancellation of notes payable to
officers of $138,800, the forgiveness of the intercompany payable to CEI of
$218,500 and the forgiveness of an intercompany note and accrued interest from
CEI to the Company in the amount of $222,000. In addition, the Company paid CEI
$20,000 in consideration for a lease cancellation. The transaction resulted in a
net loss of $75,900 which has been charged to loss on disposal of assets.
In November and December 1996, the Company sold two pipelines for cash of
$866,300, resulting in a loss of $154,100. The net loss has been charged to loss
on disposal of assets.
PRO FORMA
The following unaudited pro forma consolidated results of operations for the
years ended February 28, 1998 and February 28, 1997 assume that the transactions
discussed occurred at the beginning of fiscal 1997:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Revenues........................................................ $ 7,409,000 $ 11,408,000
Net loss........................................................ (2,353,400) (1,382,000)
Loss applicable to common stock................................. (2,353,400) (2,900,000)
Basic loss per common share..................................... (.16) (2.15)
</TABLE>
NOTE D--JOINT VENTURE OPERATIONS
During 1998 and 1997, The Company participated in 17 natural gas gathering,
processing or delivery joint ventures. All but one of the joint ventures were
operated by the Company's joint venture partners. Management fees to the joint
venture partners were a base fee plus a percentage of qualifying expenditures or
a percentage of net operating income, as defined. The joint venture agreements
contained provisions for increased income participation by the Company until
specified payout levels were attained. The agreements had 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 $135,000 in 1998 and $239,000 in 1997. As described in Note C, the
Company dissolved 15 joint ventures with Shoreham in September 1997. As of
February 28, 1998, the Company is involved in two remaining joint venture
arrangements with $940,200 of total net property and equipment included in the
accompanying balance sheet.
F-10
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE E--NOTES PAYABLE
Notes payable consist of the following:
<TABLE>
<CAPTION>
FEBRUARY 28,
----------------------
1998 1997
---------- ----------
<S> <C> <C>
Operating line of credit.............................................. $ 338,000 $ 316,000
Note payable to bank.................................................. 550,000 --
Other................................................................. 27,300 63,300
---------- ----------
$ 915,300 $ 379,300
---------- ----------
---------- ----------
</TABLE>
The Company's current operating line of credit provides for maximum
available borrowings of $500,000 through August 1998. Interest is payable
monthly at 6.7% per annum and principal is due on demand, or if no demand is
made, at maturity. The lines are collateralized by the Company's certificate of
deposit.
As of February 28, 1998, the Company has a note payable to a bank for
$550,000, due March 3, 1998 with interest at 6.7%. The note is collateralized by
the Company's certificate of deposit. This note was repaid in full in March
1998.
NOTE F--LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
FEBRUARY 28,
--------------------------
1998 1997
------------ ------------
<S> <C> <C>
Subordinated notes................................................ $ 1,005,600 $ --
Promissory notes.................................................. 595,500 1,022,600
Note payable to PCI............................................... 254,600 350,100
------------ ------------
1,855,700 1,372,700
Less current maturities........................................... 671,200 199,100
------------ ------------
$ 1,184,500 $ 1,173,600
------------ ------------
------------ ------------
</TABLE>
SUBORDINATED NOTES
In connection with the Recapitalization discussed in Note B, the Company
issued subordinated promissory notes with a face amount of $1,171,700. The
stated interest rate is 10% payable quarterly with equal annual principal
payments beginning on March 1, 2000 and continuing through March 1, 2004. The
Company calculated the fair market value of the notes to be $978,000 at March 1,
1997 and recorded the difference between fair value and the face amount as
discount on subordinated notes. The discount is being amortized to interest
expense using the interest method over the term of the subordinated notes. Such
charge to interest expense was $27,700 for the year ended February 28, 1998. As
a result, the effective interest rate of the subordinated notes is 15%.
The subordinated notes also have an aggregate 4.36% interest in the proceeds
of the sale of Castex LP after deducting the Company's investment in the limited
partnership and taxes payable on any gain on disposal. An amount of $20,000 has
been accrued for this interest as the Company's interest was sold in September
1997. The Company expects to pay the subordinated noteholders in June 1998.
F-11
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE F--LONG-TERM DEBT (CONTINUED)
PROMISSORY NOTES
During fiscal 1997, GPC issued $759,000 of convertible promissory notes,
proceeds of which were used to repay bridge loans in connection with the
purchase of Venture. The promissory notes are without collateral and bear
interest at the rate of 10% per annum payable monthly. The principal sum of the
promissory notes is due two years from the date of issuance. In fiscal 1998, the
Company redeemed $214,000 of these convertible promissory notes at stated value
plus accrued interest.
