<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
/ / ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
/X/ TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE EXCHANGE ACT OF 1934
For the transition period from March 1, 1999 to December 31, 1999
Commission File No. 1-4766
--------------------------
GATEWAY ENERGY CORPORATION
(Name of small business issuer in its charter)
DELAWARE 44-0651207
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
500 DALLAS STREET, SUITE 2615, HOUSTON, TX 77002
(Address and Zip Code of principal executive offices)
(713) 336-0844
(Issuer's telephone number)
--------------
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered
None None
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 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 period ended December
31, 1999, were $5,979,413.
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 March 24, 2000 was $3,900,856. The
number of shares outstanding of the issuer's common equity as of March 24,
2000, was 15,312,208.
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 May 25, 2000.
Transitional Small Business Disclosure Format (check one): Yes No X
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<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
Gateway Energy Corporation (the "Company"), a Delaware corporation,
was incorporated in 1960 and entered its current business in 1992. 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 500 Dallas Street, Suite 2615, Houston, Texas
77002, and its telephone number is (713) 336-0844. Gateway conducts all of its
business through its wholly owned subsidiary companies, Gateway Pipeline
Company, Gateway Offshore Pipeline Company, Gateway Energy Marketing Company,
Fort Cobb Fuel Authority, L.L.C. and Gateway Processing Company, except for a
small amount of activity in its two remaining joint ventures and one
partnership.
On November 4, 1999 the Board of Directors approved a change in the
Company's fiscal year-end from February 28/29 to December 31. Accordingly,
this report covers the period from March 1, 1999 through December 31, 1999,
and prior period data are presented for the comparable period of the prior
year. Fiscal year 1999 refers to the twelve months ended February 28, 1999.
In the following discussion, "Mcf" refers to thousand cubic feet of
natural gas; "Bbl" refers to barrel, of approximately 42 U.S. gallons; "Btu"
refers to British thermal unit, a common measure of the energy content of
natural gas; "MMBtu" refers to millions of British thermal units.
DESCRIPTION OF BUSINESS
The Company owns and operates natural gas gathering, transportation
and distribution systems and related facilities in Texas, Oklahoma and
Louisiana, and offshore in state and federal waters of the Gulf of Mexico.
These systems include approximately 900 miles of pipeline ranging in size from
2" to 20" with a combined daily throughput capacity of approximately 500
million cubic feet. The Company gathers natural gas from producing properties
owned by others and transports that gas to primary transmission pipelines. In
some cases, the Company assumes title along with possession of the gas and
sells the gas to a marketing company or markets directly to end users,
including agricultural, residential, industrial and commercial users, under
"back-to-back" purchase and sale contracts designed to minimize commodity
risk. Otherwise the Company transports the gas for a fee per MMBtu. Sometimes
the Company owns and sells natural gas liquids from a portion of the gas
streams, an additional source of revenue. For the ten months ended December
31, 1999, approximately 66% of the Company's operating margin was generated
under purchase and sale contracts and approximately 34% of the operating
margin was generated by fee-based contracts.
During fiscal year 1999 the Company acquired Abtech Resources, Inc.
("Abtech") and its license on a patented process that efficiently rejects
nitrogen from natural gas streams. The Company, through Gateway Processing
Company, intends to exploit this niche by owning and operating gas treating
plants and related facilities, and by acquiring working interests in high
nitrogen natural gas reserves where necessary to assist in creating demand for
the Company's treating services. See additional information on the acquisition
of Abtech in Note B to the Consolidated Financial Statements.
Because the Company's operating margin is generated under contracts
which have a stated fee per unit of production (Mcf, MMBtu, or Bbl) gathered
or transported, or is generated under back-to-back purchase and sales
contracts, the Company's operating margin is relatively insensitive to the
commodity prices of natural gas and oil. The primary impact on the Company of
the level of gas and oil commodity prices is their impact on drilling
activities. High prices tend to generate cash flow and thus enthusiasm for
producers to accelerate drilling; low prices tend to have the opposite effect.
2
<PAGE>
BUSINESS GROWTH STRATEGY
The Company's growth strategy is to increase earnings and cash flows
through the enhancement of existing systems and facilities, to construct or
acquire additional pipelines, plants and facilities and to expand its
marketing efforts. The Company also intends to exploit the license that it has
to process high-nitrogen natural gas as a result of its acquisition of Abtech.
During the ten months ended December 31, 1999 the Company enhanced
its existing systems by rehabilitating pipelines and facilities to preserve
strategic throughput capabilities, by responding to the needs of producers and
customers and aggressively marketing the Company's services, by continuing to
provide reliable service at reasonable cost and thereby attracting additional
business, and by controlling the Company's operating costs.
Should the future price of natural gas motivate significant
exploration and exploitation drilling, the Company would benefit further from
its presence in proven productive areas, both onshore and offshore in the Gulf
Coast region. With a current throughput volume at less than 10% of the
Company's maximum daily throughput capacity, the Company believes that it will
be able to solicit a significant amount of new marketing and transportation
business.
Successful implementation of the Company's growth strategy will
depend on maintaining an upward trend in earnings and cash flow, and in part
on its ability to secure relatively lower cost conventional financing. With a
long-term debt-to-total capitalization ratio of approximately 9%, and with
aggressively managed cash flows, the Company expects to be able to secure
conventional growth capital financing at a lower cost than that to which it
has previously had access. The Company is actively analyzing its inventory of
projects, and intends to focus its efforts on those with the maximum potential
to provide growth capital and return to shareholders. Funds from operations,
combined with borrowed capital, will be invested in the acquisition or
construction of additional income producing assets.
DISSOLUTION OF JOINT VENTURES
During fiscal year 1998 the Company entered into a Settlement
Agreement with Shoreham Pipeline Company ("Shoreham") to dissolve all of the
joint ventures between the Company and Shoreham and to settle litigation
between the parties. The Settlement Agreement provided for, among other
things, a promissory note for $2,160,000, due in twenty-four monthly
installments beginning December 1, 1997. Beginning July 1, 1998, Shoreham
ceased making the scheduled payments required under the note.
During October and November 1998 the companies entered into mediation
to settle their disputes and avoid costly litigation. On November 24, 1998,
the Company and Shoreham reached an agreement under which the Company
received, in exchange for the previous note: (i) cash of $725,000; (ii) a note
from Shoreham for $400,000, collateralized with certain properties currently
owned by Shoreham, and; (iii) the release of a net profits interest in the
Company's Shipwreck system. The Company began receiving payments toward this
note during January 1999. A portion of the receipts due to the Company under
this note have been assigned in conjunction with the settlement of the
Rosenthal lawsuit as described in ITEM 3 - LEGAL PROCEEDINGS.
As a result of the dissolution of the joint ventures, the Company
hired management and support staff to manage the business, and moved its
corporate headquarters from Omaha, Nebraska to Houston, Texas. The change in
strategy added significant general and administrative costs during fiscal year
1999, reflecting costs of additional personnel, office rent and
telecommunications, legal fees and other office costs.
MAJOR CUSTOMERS AND SUPPLIERS
The Company purchases natural gas from numerous producers and
suppliers, and during the ten months ended December 31, 1999 two major oil and
gas companies supplied 63% and 23% of its total gas purchased. During the
period, all customers with sales exceeding 10% are industrial customers. Gross
sales as a percentage of total revenue to these customers for the ten months
ended December 31, 1999 and 1998 and the fiscal year ended February 28, 1999
are as follows:
3
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, FEBRUARY 28,
--------------------------------------
1999 1998 1999
----------------- ----------------- -----------------
<S> <C> <C> <C>
Owens Corning Fiberglas Corporation................ 17% 17% 17%
Aurora Natural Gas LLC............................. 16% 7% 8%
Dart Container Corporation......................... 15% 12% 12%
</TABLE>
Although these sales constitute a significant portion of total
revenues, they do not represent a significant portion of operating margin
because of back-to-back purchase contracts to supply these major customers.
The Company believes that a loss of a major supplier or customer could be
readily replaced and would not have a material adverse effect on its financial
statements.
COMPETITION
The natural gas industry is highly competitive. The Company competes
against other companies in the gathering, transporting, and marketing business
for gas 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
affiliates of intrastate and 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
activities 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.
Fort Cobb Fuel Authority LLC ("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 the OCC in
1993; Fort Cobb has not filed for an increase in rates since that time. During
2000 the Company intends to file for an increase in its tariff rates. 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 Company, 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.
4
<PAGE>
EMPLOYEES
As of December 31, 1999, the Company had 22 full-time employees.
ITEM 2. DESCRIPTION OF PROPERTY
ONSHORE PROPERTIES
The Company owns 16 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 fee per unit of
production transported; however, one is a 14 mile delivery system which
transports natural gas for sale to industrial users in Ellis County, Texas.
The Company also owns interests in 6 systems through two joint ventures
located in Louisiana and Texas and a partnership in Oklahoma which gather and
transport natural gas under fee arrangements.
The systems are properly maintained and are capable of transporting
natural gas under prescribed pressures. At December 31, 1999, the Company's
onshore systems were comprised of approximately 148 miles of 2" to 10"
pipelines and related compressors, meters, regulators, valves and equipment.
Effective January 1, 2000, the Company entered into contracts for sale of two
non-core properties for an aggregate $1.1 million to two unrelated buyers. One
property was an undivided joint venture interest in a Louisiana pipeline
system partnership. The other property was a pipeline system in south Texas.
See Note P to the consolidated financial statements.
OFFSHORE PROPERTIES
Gateway Offshore Pipeline Company owns pipelines, a related 140' x
70' operating platform, and an onshore terminal facility (the "Crystal Beach"
facility) that services producers primarily 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 137 miles of 4" to 20"
diameter pipelines and related equipment which transport natural gas and
condensate primarily under fee-based contracts.
FORT COBB PROPERTIES
Fort Cobb is a local distribution company serving approximately 2,350
agricultural 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 and easements,
all normally associated with distribution systems.
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 30,000 Mcf per day.
The Crystal Beach facility referred to above has a storage capacity
of approximately 40,000 Bbls and, with minor modifications, has a throughput
capacity of 5,000 Bbls 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 500 Dallas Street, Suite 2615, Houston, Texas 77002.
5
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
In its Form 10-KSB for the fiscal year ended February 28, 1999, the
Company reported on a legal action entitled STANLEY ROSENTHAL V. SHOREHAM
PIPELINE COMPANY, which was filed in District Court of Milam County, Texas on
September 23, 1994. In its Form 8-K dated September 13, 1999 the Company
reported the resolution of the lawsuit.
On September 13, 1999 the Company entered into mediation with
Rosenthal and Shoreham to settle all claims between the parties. As a result
of the mediation, Rosenthal agreed to dismiss the Company from the lawsuit,
and the Company and Rosenthal agreed to release each other from any and all
claims related to the aforementioned action. In consideration, the Company
agreed to assign without recourse its right to receive payments for the
monthly periods from October 1, 1999 through November 1, 2001 to which it is
entitled under its note receivable from Shoreham dated November 18, 1998 in
the original principal amount of $400,000. Such payments include interest at
an annual rate of 7% and total $249,662. The Company will retain its right to
receive the payments, totaling $124,831, due for the monthly periods from
December 1, 2001 through December 1, 2002. In addition, the Company and
Shoreham have agreed to release each other from any claims or controversies
that exist or may arise from the lawsuit.
The financial statements of the Company for the ten months ended
December 31, 1999 include a charge to general and administrative expenses for
$395,414 representing the assignment of the principal portion of the note
receivable from Shoreham of $213,607 and the related legal fees.
From time to time the Company is involved in litigation concerning
its properties and operations. Management does not deem that any other current
litigation will have a material effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
6
<PAGE>
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 under the symbol GNRG. The prices shown reflect
the highest and lowest prices for the Company's common stock for the periods
indicated.
<TABLE>
<CAPTION>
QUARTER ENDED HIGH LOW
------------- ---- ---
<S> <C> <C>
March 31, 1999 ................................... $0.44 $0.26
June 30, 1999 .................................... 0.38 0.22
September 30, 1999 ............................... 0.26 0.19
December 31, 1999 ................................ 0.29 0.16
QUARTER ENDED HIGH LOW
------------- ---- ---
March 31, 1998 ................................... $0.66 $0.44
June 30, 1998 .................................... 1.31 0.59
September 30, 1998 ............................... 0.69 0.41
December 31, 1998 ................................ 0.53 0.31
</TABLE>
HOLDERS
As of December 31, 1999, there were approximately 3,550 shareholders
of the Company's Common Stock.
DIVIDENDS
There have been no dividends declared on the Company's Common Stock
during the ten month periods ended December 31, 1999 and 1998 or the fiscal
year ended February 28, 1999. 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, and the
discussion of the Company's Business beginning in Item 1 of this report,
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
GENERAL
The Company evaluates each of its activities based on the operating
margin it produces. The Company defines operating margin as revenues, less the
cost of purchased gas and operating and maintenance expenses. Management
reviews and evaluates the operations of three main segments--Onshore
operations, Offshore operations and Fort Cobb operations.
7
<PAGE>
<TABLE>
<CAPTION>
TOTAL OPERATIONS
TEN MONTHS ENDED DECEMBER 31, FISCAL YEAR ENDED FEBRUARY 28,
------------------------------------- ------------------------------------
1999 1998 1999 1998
-------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues $5,979,413 $6,387,838 $7,650,797 $10,680,700
Operating margins 1,144,527 1,354,243 1,671,526 1,364,800
Depreciation 648,365 611,283 748,076 743,200
</TABLE>
Operating margins for the ten months ended December 31, 1999
decreased $210,000 from the same ten month period last year. The Onshore
operations increase of $204,000 was more than offset by declines from Fort
Cobb and Offshore operations of $302,000 and $112,000, respectively. Operating
margins for fiscal year 1999 increased $307,000 compared to fiscal year 1998.
Onshore, Offshore and Fort Cobb operations contributed $341,000, $345,000 and
$351,000 of the increase, respectively, partially offset by a decline of
$730,000 due to the fiscal 1998 dissolution of the Shoreham joint ventures.
These segments are discussed individually below in greater detail. During the
ten months ended December 31, 1999 the Company spent $344,737 to construct one
new system and to maintain pipeline systems and facilities both onshore and
offshore. Of that amount $133,915 was charged to expense in the period
incurred, and $210,822 was capitalized. During fiscal year 1999 the Company
spent $908,743 to maintain or rehabilitate pipeline systems and facilities
both onshore and offshore. Of that amount $311,062 was charged to expense in
the period incurred, and $597,681 was capitalized. The Company is actively
evaluating additional opportunities that would significantly increase cash
flows for relatively little capital investment.
<TABLE>
<CAPTION>
ONSHORE OPERATIONS
TEN MONTHS ENDED DECEMBER 31, FISCAL YEAR ENDED FEBRUARY 28,
------------------------------------- ------------------------------------
1999 1998 1999 1998
-------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues $4,288,960 $3,915,261 $4,826,931 $5,814,395
Operating margins 962,741 758,948 970,994 630,202
Depreciation 392,031 375,558 463,347 425,448
</TABLE>
Onshore operations operating margins for the ten months ended
December 31, 1999 increased $204,000 over the same period of the prior year,
due mainly to a 35% increase in daily throughput volumes. The increases were
attributable to assets located in Louisiana and Oklahoma and Texas. Fiscal
year 1999 onshore operations improved over the prior year, in spite of the
prior year inclusion of the operations of the properties which were conveyed
to Shoreham due to the dissolution of the Shoreham joint ventures. Operating
margins increased $341,000, or 54%, over the prior year. The Company operated
its properties for the full year fiscal 1999 with in-house operations
management, instead of relying on joint venture partners and consultants. It
began out-sourcing the compression on its systems, and has realized cost
savings from compressors being properly maintained, and throughput increases
as compressors are appropriately sized for each application.
<TABLE>
<CAPTION>
OFFSHORE OPERATIONS
TEN MONTHS ENDED DECEMBER 31, FISCAL YEAR ENDED FEBRUARY 28,
------------------------------------- ------------------------------------
1999 1998 1999 1998
-------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues $289,899 $581,465 $697,547 $35,715
Operating margins (2,816) 108,804 171,606 (173,533)
Depreciation 110,231 100,882 122,656 70,562
</TABLE>
Operating margins for the ten months ended December 31, 1999
decreased $112,000 from the same period last year as revenues declined
$292,000 and expenses declined $180,000. Throughput volumes declined
approximately 55% while transportation rates per MMBtu transported remained
steady. The expected depletion from connected production was not offset
because the offshore development plans of producers were delayed by the
drastic decline in oil prices in the fall of 1998. The Company expects to see
exploration and development activity of unaffiliated producers pick up
momentum again as oil prices have rebounded and reached their highest levels
in 9 years.