The original conversion privileges of the Venture promissory notes allowed
noteholders to convert at any time into common stock of the Company at a
pre-reverse stock split price of $.40 per share. The promissory notes did not
contain the customary anti-dilution language to effect a change in the
conversion price in the case of stock splits, stock dividends or other
capitalization changes. As a result, in August 1997, certain noteholders
tendered their promissory notes for conversion at $.40 per share. In lieu of
conversion, the Company and the noteholders agreed at that time to i) a one year
extension on the notes, and ii) a thirty day window for conversion in the event
the Company called the promissory notes as consideration for the noteholders not
converting their notes.
As a result of this agreement, the Company recorded conversion costs and a
credit to paid-in capital of $306,800 which represents the difference in the
market price of the Company's common stock on the date of the agreement and the
conversion price of $.40 multiplied by the number of shares issued upon
conversion. Such conversion costs are reflected in interest expense and
conversion costs in the accompanying statement of operations.
In the opinion of Company's management and Board of Directors, the proper
conversion price for the Venture promissory notes is $10.00 per share, after
giving effect to the one for twenty-five reverse stock split. Subsequent
attempts to negotiate an amendment to the promissory notes to reflect the
correct conversion price have not been successful. Although the intent of the
parties was clear at the issuance of the notes, the promissory noteholders have
indicated to the Company they intend to submit their promissory notes for
conversion at the rate of $.40 per share. The Company has informed the
noteholders that the notes will be converted at $10.00 per share.
Although the final resolution of this dispute cannot be presently
determined, it is not expected to have a material impact on the Company's
results of operations or financial position.
In July 1996, the Company issued promissory notes to stockholders totaling
$150,000. At the time of issuance 18,000 shares of common stock and warrants to
purchase 36,000 shares of the Company's common stock at $3.00 per share were
issued in full consideration for interest and commitment fees in connection with
the notes. All principal payments are due July 25, 1998. As collateral for the
notes, the Company pledged all of its ownership interests in three joint
ventures. The notes may be converted to common stock at any time prior to July
25, 1998, at the rate of $5.00 per common share. The holders of the notes also
agreed to guarantee the Operating Line of Credit in the aggregate amount of
$150,000.
In March, 1997, H & F Investments, a partnership comprised of two executive
officers of the Company acquired one of the promissory notes for $50,000 and
substituted their guarantee for $50,000 for the Operating Line of Credit. The
Company subsequently repaid the promissory note in November 1997.
In September 1997, a noteholder of a $50,000 promissory note and the Company
agreed to amend the conversion price included in the original promissory note to
$.4167 per share as consideration for the effect
F-12
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE F--LONG-TERM DEBT (CONTINUED)
of the Recapitalization on the convertible promissory note. The noteholder
elected to convert the note into 120,000 shares of the Company's common stock.
The amendment of the original promissory note resulted in conversion costs of
$28,000, equal to the difference in the market price of the Company's common
stock and the conversion price on the date of the amendment multiplied by the
120,000 shares issued at conversion. Such conversion cost is reflected in
interest expense in the accompanying statement of operations.
As a result of the effects of the Recapitalization on the convertible
promissory notes, the Company and the noteholders of the remaining $50,000 of
promissory notes agreed in December 1997 to amend the original promissory notes
as follows:
- The conversion price was changed to $.25 per share.
- The Company issued attached Stock Purchase Rights to acquire 50,000
additional common shares at $.25 per share.
- The Company issued detachable warrants to purchase 200,000 additional
shares of common stock at a price of $.53 per share, the market price on
the amendment date.
- The maturity date was extended to July 25, 2002, although the holders may
exercise the conversion rights or exercise the Stock Purchase Rights or
Warrants anytime after July 25, 1998.
- In addition, the Company issued a subscription agreement allowing the
noteholders to purchase $50,000 non-interest bearing convertible
promissory notes due July 25, 2002. The notes are convertible at $.25 per
common share and include attached Stock Purchase Rights to acquire 50,000
additional shares at $.25 per share. The subscription agreement expires
July 25, 1998.
The above amendments resulted in conversion costs to the Company of $195,600
which are being amortized to interest expense through July 1998, the earliest
exercise date. During the year ended February 28, 1998, $47,100 has been charged
to interest expense and included in the accompanying statement of operations.
NOTE PAYABLE TO PCI
In May 1996, the Company issued to Pipeline Capital, Inc. ("PCI"), formerly
a related party, a promissory note for $480,000. The note is payable in
forty-eight equal monthly installments of $10,000 beginning July 1, 1996. The
Company, may, at its option, prepay all of the note at a discount rate of 8%;
therefore, the note was originally recorded at the discounted value of $423,000
and payments are applied to principal and interest based on the above rate.
In April 1996, the Company issued a promissory note for $200,000 in payment
of investment advisory and financing services. The note was without collateral,
bore interest at the rate of 9% per annum and was payable in twenty-four equal
monthly installments of $9,100 commencing April 1, 1996. The note was fully paid
in February 1998.
F-13
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE F--LONG-TERM DEBT (CONTINUED)
Aggregate future maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1999.............................................................. $ 671,200
2000.............................................................. 84,300
2001.............................................................. 246,000
2002.............................................................. 206,600
2003.............................................................. 206,600
Thereafter........................................................ 441,000
</TABLE>
NOTE G--SPONSORSHIP AGREEMENT
The Company had an agreement with PCI, whereby PCI was to raise funds for
the Company through private placements and public offerings of the Company's
securities. The agreement also provided for an "Exit Amount" due PCI of a 10%
cumulative participation in the net operating income, as defined, from the
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 were reduced by cumulative prior cash payments and stock issued
to PCI.
In May 1996, the Company and PCI terminated their relationship and entered
into a Settlement and Purchase Agreement, which provided for the following:
- The Company repurchased 56.25 shares of Series C Preferred Stock owned by
PCI, which represented 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.
- PCI executed a new promissory note for approximately $279,000 plus
interest at 7% per annum representing all advances to PCI to date. All
principal and interest on this note was to 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 PCI one share of its Series O preferred stock which was
non-voting and had no dividend rights. The Series O preferred stock
entitled PCI to receive 10% of the consideration paid for the Company in a
sale, merger or exchange less the outstanding balance of the promissory
note executed by PCI. In the event there was no sale, merger or exchange
prior to July 1, 2000, the Company was obligated to obtain an appraisal to
value the Company and PCI was to receive an amount equal to 10% of the
fair market value appraisal, less the promissory note due to the Company.
As a result of this settlement, the Company recorded an increase to the
provision for preferred dividends of $693,000.
In connection with the Recapitalization discussed in Note B, effective March
1, 1997, PCI exchanged its Series O preferred stock for 214,000 shares of the
Company's common stock and canceled the promissory note due to the Company.
F-14
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE H--PREFERRED STOCK
Preferred stock consisted of the following at February 28, 1997:
<TABLE>
<S> <C>
NON-VOTING PREFERRED STOCK OF SUBSIDIARY
Series A, 10% cumulative, participating convertible, $.01 par
value, $1,000 stated value, authorized 750 shares; issued
537.5 shares. (recorded at fair value due to
Recapitalization)........................................... $ 358,500
---------
---------
NON-VOTING MANDATORY REDEEMABLE PREFERRED STOCK
Series O, $1.00 par value, 1 share authorized and issued...... $ 512,700
Series G, 12% cumulative, convertible, $1.00 par value,
$1,000 stated value, authorized 10,000 shares;
issued 7,769.8 shares.
(recorded at fair value due to Recapitalization)............ 5,882,000
---------
$6,394,700
---------
---------
NON-VOTING PREFERRED STOCK
Series B, 12% cumulative, convertible, $1.00 par value,
$1,000 stated value, authorized 4,000 shares; issued 1,650
shares...................................................... $ 1,700
Series J, 10% cumulative, convertible, $1.00 par value,
$1,000 stated value, authorized 750 shares; issued 747.5
shares...................................................... 700
Series K, 12%, cumulative, convertible, $1.00 par value,
$1,000 stated value, authorized and issued 750 shares....... 800
Series L, 12%, cumulative, convertible $1.00 par value,
$1,000 stated value, authorized 255 shares; issued 238
shares...................................................... 200
Series M, 12%, cumulative, convertible, $1.00 par value,
$1,000 stated value, authorized 500 shares; issued 437.5
shares...................................................... 400
Series N, 12%, cumulative, convertible $1.00 par value,
$1,000 stated value, authorized 21,000 shares; issued 5,601
shares...................................................... 5,600
---------
$ 9,400
---------
---------
</TABLE>
RECAPITALIZATION
As discussed in Note B, on March 1, 1997, the Company redeemed all of its
outstanding preferred stock and related accrued and unpaid dividends in exchange
for 12,158,900 shares of common stock, 62,000 of common stock purchase warrants
and $1,171,700 in subordinated promissory notes.
SERIES G AMORTIZATION
Issue costs were being amortized to the initial mandatory date and are
reflected as preferred dividends in the accompany statements of operations using
the interest method. The provision for preferred dividends includes $482,100 of
such amortization in 1997. See also Note B regarding adjustment of all preferred
stock to fair value as a result of the March 1997 Recapitalization.