8
<PAGE>
Fiscal year 1999 was very active for the Company's offshore segment,
as the Company expended $248,000 to rehabilitate the Shipwreck platform and
several smaller strategic assets. The Company placed the Crystal Beach
facility, acquired during the prior year, more fully into operation and
secured two transportation agreements with unaffiliated producers. Revenues
increased $662,000 over the prior fiscal year and yielded a net operating
margin of $172,000. The Company continues to evaluate potential projects in
the Gulf of Mexico, both in Texas and federal waters.
<TABLE>
<CAPTION>
FORT COBB OPERATIONS
TEN MONTHS ENDED DECEMBER 31, FISCAL YEAR ENDED FEBRUARY 28,
------------------------------------- ------------------------------------
1999 1998 1999 1998
-------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues $1,400,554 $1,891,112 $2,126,319 $1,558,890
Operating margins 184,602 486,491 528,926 177,684
Depreciation 146,103 134,843 162,073 133,880
</TABLE>
Operating margin for the ten months ended December 31, 1999 declined
from the same period last year by $302,000 mainly due to weather-related
reduction in demand in the spring and summer irrigation season that caused the
ten-month average throughput volumes to decline by 35% from the same period of
the prior year. During 2000 the Company intends to file with the Oklahoma
Corporation Commission for an increase in its tariff rates, which were last
approved by the OCC in 1993. Management believes its rates could be increased
and still remain competitive. Fort Cobb will strive to expand its customer
base by building on its record of excellent customer service at competitive
prices. Fort Cobb receives its supply of natural gas from any of three major
intra-state pipeline companies, allowing it to purchase gas at competitive
prices and ensuring deliverability.
Fort Cobb's fiscal year 1999 performance was its best in several
years. These changes coincided with several significant management changes
made at the utility, and reflect positively on the new management philosophy
and direction of Fort Cobb. Additionally, the weather in its service area was
favorable to both the irrigation and crop-drying seasons, and additional
business was solicited from new hog farms in the area. Operating margins
increased $351,000, or 198% over the prior year. On average for the year, Fort
Cobb's agricultural service represented 71% of its business, and residential
service another 23%. Fort Cobb also services commercial and industrial
customers, and all of its business is seasonal.
OTHER OPERATIONS
The Company, through its wholly owned subsidiary Gateway Processing
Company, acquired Abtech Resources, Inc. during fiscal year 1999 for cash and
stock, and as a result owns a license to a patented process to reject nitrogen
from streams of natural gas. Several projects to construct nitrogen rejection
units employing the patented technology are currently being evaluated for
their investment potential.
During the fall of 1998 Gateway Processing Company participated as a
non-operating working interest owner in the drilling of two natural gas wells.
Each of the two wells was expected to yield high-nitrogen natural gas reserves
and employ the Company's licensed nitrogen rejection process to meet pipeline
specifications. Both wells were uneconomic and were abandoned. The
accompanying consolidated statements of operations for the ten months ended
December 31, 1998 and the fiscal year ended February 28, 1999 include an
impairment charge against earnings of $206,497 reflecting the abandonment of
these projects.
<TABLE>
<CAPTION>
OPERATIONS SUPPORT
TEN MONTHS ENDED DECEMBER 31, FISCAL YEAR ENDED FEBRUARY 28,
------------------------------------ ----------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
General and administrative $1,965,574 $2,539,431 $2,868,704 $2,037,400
Interest income 57,234 159,743 173,080 197,731
Interest expense (137,515) (305,173) (331,494) (776,200)
Other income (expense) (83,686) 69,491 73,492 829,469
</TABLE>
9
<PAGE>
General and administrative expenses for the ten months ended December
31, 1999 decreased $574,000 from the same period of the prior year. The
decrease was due primarily to the prior year inclusion of Shoreham Pipeline
Company bad debt expense and related legal and other costs, plus corporate
office moving costs as described below, partially offset by a current year
increase in legal expense incurred to defend against the Rosenthal lawsuit.
During the ten months ended December 31, 1999 the Company
successfully mediated the lawsuit STANLEY ROSENTHAL V. SHOREHAM PIPELINE
COMPANY in which the Company was named as a defendant by reason of its former
joint venture association with Shoreham Pipeline Company. See the discussion
in ITEM 3 - LEGAL PROCEEDINGS. The financial statements of the Company for the
ten months ended December 31, 1999 reflect a charge to earnings for $395,414
related to this matter.
General and administrative expense for the ten months ended December
31, 1998 and the fiscal year 1999 increased over the prior fiscal year as the
Company recognized bad debt expense, legal fees and related costs of the
settlement with Shoreham, and the non-recurring moving costs described below.
During the ten months ended December 31, 1998 and the fiscal year
ended February 28, 1999, the Company finalized the dissolution of its joint
ventures with Shoreham, a process that began during fiscal year 1998. On
November 24, 1998, the Company and Shoreham reached an agreement under which
the Company received: (i) cash of $725,000; (ii) a note for $400,000,
collateralized with certain properties owned by Shoreham, and; (iii) the
release of a net profits interest in the Company's Shipwreck system. As a
result of the dissolution of the joint ventures, the Company hired management
and support staff who manage its operations in place of the joint venture
partner or contract management companies. This change in strategy added
significant general and administrative costs, reflecting costs of additional
personnel, office rent and telecommunications, legal fees and other office
costs. Such costs were considered essential to equipping the Company with the
appropriate depth of operating and management experience required to implement
the growth strategy. The Company recognized bad debt expense, legal fees and
related costs of the settlement with Shoreham totaling $550,000 during the
fiscal year ended February 28, 1999.
In late 1998 the Company moved its corporate headquarters to Houston,
Texas. Accordingly, the ten months ended December 31, 1998 and the fiscal year
1999 include $198,000 of nonrecurring costs related to this move, which
includes costs of maintaining both offices, employee severance and other
moving costs.
Interest income for all years presented fluctuates directly with the
average certificate of deposit balance, and the balance of the interest
bearing notes receivable from Shoreham.
Interest expense for the ten months ended December 31, 1999 declined
significantly compared to the same period of last year because the prior year
included debt restructure costs recorded as interest expense, and additional
interest incurred on the Gateway Pipeline Company convertible promissory
notes. Fiscal year 1999 interest expense was significantly lower than fiscal
year 1998 due to fiscal year 1998 debt conversion costs of $306,800 and higher
average outstanding debt balance.
LIQUIDITY AND CAPITAL RESOURCES
Going forward, the Company's strategy is to maximize the potential of
currently owned properties, to construct new pipeline systems and treating
facilities, and to acquire properties that meet its economic performance
hurdles. Capital is expected to come from operations, from traditional bank
credit facilities or from strategic alliances with other companies. The
Company has an inventory of projects that it may be successful financing, and
will use the resulting cash flows to service anticipated debt and to
collateralize additional acquisition or expansion borrowings.
The Company has in place an operating line of credit agreement with a
bank that provides for borrowings of up to $0.5 million. As of December 31,
1999 there was $135,000 outstanding under the agreement. The Company believes
that the aggregate working capital available under the credit agreement, from
available funds, and cash flows from operations will be sufficient to fund its
operating and maintenance capital requirements for the foreseeable future.
10
<PAGE>
Natural gas prices as represented by the NYMEX Henry Hub index
averaged $2.43 for the ten months ended December 31, 1999 compared to $2.00
for the same period of the prior year and $1.95 in fiscal 1999. 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 fee
arrangement. However, long-term depression of prices can affect exploration
and development and result in lower or delayed volumes available for
transportation.
FACTORS AFFECTING FUTURE RESULTS
One of the principal objectives of the Company is to enhance
stockholder value through the execution of certain strategies. These
strategies include: (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 to increase
operating margins, enabling fixed overhead costs to be spread over a larger
asset base. The Company believes its experienced personnel 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.
The Company's ability to generate long-term value for the common
stockholder is dependent in part upon the successful acquisition of
additional 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, to drill
development or exploratory wells, and to rework or maximize production on
existing wells. Natural gas prices have recently achieved 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. Above normal 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" caused no business disruption for the Company.
The cost of ensuring compliance of the Company's systems was not significant.
11
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Certified Public Accountants.................................................... 15
Consolidated Balance Sheets as of December 31, 1999 and 1998.......................................... 16
Consolidated Statements of Operations for the ten months ended December 31, 1999 and 1998 and
the fiscal year ended February 28, 1999............................................................ 17
Consolidated Statement of Stockholders' Equity for the ten months ended December 31, 1999
and the fiscal year ended February 28, 1999........................................................ 18
Consolidated Statements of Cash Flows for the ten months ended December 31, 1999 and 1998
and the fiscal year ended February 28, 1999........................................................ 19
Notes to Consolidated Financial Statements............................................................ 20
</TABLE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
None.
12
<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 May 25, 2000, under the
captions ELECTION OF DIRECTORS, LIST OF CURRENT EXECUTIVE OFFICERS OF THE
COMPANY, and COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
ITEM 10. EXECUTIVE COMPENSATION
Incorporated by reference from the Gateway Energy Corporation Proxy
Statement for Annual Meeting of Stockholders to be held May 25, 2000, 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 May 25, 2000, under the
captions SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT and
ADDITIONAL INFORMATION CONCERNING BOARD 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 May 25, 2000, under the
caption 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 Form 10-KSB.
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION OF DOCUMENT
<S> <C>
3(a)* Restated Certificate of Incorporation dated May 26, 1999.
3(b)* Bylaws, as amended through May 26, 1999.
4(a)* Form of the Common Stock Certificate.
10(a)(1) 1994 Incentive and Non-Qualified Stock Option Plan; incorporated by reference to Exhibit 10(a) to
Form 10-KSB for the year ended February 28, 1997.
10(a)(2)* 1998 Stock Option Plan.
10(a)(3)* 1998 Outside Directors' Stock Option Plan.
10(b)(1)* Memorandum of Understanding dated March 17, 1997 re: Michael T. Fadden employment.
10(b)(2) Employment Agreement dated July 1, 1996 with Donald L. Anderson; incorporated by reference to
Exhibit 10(b) to Form 10-KSB for the year ended February 28, 1997.
10(c)* Executive Compensation Plan approved November 19, 1997.
10(d)* Houston Office Lease dated January 20, 1998 with Trizec Allen Center Limited Partnership.
10(e)* Agreement and Plan of Merger dated May 1, 1998 with Abtech Resources, Inc.
11 Statement Regarding Computation of Earnings Per Share.
21 Subsidiaries.
23 Consent of Grant Thornton LLP.
27 Financial Data Schedule.
</TABLE>
* Incorporated by reference to Form 10-KSB for the year end
February 28, 1999.
(b) REPORTS ON FORM 8-K
November 4, 1999 - Change in the Company's fiscal year-end from
February 28/29 to December 31.
13
<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/ M. T. Fadden
---------------------------------------
M. T. Fadden
Chairman, President & CEO
By: /s/ S. D. Heflin
---------------------------------------
S. D. Heflin
CFO and Treasurer
Date: March 30, 2000
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.
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S> <C> <C>
/s/ MICHAEL T. FADDEN Director March 30, 2000
----------------------------------------------
Michael T. Fadden
/s/ JOHN B. EWING Director March 30, 2000
----------------------------------------------
John B. Ewing
/s/ SCOTT D. HEFLIN Director March 30, 2000
----------------------------------------------
Scott D. Heflin
/s/ EARL P. HOFFMAN Director March 30, 2000
----------------------------------------------
Earl P. Hoffman
/s/ CHARLES A. HOLTGRAVES Director March 30, 2000
----------------------------------------------
Charles A. Holtgraves
/s/ L. J. HORBACH Director March 30, 2000
----------------------------------------------
L. J. Horbach
/s/ GARY A. MCCONNELL Director March 30, 2000
----------------------------------------------
Gary A. McConnell
/s/ ABE YEDDIS Director March 30, 2000
----------------------------------------------
Abe Yeddis
</TABLE>
14
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Gateway Energy Corporation
We have audited the accompanying consolidated balance sheet of Gateway
Energy Corporation (a Delaware corporation) and subsidiaries as of December 31,
1999, and the related consolidated statements of operations, stockholders'
equity and cash flows for the ten month period ended December 31, 1999 and the
year ended February 28, 1999. 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 auditing standards generally accepted
in the United States. 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 December 31, 1999, and the consolidated
results of their operations and their cash flows for the ten month period ended
December 31, 1999 and the year ended February 28, 1999 in conformity with
accounting principles generally accepted in the United States.
GRANT THORNTON LLP
Houston, Texas
February 23, 2000
15
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
ASSETS 1999 1998
------------- -------------
(Unaudited)
<S> <C> <C>
Current Assets
Cash and cash equivalents................................................. $ 26,089 $ 152,174
Certificates of deposit................................................... 973,540 915,901
Trade accounts receivable................................................. 1,035,074 1,272,596
Notes receivable - current portion........................................ - 105,167
Inventories............................................................... 59,316 82,086
Prepaid expenses and other assets......................................... 153,642 263,920
Properties held for sale, net............................................. 950,226 -
------------- -------------
Total current assets................................................ 3,197,887 2,791,844
Property and Equipment, at cost
Gas gathering, processing and transportation.............................. 8,634,511 9,802,546
Office furniture and other equipment...................................... 664,061 704,037
------------- -------------
9,298,572 10,506,583
Less accumulated depreciation and amortization............................... 2,695,105 2,420,147
------------- -------------
6,603,467 8,086,436
Other Assets
Notes receivable, less current portion.................................... 119,751 294,833
Equity investment in partnership.......................................... 277,825 300,722
Other..................................................................... 259,067 379,319
------------- -------------
656,643 974,874
------------- -------------
$10,457,997 $11,853,154
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable.......................................................... $ 811,852 $ 669,209
Accrued expenses and other liabilities.................................... 358,649 453,809
Notes payable............................................................. 135,167 -
Current maturities of long-term debt...................................... 292,952 114,872
Proceeds from deferred property sale...................................... 200,000 -
------------- -------------
Total current liabilities.............................................. 1,798,620 1,237,890
Long-term debt, less current maturities...................................... 822,015 1,087,296
Stockholders' Equity
Preferred stock - $1.00 par value; 10,000 shares authorized; no shares
issued and outstanding in 1999 and 1998................................ - -
Common stock - $0.25 par value; 17,500,000 shares authorized; 15,312,208
and 15,242,494 shares issued and outstanding in 1999 and 1998.......... 3,828,052 3,810,624
Additional paid-in capital................................................ 15,961,404 15,963,858
Accumulated deficit....................................................... (11,952,094) (10,246,514)
------------- -------------
7,837,362 9,527,968
------------- -------------
$ 10,457,997 $ 11,853,154
============= =============
</TABLE>
The accompanying notes are an integral part of these statements.
16
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
TEN MONTHS ENDED YEAR ENDED
DECEMBER 31, FEBRUARY 28,
------------------------------- ------------
1999 1998 1999
------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C>
Operating revenues
Natural gas sales............................ $ 5,043,220 $ 5,352,868 $ 6,339,694
Transportation and processing................ 761,362 921,178 1,161,450
Other........................................ 174,831 113,792 149,653
----------- ----------- -----------
5,979,413 6,387,838 7,650,797
Operating costs and expenses
Cost of natural gas purchased................ 3,910,131 3,932,968 4,693,043
Operation and maintenance.................... 924,755 1,100,627 1,286,228
Depreciation and amortization................ 648,365 611,283 748,076
Impairment of long-lived assets.............. - 236,549 236,707
General and administrative................... 1,965,574 2,539,431 2,868,704
----------- ----------- -----------
7,448,825 8,420,858 9,832,758
----------- ----------- -----------
Operating loss............................. (1,469,412) (2,033,020) (2,181,961)
Other income (expense)
Interest income.............................. 57,234 159,745 173,080
Interest expense and debt conversion costs... (137,515) (305,173) (331,494)
Equity in earnings of partnership............ 71,268 69,343 83,801
Gain on disposal of assets................... - 8,000 8,000
Other income (expense), net.................. (83,686) 61,491 65,491
----------- ----------- -----------
(92,699) (6,594) (1,122)
----------- ----------- -----------
Loss before income taxes........................ (1,562,111) (2,039,614) (2,183,083)
Income taxes.................................... - 10,000 10,000
----------- ----------- -----------
Net loss........................................ $(1,562,111) $(2,049,614) $(2,193,083)
=========== =========== ===========
Basic and diluted loss per share................ $ (0.10) $ (0.13) $ (0.14)
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
17
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
----------------------- PAID-IN ACCUMULATED
SHARES AMOUNTS CAPITAL DEFICIT TOTAL
---------- ---------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Balance at March 1, 1998................... 14,457,400 $3,614,400 $15,896,500 $ (8,196,900) $ 11,314,000
Net loss................................... - - - (2,193,083) (2,193,083)
Acquisition of Abtech Resources, Inc....... 285,061 71,265 96,921 - 168,186
Director compensation under stock award
plans................................... 48,000 12,000 18,000 - 30,000
Stock options issued to non-employee
directors............................... - - 10,960 - 10,960
Retirement of convertible debt............. 460,000 115,000 (52,500) - 62,500
Retirement of common stock................. (7,967) (2,041) (6,021) - (8,062)
---------- ---------- ----------- ------------- -----------
Balance at February 28, 1999............... 15,242,494 3,810,624 15,963,860 (10,389,983) 9,384,501
Net loss................................... - - - (1,562,111) (1,562,111)
Director compensation under stock award
plans................................... 69,768 17,442 (2,442) - 15,000
Retirement of common stock................. (54) (14) (14) - (28)
---------- ---------- ----------- ------------- -----------
Balance at December 31, 1999............... 15,312,208 $3,828,052 $15,961,404 $(11,952,094) $ 7,837,362
========== ========== =========== ============ ===========
</TABLE>
The accompanying notes are an integral part of this statement.