F-15
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE H--PREFERRED STOCK (CONTINUED)
REDEMPTIONS AND CONVERSIONS
The Company redeemed 97 shares of Series G in 1997 and converted 1,882
shares into 714,500 common shares in 1997. In 1997 Series B stockholders
converted 100 shares into 15,100 shares of common stock. In 1997, 17 shares of
Series L and 62.5 shares of Series M were converted into 3,200 and 11,500 shares
of common stock, respectively.
AUTHORIZED SHARES
During 1997, the Company decreased its authorized preferred stock from
1,750,000 shares to 10,000 shares.
NOTE I--INCOME TAXES
The provision for income taxes for the years ended February 28, 1998 and
1997 consisted of the following:
<TABLE>
<CAPTION>
1998 1997
--------- -----------
<S> <C> <C>
Current............................................................... $ 12,000 $ 346,000
Benefit of tax net operating loss carryforwards....................... -- (280,000)
--------- -----------
Total................................................................. $ 12,000 $ 66,000
--------- -----------
--------- -----------
</TABLE>
The differences between income taxes computed using the average statutory
federal income tax rates of 34% and the provision for income taxes for the years
ended February 28, 1998 and 1997 follow:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Taxes at statutory rate............................................. $ (396,000) $ 99,000
State income taxes, net of federal tax benefit...................... 3,000 32,000
Increase (decrease) in valuation allowance.......................... 172,000 (198,000)
Goodwill amortization and other nondeductible expenses.............. 228,000 117,000
Other............................................................... 5,000 16,000
----------- -----------
$ 12,000 $ 66,000
----------- -----------
----------- -----------
</TABLE>
F-16
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I--INCOME TAXES (CONTINUED)
The tax effects of the temporary differences that give rise to deferred tax
assets and liabilities as of February 28, 1998 and 1997 follow:
<TABLE>
<CAPTION>
FEBRUARY 28,
--------------------------
1998 1997
------------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.................................... $ 618,000 $ 566,000
Property and equipment.............................................. 257,000 121,000
Other............................................................... 136,000 59,000
------------- -----------
1,011,000 746,000
Valuation allowance................................................. (1,011,000) (746,000)
------------- -----------
$ -- $ --
------------- -----------
------------- -----------
</TABLE>
The valuation allowance increased $265,000 in 1998 and decreased $1,941,000
in 1997. The changes in both years result primarily from the increase in, or
expiration of, net operating loss carryforwards.
At February 28, 1998, the Company had approximately $1,819,000 federal net
operating loss carryforwards which may be applied against future taxable income
and which expire from 1999 through 2013.
NOTE J--STOCK-BASED BENEFIT PLANS
The Company has a stock option plan and several agreements under which key
employees have been granted incentive and nonqualified stock options or warrants
to purchase the Company's common stock. Generally, the options are exercisable
within three years of the date of grant and expire ten years after the date of
grant. All options or warrants issued have exercise prices of not less than 100%
of the fair market value on date of grant.
The following is a summary of stock option activity and related information:
<TABLE>
<CAPTION>
1998 1997
---------------------------- ------------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
--------- ----------------- ----------- -----------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year............... 14,188 $ 6.06 14,188 $ 6.06
Granted........................................ 310,750 .72 --
--------- -----------
Outstanding at end of year..................... 324,938 $ .94 14,188 $ 6.06
--------- -----------
--------- -----------
Options available for grant at end of year..... 7,000 7,000
--------- -----------
--------- -----------
</TABLE>
F-17
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J--STOCK-BASED BENEFIT PLANS (CONTINUED)
The following table summarizes information about options outstanding at
February 28, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------------------------------
WEIGHTED AVERAGE OPTIONS EXERCISABLE
REMAINING ------------------------------
RANGE OF NUMBER CONTRACTUAL WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
EXERCISE PRICE OUTSTANDING LIFE (YEARS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- -------------- ----------- ------------------- ----------------- ----------- -----------------
<S> <C> <C> <C> <C> <C>
$ 0.47 to 0.70 260,750 9.52 $ 0.63 175,750 $ 0.68
1.19 to 1.25 51,188 9.87 1.19 51,188 1.19
6.25 13,000 6.76 6.25 13,000 6.25
----------- -----------
$ 0.47 to 6.25 324,938 0.94 239,938 1.09
----------- -----------
----------- -----------
</TABLE>
The fair value of the Company's stock-based awards to employees was
estimated using a Black-Scholes option pricing model. The Black-Scholes model
was developed for use in estimating the fair value of traded options which have
no vesting restrictions and are fully transferable. In addition, the Black-
Scholes model requires the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's stock-based awards have
characteristics significantly different from those traded options, and because
changes in the subjective input can materially affect the fair value estimate,
in management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its stock-based awards to
employees. The fair value of the Company's stock-based awards was estimated
assuming no expected dividends and the following weighted average assumptions:
<TABLE>
<CAPTION>
1998
-----
<S> <C>
Expected life in years....................................................... 8.1
Expected stock price volatility.............................................. 88%
Risk-free interest rate...................................................... 5.8%
</TABLE>
There were no options granted in fiscal 1997.