18
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
TEN MONTHS ENDED
DECEMBER 31, YEAR ENDED
--------------------------- FEBRUARY 28,
1999 1998 1999
----------- ------------- ------------
(Unaudited)
<S> <C> <C> <C>
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS
Cash flows from operating activities
Net loss..................................................................... $(1,562,111) $ (2,049,614) $ (2,193,083)
Adjustments to reconcile net loss to net cash
used in operating activities:
Equity in undistributed earnings of partnerships........................... (3,252) (3,187) 3,254
Depreciation, depletion and amortization................................... 635,067 611,283 748,076
Gain on disposal of assets................................................. - (8,000) (8,000)
Impairment of long-lived assets............................................ - 236,707 236,707
Noncash expenses, net...................................................... 142,163 633,318 632,206
Settlement of Rosenthal lawsuit............................................ 213,607 - -
Other...................................................................... 23,250 (8,063) 12,223
Net change in cash and cash equivalents resulting from changes in:
Trade accounts receivable.................................................. (251,116) (365,796) 66,270
Inventories................................................................ 18,996 39,614 43,388
Prepaid expenses and other current assets.................................. 6,784 (47,002) 67,455
Accounts payable........................................................... 313,380 (388,091) (494,921)
Accrued expenses and other liabilities..................................... 233,443 210,109 (115,464)
----------- ------------ ------------
Net cash used in operating activities.................................... (229,789) (1,138,722) (1,001,889)
----------- ------------ ------------
Cash flows from investing activities
Capital expenditures....................................................... (212,663) (778,990) (804,177)
(Increase) decrease in certificates of deposit............................. (45,340) 1,834,099 1,821,800
Acquisitions of businesses................................................. - (44,000) (57,850)
Proceeds from deferred property sale....................................... 200,000 - -
Collections of notes receivable............................................ 52,107 1,371,360 1,385,882
Other...................................................................... - 10,518 -
----------- ------------ ------------
Net cash (used) provided by investing activities........................... (5,896) 2,392,987 2,345,655
----------- ------------ ------------
Cash flows from financing activities
Proceeds from borrowings................................................... 333,500 1,237,674 1,267,674
Payments on borrowings..................................................... (295,419) (2,832,065) (2,879,971)
Proceeds from issuance of common stock..................................... - 52,500 52,424
----------- ------------ ------------
Net cash provided (used) by financing activities........................... 38,081 (1,541,891) (1,559,873)
----------- ------------ ------------
Net change in cash and cash equivalents.......................................... (197,604) (287,626) (216,107)
Cash and cash equivalents at beginning of period................................. 223,693 439,800 439,800
----------- ------------ ------------
Cash and cash equivalents at end of period....................................... $ 26,089 $ 152,174 $ 223,693
=========== ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
19
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
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 and its wholly owned subsidiary companies, Gateway Pipeline
Company, Gateway Offshore Pipeline Company, Gateway Energy Marketing Company,
Fort Cobb Fuel Authority, L.L.C. and Gateway Processing Company, plus a small
amount of activity in its two remaining joint ventures and one partnership.
Based on its ownership, the Company proportionally consolidates its joint
venture interests, and accounts for its partnership interest on the equity
method. All significant intercompany transactions have been eliminated in
consolidation.
The Company owns and operates natural gas gathering, transportation
and distribution systems and related facilities in Texas, Oklahoma and
Louisiana, and offshore in state and federal waters of the Gulf of Mexico. The
Company also operates a natural gas distribution company in Oklahoma.
In 1999 the Board of Directors approved a change in the Company's
fiscal year-end from February 28/29 to December 31. Accordingly, this report
covers the period from March 1, 1999 through December 31, 1999, and prior
period unaudited data are presented for the comparable period of the prior
year. Fiscal year 1999 refers to the twelve months ended February 28, 1999.
2. PROPERTY AND EQUIPMENT
Property and equipment is stated at cost, plus capitalized interest
costs on major pipeline projects during their construction period. Additions
and improvements that add to the productive capacity or extend the useful life
of an 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 ranging from 6 to 30 years
for pipeline systems, gas plant and processing equipment, and from 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 resulting gain or
loss is credited to or charged against operations.
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. The Company's
net investment in oil and gas properties is subject to a ceiling limitation
calculation that is based on the present value of future net revenues from
estimated production of oil and gas reserves valued at current prices. Costs
in excess of the ceiling limitation are charged to expense.
The Company's primary intangible asset, its license for a patented
process to remove nitrogen from streams of natural gas, is being amortized to
expense over the average 17-year life of the underlying patents.
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. See discussion at Note E.
20
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
3. CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, the
Company considers all highly liquid debt instruments purchased with original
maturities of three months or less to be cash equivalents.
4. INCOME TAXES
Deferred tax assets and liabilities are recognized for the expected
future tax consequences of events that have been included in the financial
statements or income tax returns. Under this method, deferred tax assets and
liabilities are determined based on the difference between the financial
statement and tax bases of assets and liabilities as measured by the enacted
tax rates 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.
5. STOCK-BASED COMPENSATION
Compensation for stock-based awards to employees is measured using
the intrinsic method. This method recognizes compensation over the vesting
period when the fair value of the underlying common stock exceeds the exercise
price of the instrument at the date of grant.
6. EARNINGS PER SHARE
Basic earnings per share is computed by dividing net earnings or loss
by the weighted average number of common shares outstanding during the period.
Diluted earnings per share is computed by dividing net earnings or loss by the
weighted average number of shares outstanding, after giving effect to
potentially dilutive common share equivalents outstanding during the period.
Potentially dilutive common share equivalents are not included in the
computation of diluted earnings per share if they are anti-dilutive. For the
ten months ended December 31, 1999 and 1998 and the fiscal year ended February
28, 1999, 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 the ten months ended
December 31, 1999 and 1998 and the fiscal year ended February 28, 1999 was
15,275,554, 14,764,327 and 14,841,630.
7. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
NOTE B - ACQUISITIONS AND DIVESTITURES
The Company, through its wholly owned subsidiary, Gateway Processing
Company, acquired Abtech Resources, Inc. ("Abtech") effective July 1, 1998 for
$44,000 cash and 285,061 shares of common stock. The majority of Abtech's
outstanding stock was owned by the Company's current chief executive officer.
The acquisition was accounted for as a purchase and the purchase
price was allocated to Abtech's principal asset, a License Agreement between
Abtech and a company which owns a patented process for rejecting nitrogen
21
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
NOTE B ACQUISITIONS AND DIVESTITURES (CONTINUED)
from streams of natural gas. The License Agreement gives the Company the
exclusive right to utilize this rejection process for conventional natural gas
in the Permian Basin and for all coalbed methane or landfill gas in the
continental United States.
The Company is required to pay a license fee upon volumes processed
through each unit so long as there are any unexpired patents covering the
rejection technology. The Company must have installed or have commitments to
install processing units with a stated minimum capacity as of December 31,
2002, to maintain the exclusive rights to the process. Several projects that
could employ the patented technology are currently being evaluated for their
investment potential.
Had the acquisition of Abtech been effective as of March 1, 1998, the
effect on the Company's revenues and net loss for fiscal year 1999 would not
have been material.
During fiscal year 1998 the Company entered into a Settlement
Agreement with Shoreham Pipeline Company ("Shoreham") to dissolve all of the
joint ventures between the Company and Shoreham and to settle litigation
between the parties. The Settlement Agreement provided for, among other
things, a promissory note for $2,160,000, due in twenty-four monthly
installments beginning December 1, 1997. Beginning July 1, 1998, Shoreham
ceased making the scheduled payments required under the note.