For pro forma purposes, the estimated value of the Company's stock-based
awards to employees is amortized over the options' vesting period. The Company's
pro forma information follows:
<TABLE>
<CAPTION>
1998
-------------
<S> <C>
Net loss--as reported................................................ $ (1,176,800)
Net loss--pro forma.................................................. (1,353,500)
Basic net loss per share--as reported................................ (.08)
Basic net loss per share--pro forma.................................. (.09)
</TABLE>
NOTE K--OTHER EMPLOYEE BENEFIT PLAN
The Company makes available to its employees a 401(k) plan which covers all
employees at least 21 years of age with one year of service. The Company matches
employee contributions up to a maximum of 2% of salary. The Company can make
additional discretionary contributions with approval of the Board of Directors.
Total Company contributions to the plan were $9,300 and $10,400 for the
years ended February 28, 1998 and 1997, respectively.
F-18
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE L--LEASES
The Company leases office space in Omaha, Nebraska and Houston, Texas under
lease agreements expiring in August 1999, and January 2003, respectively. The
lease in Houston is collateralized by a Letter of Credit issued by the Company
in favor of the lessor in the amount of $101,100. The Letter of Credit is
collateralized by the Company's short-term investment.
The Company also has various month-to-month equipment operating leases. Rent
expense from all leases totaled approximately $332,000 and $512,000 during 1998
and 1997 respectively.
The following is a schedule by years of future minimum annual rental
payments under noncancelable operating leases at February 28, 1998:
<TABLE>
<CAPTION>
YEAR ENDING
- ------------------------------------------------------------------------
<S> <C>
1999.................................................................... $ 88,200
2000.................................................................... 82,900
2001.................................................................... 71,700
2002.................................................................... 71,700
2003.................................................................... 71,700
Later years............................................................. 6,000
----------
$ 392,200
----------
----------
</TABLE>
NOTE M--RELATED PARTY TRANSACTIONS
During the year ended February 28, 1997, PCI received cash payments of
$167,500 and 9,000 shares of common stock at a total recorded cost of $36,400,
for various services related to preferred stock fundraising and property
acquisitions. A director received $6,400 for services related to stock
subscription administration.
Included in accounts payable at February 28, 1997, are amounts due PCI of
$24,000. The $298,700 note receivable from a related party represented a note
from PCI for advances to and expenses paid on its behalf related to fundraising
activities. The note was collateralized by the Series O preferred stock, bore
interest at 7% and was due no later than July 1, 2000. This note was cancelled
in March 1998 with the exchange of Series O preferred stock for common stock in
connection with the Recapitalization.
NOTE N--COMMITMENTS AND CONTINGENCIES
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 O--SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest was $256,000 and $268,900 in 1998 and 1997,
respectively. Cash paid for income taxes was $84,400 and $16,000 in 1998 and
1997, respectively.
F-19
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE O--SUPPLEMENTAL CASH FLOW INFORMATION (CONTINUED)
NONCASH INVESTING AND FINANCING ACTIVITIES
During 1998, the Company exchanged all of its outstanding preferred stock
(except Series C) with a stated value of $17,731,300 plus accrued dividends of
$908,600 for 12,158,900 shares of common stock, $1,171,700 of subordinated notes
and 62,000 common stock purchase warrants. The Company also exchanged its Series
C preferred stock issued to PCI for 214,000 shares of common stock and cancelled
the promissory note of $298,700 due to the Company. The Company issued 10,000
shares of common stock in connection with certain costs of the Recapitalization.
In addition, 26,000 shares of common stock were issued as payment for accrued
dividends of $52,000.
As described in Note C, during 1998, the Company sold its limited
partnership interest in Castex LP and its oil and gas properties for $3,502,000.
In connection with the sale, the Company issued a note receivable to the buyer
for $350,000. The Company also entered into a settlement agreement with Shoreham
whereby it transferred its interest in six operating joint ventures to Shoreham
in return for a $2,160,000 note receivable, $540,000 in cash, interest in nine
joint venture properties valued at $450,300 and Shoreham's 20% ownership in
Gateway Offshore Pipeline Company ("Offshore"). Offshore's ownership of an
offshore pipeline system was transferred to Shoreham as part of the settlement.
During 1998, the Company converted a $50,000 promissory note into 120,000
shares of the Company's common stock.
During 1997, approximately 851,800 shares of restricted common stock were
issued as part of various preferred stock conversions and for offering costs of
$243,200 and debt issuance costs of $188,400. Certain Series G mandatory
redeemable preferred stockholders converted 1,882 shares with a carrying value
of approximately $1,653,000, which included approximately $229,000 of issue
costs that were charged to additional paid-in capital, to 714,500 shares of
common stock.
As described in Note G, the Company redeemed the Series C mandatory
redeemable preferred stock and recorded a charge to additional paid-in capital
of $693,000. Also during 1997, the carrying value of Series G and Series O
preferred stock was decreased by $587,200 through a credit to additional paid-in
capital, representing amortization of issue costs of $482,100 offset by an
adjustment to fair value of $1,069,300 as a result of the Recapitalization
discussed in Note B.
During 1997, bridge notes of $375,000 were exchanged for promissory notes of
$367,100 and common stock and common stock warrants of $7,900. The Company also
sold its investment in CEI in exchange for cancellation of notes payable of
$138,800.
As described in Note C, during 1997 the Company purchased all the capital
stock of Venture Resources, Inc. for $1,305,000. In connection with the
acquisition, $66,000 of liabilities were assumed.
NOTE P--FINANCIAL INSTRUMENTS
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, CERTIFICATE OF DEPOSIT AND NOTES RECEIVABLE: The
carrying amounts of cash and cash equivalents, certificate of deposit, notes
receivable and the note receivable-related party approximate fair value because
of the relatively short maturity or recent issuance of those instruments.
F-20
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE P--FINANCIAL INSTRUMENTS (CONTINUED)
NOTES PAYABLE: 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 approximated their carrying values due to
adjustments required as part of the Recapitalization described in Note B. The
fair values were based on the estimated fair values of common stock, warrants
and subordinated notes issued in connection with the Recapitalization.
The estimated fair values of the Company's financial instruments are as
follows:
<TABLE>
<CAPTION>
FEBRUARY 28, 1998 FEBRUARY 28, 1997
---------------------------- ----------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT OF FAIR VALUE OF AMOUNT OF FAIR VALUE OF
ASSETS ASSETS ASSETS ASSETS
(LIABILITIES) (LIABILITIES) (LIABILITIES) (LIABILITIES)
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents................. $ 439,800 $ 439,800 $ 329,500 $ 329,500
Certificate of deposit.................... 2,750,000 2,750,000 -- --
Note receivable-related party............. -- -- 298,700 298,700
Notes receivable.......................... 2,239,500 2,239,500 -- --
Financial liabilities:
Notes payable............................. (915,300) (915,300) (379,300) (379,300)
Long term debt............................ (1,855,700) (1,851,900) (1,372,700) (1,364,400)
Mandatory redeemable preferred stock...... -- -- (6,394,700) (6,394,700)
</TABLE>
NOTE Q--SEGMENTS, MAJOR CUSTOMERS AND CONCENTRATIONS
The Company operates in only one segment of business. The Company is engaged
in the gathering, transportation and marketing of natural gas and provides
services including gas processing, separation and dehydration. The Company sells
natural gas to gas marketing companies, industrial users and retail customers in
Texas, Louisiana and Oklahoma.
The following table sets forth the Company's major customers and their
percent of total revenue:
<TABLE>
<CAPTION>
1998 1997
----- -----
<S> <C> <C>
Customer A............................................................ 21% 28%
Customer B............................................................ 2% 16%
Customer C............................................................ 11% 6%
</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
F-21
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE Q--SEGMENTS, MAJOR CUSTOMERS AND CONCENTRATIONS (CONTINUED)
similarly affected by the changes in economic or other conditions. The Company's
accounts receivable are generally not collateralized.
The Company has a certificate of deposit with a financial institution for
$2,750,000. The balance is insured by the Federal Deposit Insurance Corporation
up to $100,000. The Company has collateralized certain loans at this financial
institution with this certificate of deposit. The Company believes it is not
exposed to any significant credit risk. The Company also has an uncollateralized
note receivable from its former joint venture partner totaling $1,939,500 at
February 28, 1998. All payments are current and the Company expects no future
collection problems.
NOTE R--NON-EMPLOYEE COMMON STOCK OPTIONS AND WARRANTS
During fiscal 1998 and 1997, the Company issued common stock warrants in
connection with various preferred stock and debt issuances and for services
provided. The warrants entitled the holders to purchase shares of the Company's
common stock at prices ranging from $2.50 to $11.25 per share and were
exercisable at various dates through April 2000. In conjunction with the
Recapitalization, the exercise price for substantially all warrants outstanding
at March 1, 1997 was modified to $3.00 per share. Warrants with expiration dates
prior to March 1, 1999, were extended to that date.