During October and November 1998 the companies entered into mediation
to settle their disputes and avoid costly litigation. On November 24, 1998,
the Company and Shoreham reached an agreement under which the Company
received, in exchange for the previous note: (i) cash of $725,000; (ii) a note
from Shoreham at 7% over 48 months for $400,000, collateralized with certain
properties currently owned by Shoreham, and; (iii) the release of a net
profits interest in the Company's Shipwreck system. The Company began
receiving payments toward this note during January 1999. A portion of the
receipts due to the Company under this note have been assigned in conjunction
with the settlement of the Rosenthal lawsuit as described in Note J.
General and administrative expenses for the fiscal year ended
February 28, 1999 include $466,470 of charges for the write-off of amounts
receivable from Shoreham, plus related legal fees for the period of $80,140.
Interest expense for fiscal year 1999 includes $34,451 for the write-off of
interest income previously recognized on the Shoreham note receivable.
NOTE C - NOTES PAYABLE
The Company's notes payable balance of $135,167 at December 31, 1999
consisted of borrowings against the Company's operating line of credit. The
Company had no outstanding current notes payable as of December 31, 1998.
The Company's current operating line of credit agreement provides for
maximum available borrowings of $0.5 million through February 2001. Interest
is payable monthly at 6.0% per annum and principal is due on demand, or if no
demand is made, at maturity. The line is collateralized by a $500,000
certificate of deposit.
22
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
NOTE D - LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1999 1998
------------- -------------
<S> <C> <C>
Subordinated notes $ 1,056,343 $ 1,028,672
Note payable to Pipeline Capital, Inc. ("PCI") 58,624 173,496
------------- -------------
1,114,967 1,202,168
Less current maturities 292,952 114,872
------------- -------------
$ 822,015 $ 1,087,296
============= =============
</TABLE>
SUBORDINATED NOTES
In connection with the Recapitalization that was effective March 1,
1997, 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 $23,059 for each of
the ten month periods ended December 31, 1999 and 1998, and $27,671 for the
fiscal year ended February 28, 1999. As a result, the effective interest rate
of the subordinated notes is 15%.
PROMISSORY NOTES
During fiscal 1997, Gateway Pipeline Company issued $759,000 of
convertible promissory notes, proceeds of which were used to repay bridge
loans in connection with the purchase of Venture Resources, Inc. ("Venture").
The promissory notes were without collateral and bore interest at the rate of
10% per annum payable monthly. The principal sum of the promissory notes was
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 balance of the notes were redeemed during fiscal 1999 as
discussed below.
The Company and the noteholders disagreed as to the proper conversion
price per share after giving effect to the one for twenty-five reverse split
that occurred pursuant to the Recapitalization that was effective March 1,
1997. In the opinion of Company's management and Board of Directors, the
proper conversion price for the Venture promissory notes was $10.00 per share,
after giving effect to the one for twenty-five reverse stock split.
In October 1998, the Company and the noteholders reached an agreement
whereby the Company exchanged outstanding convertible promissory notes, with
principal and accrued interest through October 15, 1998 totaling $600,474, for
cash of $537,974 and 460,000 shares of common stock. In addition, certain
noteholders agreed to cancel a Subscription Agreement with attached Stock
Purchase Rights and to reduce warrants issued to the noteholders from 200,000
to 40,000. This exchange had no impact on the statement of operations for
fiscal 1999.
NOTE PAYABLE TO PCI
In May 1996 the Company repurchased and retired one share of Series O
preferred stock from Pipeline Capital, Inc. ("PCI"), a former related party,
in exchange for a note payable by the Company to PCI in the amount of
$480,000, payable at $10,000 per month for the period from July 1, 1996
through June 1, 2000. The repurchase was effected in connection with the
Company's recapitalization that was effective March 1, 1997.
23
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
NOTE D - LONG-TERM DEBT (CONTINUED)
<TABLE>
<CAPTION>
AGGREGATE FUTURE MATURITIES
Aggregate future maturities of long-term debt are as follows:
<S> <C>
2000...............................................................................$ 292,952
2001............................................................................... 234,328
2002............................................................................... 234,328
2003............................................................................... 234,328
2004............................................................................... 234,328
Thereafter......................................................................... -
</TABLE>
NOTE E - IMPAIRMENT EXPENSE
During fiscal 1999, Gateway Processing Company participated as a
non-operating working interest owner in the drilling of two natural gas wells.
Each of the two wells was expected to yield high-nitrogen natural gas reserves
and employ the Company's licensed nitrogen rejection process to meet pipeline
specifications. Both wells were uneconomic and were abandoned. The
accompanying consolidated statement of operations for the fiscal year 1999
includes an impairment charge against earnings of $206,497 reflecting the
abandonment of these projects.
Additionally, during fiscal 1999, Gateway Pipeline Company abandoned
several minor pipeline systems and recognized an aggregate impairment charge
against earnings of $30,210.
NOTE F - INCOME TAXES
The provision for income taxes for the ten months ended December 31,
1999 and 1998 and the fiscal year ended February 28, 1999 consisted of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------- FEBRUARY 28,
1999 1998 1999
------------ ------------- --------------
<S> <C> <C> <C>
Current ........................................................... $10,000 $10,000
Benefit of tax net operating loss carryforwards.................... - - -
------- ------- -------
Total ............................................................. - $10,000 $10,000
======= ======= =======
</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 ten
months ended December 31, 1999 and 1998 and the fiscal year ended February 28,
1999 follow:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------- FEBRUARY 28,
1999 1998 1999
------------- ------------ --------------
<S> <C> <C> <C>
Taxes at statutory rate............................................ $(531,000) $(693,000) $ (742,000)
State income taxes, net of federal tax benefit..................... - 8,000 8,000
Increase in valuation allowance.................................... 497,000 652,000 688,000
Goodwill amortization and other nondeductible......................
expenses........................................................... 8,000 32,000 39,000
Other.............................................................. 26,000 11,000 17,000
-------- -------- ---------
$ - $ 10,000 $ 10,000
========= ========= ==========
</TABLE>
24
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
NOTE F - INCOME TAXES (CONTINUED)
The tax effects of the temporary differences that give rise to
deferred tax assets and liabilities follow:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1999 1998
------------- -------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards............................. $1,686,000 $1,333,000
Property and equipment....................................... 459,000 304,000
Other........................................................ 51,000 26,000
---------- ----------
2,196,000 1,663,000
Valuation allowance............................................. (2,196,000) (1,663,000)
----------- -----------
$ - $ -
=========== ===========
</TABLE>
The valuation allowance increased $497,000 for all periods primarily
from the increase in, net of the expiration of, net operating loss
carryforwards.
At December 31, 1999, the Company had approximately $4,960,000 of
federal net operating loss carryforwards which may be applied against future
taxable income and which expire from 2001 through 2019.
NOTE G - STOCK-BASED BENEFIT PLANS
The Company has stock option plans 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.
In November 1999 a total of 225,750 options, with a weighted average
exercise price of $0.80, were repriced to $0.40. The following table is a
summary of stock option and warrant activity and related information for the
ten months ended December 31, 1999 and 1998, and the fiscal year ended
February 28, 1999:
<TABLE>
<CAPTION>
DECEMBER 31, 1999 DECEMBER 31, 1998 FEBRUARY 28, 1999
----------------------- ----------------------- ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
OPTIONS/ EXERCISE OPTIONS/ EXERCISE OPTIONS/ EXERCISE
WARRANTS PRICE WARRANTS PRICE WARRANTS PRICE
---------- ---------- ---------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of period............. 420,750 $0.63 324,938 $0.94 324,938 $0.94
Granted........................................ - - 50,000 0.44 110,000 0.39
Forfeited...................................... - - (14,188) 5.78 (14,188) 5.78
------- -------- --------
Outstanding at end of period................... 420,750 0.42 360,750 0.68 420,750 0.63
======= ======= =======
Options exercisable at end of period........... 290,745 0.42 245,750 0.77 254,083 0.76
======= ======= =======
Options available for grant at end of period... 490,000 550,000 490,000
======= ======= =======
</TABLE>
25
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
NOTE G - STOCK-BASED BENEFIT PLANS (CONTINUED)
The following table summarizes information about options and warrants
outstanding at December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS/WARRANTS OUTSTANDING
--------------------------------------------------------
WEIGHTED AVERAGE OPTIONS/WARRANTS 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>
$0.34 to 0.53 420,750 7.95 $0.42 290,745 $0.42
</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 of
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 (including the repricing discussed above) was estimated assuming no
expected dividends and the following weighted average assumptions for the ten
months ended December 31, 1999 and 1998 and the fiscal year ended February 28,
1999:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------ FEBRUARY 28,
1999 1998 1999
---------- ---------- --------------
<S> <C> <C> <C>
Expected life in years.............................................. 5.7 8.0 8.0
Expected stock price volatility..................................... 93% 75% 75%
Risk-free interest rate............................................. 6.18% 5.65% 5.65%
Average fair value per option....................................... $0.21 $0.34 $0.30
</TABLE>
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 for the ten months ended December 31, 1999
and 1998 and the fiscal year ended February 28, 1999 follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------- FEBRUARY 28,
1999 1998 1999
-------------- -------------- ---------------
<S> <C> <C> <C>
Net loss - as reported............................................... $ (1,562,111) $ (2,049,614) $ (2,193,083)
Net loss - pro forma................................................. (1,590,739) (2,053,947) (2,198,283)
Basic and diluted net loss per share - as reported................... (0.10) (0.13) (0.14)
Basic and diluted net loss per share - pro forma..................... (0.10) (0.13) (0.14)
</TABLE>
NOTE H - OTHER EMPLOYEE BENEFIT PLAN
Effective September 1, 1998, the Houston employees of the Company
entered into an employee leasing agreement with Administaff, Inc.
("Administaff"). The employees of Fort Cobb also entered into an agreement
with Administaff effective January 1, 1999. As part of the benefits package
offered by Administaff, all eligible employees were offered enrollment in the
Administaff 401(k) plan. Matching contributions for non-highly compensated
employees began in January 1999, and matching contributions for highly
compensated employees
26
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
NOTE H - OTHER EMPLOYEE BENEFIT PLAN (CONTINUED)
began March 31, 1999. The Company believes it is in compliance with ERISA and
other laws which would govern the plan. Contributions to the Gateway 401(k)
plan were discontinued in July 1998. The Company has requested a ruling from
the IRS on the former Gateway plan qualification status in order to allow
employees to rollover investment balances into the new Administaff plan.
Total Company contributions to both plans were $19,401, $6,058 and $6,350 for
the ten months ended December 31, 1999 and 1998 and for the fiscal year ended
February 28, 1999.
NOTE I - LEASES
The Company leases office space in Houston, Texas under a lease
agreement expiring in January 2003. The lease is secured by a Letter of Credit
issued by the Company in favor of the lessor in the amount of $64,041. 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 $103,963, $85,124
and $114,061 for the ten months ended December 31, 1999 and 1998 and the
fiscal year ended February 28, 1999.
The following is a schedule by year of future minimum annual rental
payments under noncancelable operating leases at December 31, 1999:
<TABLE>
<CAPTION>
<S> <C>
YEAR
2000...................................................... 124,294
2001...................................................... 122,014
2002...................................................... 120,874
2003...................................................... 30,822
Later years............................................... -
-----------
$398,004
===========
</TABLE>
NOTE J - COMMITMENTS AND CONTINGENCIES
The Company's obligations under the legal action entitled STANLEY
ROSENTHAL V. SHOREHAM PIPELINE COMPANY were successfully mediated on September
13, 1999. As a result of the mediation, Rosenthal dismissed the Company from
the lawsuit, and the Company and Rosenthal released each other from any and
all claims related to the action. In consideration, the Company assigned
without recourse its right to receive payments for the monthly periods from
October 1, 1999 through November 1, 2001 to which it is entitled under its
note receivable from Shoreham dated November 18, 1998 in the original
principal amount of $400,000. Such payments include interest at an annual rate
of 7% and total $249,662. The Company retained its right to receive the
payments, totaling $124,831, due for the monthly periods from December 1, 2001
through December 1, 2002. In addition, the Company and Shoreham released each
other from any claims or controversies that existed or may arise from the
lawsuit.
The financial statements of the Company for the ten months ended
December 31, 1999 include a charge to general and administrative expenses for
$395,414 representing the settlement of the matter and the related legal fees.
27
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
NOTE J - COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company is contingently obligated under a note agreement entered
into in conjunction with its acquisition of a pipeline system. The contingent
amount is payable on or before April 15, 2004. The amount that the Company
ultimately pays will be calculated using a formula in the note agreement, and
will depend upon achievement of certain asset performance goals. No amounts
have been paid or accrued for this obligation as of December 31, 1999.
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 K - SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest was $103,374 and $150,670 for the ten months
ended December 31, 1999 and 1998, and $184,559 in fiscal 1999. Cash paid for
taxes, including state franchise taxes, was $6,278, $31,914 and $26,176 for
the ten months ended December 31, 1999 and 1998 and for the fiscal year ended
February 28, 1999.
NONCASH INVESTING AND FINANCING ACTIVITIES
See Note D for a discussion of the Company's settlement with
convertible promissory noteholders. In October 1998, the Company and the
noteholders reached an agreement whereby the Company exchanged outstanding
convertible promissory notes, with principal and accrued interest through
October 15, 1998 totaling $600,474, for cash of $537,974 and 460,000 shares
of common stock. In addition, certain noteholders agreed to cancel a
Subscription Agreement with attached Stock Purchase Rights and to reduce
warrants issued to the noteholders from 200,000 to 40,000. This exchange had
no impact on the statement of operations for fiscal 1999.
NOTE L - 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, certificates
of deposit and notes receivable approximate fair value because of the
relatively short maturity or recent issuance of those instruments.
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.
28
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
NOTE L - FINANCIAL INSTRUMENTS (CONTINUED)
The estimated fair values of the Company's financial instruments are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1999 DECEMBER 31, 1998
----------------------------- -----------------------------
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 $ 26,089 $ 26,089 $ 152,174 $ 152,174
Certificates of deposit 973,540 973,540 915,901 915,901
Notes receivable 119,751 119,751 400,000 400,000
Financial liabilities:
Notes payable (135,167) (135,167) - -
Long-term debt (1,114,967) (1,048,608) (1,202,168) (1,103,593)
</TABLE>
NOTE M - SEGMENTS, MAJOR CUSTOMERS AND CONCENTRATIONS
The company adopted SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION, in fiscal 1999 and has accordingly
presented additional information about its operations for the current year.
All of the Company's operations are in the domestic U.S. and in Texas and
federal waters in the Gulf of Mexico.
The Company's management reviews and evaluates the operations
separately of three main segments--Onshore Operations, Offshore Operations
and Fort Cobb Operations. Each segment is an aggregation of operations
subject to similar economic and regulatory conditions such that they are
likely to have similar long-term prospects for financial performance. Onshore
Operations include natural gas gathering, transportation and distribution
activities in Texas, Oklahoma and Louisiana. Offshore Operations include
natural gas gathering and transportation activities in the Gulf of Mexico in
Texas and federal waters. The principal markets for both of these segments
are affiliates of large intrastate and interstate pipeline companies. Fort
Cobb Operations are comprised of a local natural gas distribution company in
Oklahoma. This segment supplies natural gas to approximately 2,350 customers,
principally for irrigation and crop drying fuel for farming cooperatives, and
residential fuel.
The accounting policies of the reportable segments are the same as
those described in Note A to the Consolidated Financial Statements. The
Company evaluates the segments based on operating margins, defined as
revenues less cost of purchased gas and operating and maintenance expenses.
Such amounts are before general and administrative expense, interest income
or expense or income taxes. Inter-segment sales are eliminated.