In fiscal 1998, the Company issued 150,000 common stock warrants at $1.25 to
its investment adviser in connection with services related to the
Recapitalization, 200,000 common stock warrants at $0.53 to certain noteholders
in connection with the resolution of disagreements regarding the original terms
of promissory notes issued in 1997, 62,000 common stock warrants at $3.00 to
various preferred stock shareholders, and 40,000 common stock options at $0.53
to non-employee directors. The Company valued these warrants and options using
the Black-Sholes model with the following weighted average assumptions:
risk-free interest rate of 5.8%, expected average life of approximately four
years and expected stock price volatility of 88%, and recorded the value of such
options and warrants as recapitalization costs, interest expense or general and
administrative expenses.
The following is a summary of the status of the Company's non-employee
options and warrants for 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
----------------------------------- -----------------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
OPTIONS/WARRANTS EXERCISE PRICE OPTIONS/WARRANTS EXERCISE PRICE
---------------- ----------------- ---------------- -----------------
<S> <C> <C> <C> <C>
Outstanding at beginning of
year.......................... 208,800 $ 6.32 53,600 $ 8.46
Issued.......................... 452,000 0.87 155,200 5.58
Cancelled....................... (208,800) 6.32 -- --
Reissued........................ 208,800 3.00 -- --
-------- -------
Outstanding at end of year...... 660,800 1.71 208,800 6.32
-------- -------
-------- -------
</TABLE>
F-22
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE R--NON-EMPLOYEE COMMON STOCK OPTIONS AND WARRANTS (CONTINUED)
The following table summarizes information about options and warrants
outstanding at February 28, 1998.
<TABLE>
<CAPTION>
OPTIONS/WARRANTS OUTSTANDING AND EXERCISABLE
------------------------------------------------------
NUMBER WEIGHTED AVERAGE
OUTSTANDING REMAINING
AND CONTRACTUAL WEIGHTED AVERAGE
RANGE OF EXERCISE PRICES EXERCISABLE LIFE (YEARS) EXERCISE PRICE
- -------------------------------------------------------------- -------------- ------------------- -----------------
<S> <C> <C> <C>
$0.53 to 0.56................................................. 240,000 3.33 $ 0.54
1.25......................................................... 150,000 7.00 1.25
3.00......................................................... 270,800 1.69 3.00
-------
$0.53 to 3.00................................................. 660,800 3.49 1.71
-------
-------
</TABLE>
NOTE S--FOURTH QUARTER ADJUSTMENTS
Aggregate year end adjustments recorded in the fourth quarter reduced net
earnings by approximately $585,400. The adjustments included conversion costs of
$383,100 related to amendments made to certain convertible promissory notes
(Note F) and a reduction of accounts receivable of $202,300.
NOTE T--INVESTMENT IN CASTEX LP
The following presents summarized financial information of Castex LP carried
at equity in fiscal 1998 and 1997. The Company sold its equity investment in
September 1997; accordingly, 1998 operating financial information is for the six
months ended August 1997.
<TABLE>
<CAPTION>
FEBRUARY 28,
1997
----------------
<S> <C> <C>
Condensed Balance Sheet:
Current assets....................................................... $ 4,139,600
Property and equipment, net.......................................... 15,279,300
Other assets......................................................... 419,400
----------------
$ 19,838,300
----------------
----------------
Current liabilities.................................................. $ 6,284,500
Noncurrent liabilities............................................... 10,634,300
Partnership equity................................................... 2,919,500
----------------
$ 19,838,300
----------------
----------------
<CAPTION>
1998 1997
------------ ----------------
<S> <C> <C>
Condensed Statements of Operations:
Operating revenue.................................................... $ 5,209,400 $5,474,600
Operating Profit..................................................... 1,863,200 1,806,800
Net earnings......................................................... 611,900 401,600
</TABLE>
The Company's equity investment in Castex LP was $2,022,700 as of February
28, 1997 and was included in assets held for sale in the 1997 consolidated
balance sheet. The Company's equity in earnings
F-23
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE T--INVESTMENT IN CASTEX LP (CONTINUED)
of Castex LP was $307,200 and $295,400 in 1998 and 1997, respectively, and is
included in equity in earnings of partnerships in the consolidated statements of
operations.
The Company's equity investment in Castex LP constitutes substantially all
of the Company's oil and gas operations; accordingly, 1998 and 1997 oil and gas
disclosures relate only to the Company's equity in Castex LP through the date of
sale of its equity investment. The Company's equity in net capitalized costs of
Castex LP was $10,100,000 at February 28, 1997 and the Company's equity in costs
incurred in oil and gas producing activities by Castex LP was approximately
$7,854,000 and $4,800,000 for 1998 and 1997, respectively.
F-24
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SUPPLEMENTAL FINANCIAL DATA
(UNAUDITED)
The following 1997 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 SFAS No. 69, DISCLOSURES ABOUT OIL AND
GAS PRODUCING ACTIVITIES. As discussed in Note A, the Company accounted for its
investment in Castex LP using the equity method. This investment constitutes
substantially all of the Company's oil and gas operations; accordingly, oil and
gas disclosures relate only to the Company's equity in Castex LP. Disclosures
related to 1998 are not included since the Company sold its investment in Castex
LP in September 1997.
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.
For the year ended February 28, 1997, the Company's equity in proved
reserves for Castex LP was approximately 100,000 bbls and 12,900,000 MCF and the
Company's equity in discounted future net cash flows of Castex LP was
$14,300,000.
F-25
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
EXHIBIT 11
<TABLE>
<CAPTION>
YEAR ENDED
----------------------------
FEBRUARY 28, FEBRUARY 28,
1998 (2) 1997 (2)
------------- -------------
<S> <C> <C>
Weighted average number of common shares outstanding for basic earnings per share... 14,318,900 1,351,000
Potential dilutive common shares:
Add shares issuable pursuant to warrant agreements less shares assumed repurchased
at the average market price..................................................... 9,800(1) 12,900(1)
Add shares issuable pursuant to stock options less shares assumed repurchased at
the average market price........................................................ 100(1) 1,500(1)
Add shares issuable from assumed conversion of convertible promissory notes....... 861,500(1) 58,300(1)
Add additional dilutive shares issuable assuming conversion of all preferred stock
into common stock............................................................... -- 4,525,600(1)
------------- -------------
Tentative number of shares for computation of diluted earnings per share............ 15,190,300 5,949,300
------------- -------------
------------- -------------
Loss applicable to common stock..................................................... $ (1,176,800) $ (1,283,300)
Add back provision for preferred dividends relating to convertible preferred
stock........................................................................... -- 1,508,700
Add back interest expense for convertible promissory notes assumed converted...... 66,300 47,400
------------- -------------
Tentative earnings (loss) computation for diluted earnings per share................ $ (1,110,500) $ 272,800
------------- -------------
------------- -------------
Basic loss per common share......................................................... $ (0.08) $ (0.95)
------------- -------------
------------- -------------
Diluted loss per common share (3)................................................... $ (0.08) $ (0.95)
------------- -------------
------------- -------------
</TABLE>
- ------------------------
(1) Not used in diluted earnings per share calculation as effect would be
antidilutive.
(2) All share data reflects the retroactive effect of a one for twenty-five
reverse split, effected March 4, 1997.
(3) Determined based upon the loss applicable to common stock divided by the
weighted average number of common shares since the effect of potential
dilutive shares is anti-dilutive.
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
EXHIBIT 21--SUBSIDIARIES
<TABLE>
<CAPTION>
COMPANY STATE PERCENT OWNED
- ------------------------------------------------------------------------------------ ------------ --------------
<S> <C> <C>
Gateway Pipeline Company............................................................ Texas 100%
Gateway Energy Marketing.......................................................... Texas 100%
Gateway Processing Company........................................................ Texas 100%
Fort Cobb Fuel Authority, L.L.C..................................................... Oklahoma 100%
Gateway Offshore Pipeline Company................................................... Nebraska 100%
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> FEB-28-1998
<PERIOD-START> MAR-01-1997
<PERIOD-END> FEB-28-1998
<CASH> 439,800
<SECURITIES> 2,750,000
<RECEIVABLES> 906,800
<ALLOWANCES> 0
<INVENTORY> 121,700
<CURRENT-ASSETS> 5,900,400
<PP&E> 9,964,300
<DEPRECIATION> 1,858,800
<TOTAL-ASSETS> 15,386,000
<CURRENT-LIABILITIES> 2,887,500
<BONDS> 1,184,500
0
0
<COMMON> 3,614,400
<OTHER-SE> 7,699,600
<TOTAL-LIABILITY-AND-EQUITY> 15,386,000
<SALES> 10,680,700
<TOTAL-REVENUES> 10,680,700
<CGS> 7,213,000
<TOTAL-COSTS> 10,059,100
<OTHER-EXPENSES> 2,037,400
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 776,200
<INCOME-PRETAX> (1,164,800)
<INCOME-TAX> 12,000
<INCOME-CONTINUING> (1,176,800)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,176,800)
<EPS-PRIMARY> (.08)
<EPS-DILUTED> (.08)
</TABLE>