29
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
NOTE M - SEGMENTS, MAJOR CUSTOMERS AND CONCENTRATIONS (CONTINUED)
Summarized financial information of the Company's reportable
segments for the ten months ended December 31, 1999 and 1998 and the fiscal
year ended February 28, 1999 is presented below:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------- FEBRUARY 28,
1999 1998 1999
---------- ----------- ------------
(Unaudited)
<S> <C> <C> <C>
ONSHORE OPERATIONS
Revenues $4,288,960 $3,915,261 $4,826,931
Operating margin 962,741 758,948 970,994
Depreciation and amortization 392,031 375,558 463,347
Total assets 6,099,444 7,003,404 6,554,339
OFFSHORE OPERATIONS
Revenues 289,899 581,465 697,547
Operating margin (2,816) 108,804 171,606
Depreciation and amortization 110,231 100,882 122,656
Total assets 1,783,032 1,988,806 1,979,969
FORT COBB OPERATIONS
Revenues 1,400,554 1,891,112 2,126,319
Operating margin 184,602 486,491 528,926
Depreciation and amortization 146,103 134,843 162,073
Total assets 2,575,521 2,860,944 2,729,802
TOTAL
Revenues 5,979,413 6,387,838 7,650,797
Operating margin 1,144,527 1,354,243 1,671,526
Depreciation and amortization 648,365 611,283 748,076
Total assets 10,457,997 11,853,154 11,264,110
</TABLE>
The following table sets forth the Company's major customers and their
percent of total revenues for the ten months ended December 31, 1999 and 1998
and the fiscal year ended February 28, 1999. All of the listed entities are
customers of the onshore segment.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------- FEBRUARY 28,
1999 1998 1999
---------- --------- ---------------
<S> <C> <C> <C>
Owens Corning Fiberglas Corporation............................. 17% 17% 17%
Aurora Natural Gas LLC.......................................... 16% 7% 8%
Dart Container Corporation...................................... 15% 12% 12%
</TABLE>
The Company's natural gas pipeline operations have a concentration
of customers in the natural gas transmission, distribution and petrochemical
industries. These concentrations of customers may impact the Company's
overall exposure to credit risk, either positively or negatively, in that the
customers may be similarly affected by the changes in economic or other
conditions. The Company's accounts receivable are generally not
collateralized.
30
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
NOTE M - SEGMENTS, MAJOR CUSTOMERS AND CONCENTRATIONS (CONTINUED)
The Company has three certificates of deposit with a financial
institution at December 31, 1999 totaling $973,540. The balances are insured
by the Federal Deposit Insurance Corporation up to $110,000. The Company has
collateralized certain loans at this financial institution with these time
deposits. The Company believes it is not exposed to any significant credit
risk.
NOTE N - NON-EMPLOYEE COMMON STOCK OPTIONS AND WARRANTS
The Company has a stock option plan and several agreements under
which non-employee directors and others have been granted nonqualified stock
options or warrants to purchase the Company's common stock. Generally, the
options are exercisable immediately and expire ten years after the date of
grant, or 12 months after cessation of service on the Company's Board if
sooner, in the case of director options. All options or warrants issued have
exercise prices of not less than 100% of the fair market value on date of
grant.
In fiscal 1999, the Company cancelled 200,000 common stock warrants
at $0.53 and reissued 40,000 warrants at $0.53 in connection with the
settlement with the convertible promissory noteholders discussed in Note D.
Additionally, it issued 20,000 options at $0.625 to non-employee directors.
The balance outstanding at Feburary 28, 1999 includes 201,176 warrants at
$3.00 that expired on March 1, 1999.
The following is a summary of the status of the Company's
non-employee options and warrants for the ten months ended December 31, 1999
and 1998 and the fiscal year ended February 28, 1999:
<TABLE>
<CAPTION>
DECEMBER 31, 1999 DECEMBER 31, 1998 FEBRUARY 28, 1999
------------------------- ------------------------ ----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
OPTIONS/ EXERCISE OPTIONS/ EXERCISE OPTIONS/ EXERCISE
WARRANTS PRICE WARRANTS PRICE WARRANTS PRICE
---------- ---------- ----------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of 520,339 $2.02 660,800 $1.71 660,800 $1.71
period........................
Issued........................ - - 12,000 0.63 20,000 0.63
Cancelled/Expired............. (201,176) 3.00 (200,461) 0.55 (200,461) 0.55
Reissued...................... - - 40,000 0.53 40,000 0.53
---------- ----------- -----------
Outstanding and exercisable at
end of period................. 319,163 $1.41 512,339 $2.05 520,339 $2.02
========== =========== ===========
</TABLE>
The following table summarizes information about options and warrants
outstanding at December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS/WARRANTS OUTSTANDING AND EXERCISABLE
----------------------------------------------------------------------------
WEIGHTED AVERAGE
NUMBER REMAINING
OUTSTANDING CONTRACTUAL WEIGHTED AVERAGE
RANGE OF EXERCISE PRICES AND EXERCISABLE LIFE (YEARS) EXERCISE PRICE
- ------------------------ --------------- ------------ --------------
<S> <C> <C> <C>
$0.53 to 0.63............ 100,000 5.84 $0.56
1.19 to 1.25............ 151,188 4.86 1.25
3.00.................... 67,975 2.01 3.00
-------
$0.53 to 3.00............ 319,163 4.56 1.41
=======
</TABLE>
NOTE O - FOURTH QUARTER ADJUSTMENTS
Aggregate year-end adjustments recorded in the fourth quarter
reduced net earnings by approximately $83,032, and included the write-offs of
a production barge of $32,032 and the Company's $51,000 investment in Ozark
Natural Gas Company.
31
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF DECEMBER 31, 1998 AND FOR THE TEN MONTHS THEN ENDED IS
UNAUDITED)
NOTE P - SUBSEQUENT EVENT
The Company entered into contracts, both of which were effective
January 1, 2000, for the sale of two non-core properties for an aggregate
$1.1 million to two unrelated buyers. One property was an undivided joint
venture interest in a Louisiana pipeline system partnership. The other
property was a pipeline system in south Texas. The Company received cash of
$200,000 for one of the acquisitions which is reflected as proceeds from
deferred property sale in the accompanying consolidated financial statements
for the ten months ended December 31, 1999. Additionally, the book value of
the properties has been reclassified to properties held for sale, net of
accumulated depreciation, in the December 31, 1999 balance sheet. The Company
will recognize a gain during 2000 on the combined sale transactions of
approximately $150,000, net of related transaction costs.
32
<PAGE>
GATEWAY ENERGY CORPORATION
EXHIBIT 11
STATEMENT REGARDING COMPUTATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
TEN MONTHS ENDED FISCAL YEAR
DECEMBER 31, ENDED
---------------- FEBRUARY 28,
1998 1998 1999
----------- ----------- ------------
<S> <C> <C> <C>
Weighted average number of common shares
outstanding 15,275,554 15,242,547 14,841,630
Add shares issuable pursuant to common stock
options/warrants less shares assumed
repurchased at the average market price - 25,877(1) 1,955(1)
Add shares issuable from assumed conversion
of convertible notes - 386,610(1) 271,400(1)
----------- ----------- ------------
Tentative number of shares for computation
of fully diluted earnings per share 15,275,554 15,655,034 15,114,985
=========== =========== ============
Loss applicable to common stock $(1,562,111) (2,049,614) (2,193,083)
Add back interest expense for convertible
promissory notes assumed converted - 82,300(1) 31,480(1)
----------- ----------- ------------
Tentative earnings (loss) for computation
of fully diluted earnings per share $(1,562,111) $(1,967,314) $ (2,161,603)
=========== =========== ============
Basic loss per common share $ (0.10) $ (0.13) $ (0.14)
=========== =========== ============
Fully diluted loss per common share $ (0.10) $ (0.13) $ (0.14)
=========== =========== ============
</TABLE>
(1) Not used in fully diluted earnings per share calculations as effect would
be antidilutive.
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
EXHIBIT 21
SUBSIDIARIES
<TABLE>
<CAPTION>
COMPANY STATE PERCENT OWNED
------- ----- -------------
<S> <C> <C>
Gateway Pipeline Company Texas 100%
Gateway Offshore Pipeline Company Nebraska 100%
Gateway Energy Marketing Company Louisiana 100%
Gateway Processing Company Texas 100%
Fort Cobb Fuel Authority, L.L.C. Oklahoma 100%
</TABLE>
<PAGE>
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
EXHIBIT 23
CONSENT OF GRANT THORNTON LLP
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated February 23, 2000, accompanying the
consolidated financial statements included in the Annual Report of Gateway
Energy Corporation on Form 10-KSB for the ten months ended December 31, 1999.
We hereby consent to the incorporation by reference of said report in the
Registration Statement of Gateway Energy Corporation on Form S-8 (File
No. 333-80897, effective June 17, 1999).
GRANT THORNTON LLP
Houston, Texas
March 30, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE GATEWAY
ENERGY CORPORATION FORM 10-KSB FOR THE TEN MONTHS ENDED DECEMBER 31, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 10-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> MAR-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 26,089
<SECURITIES> 973,540
<RECEIVABLES> 1,035,074
<ALLOWANCES> 0
<INVENTORY> 59,316
<CURRENT-ASSETS> 3,197,887
<PP&E> 9,298,572
<DEPRECIATION> 2,695,105
<TOTAL-ASSETS> 10,457,997
<CURRENT-LIABILITIES> 1,798,620
<BONDS> 822,015
0
0
<COMMON> 3,828,052
<OTHER-SE> 4,009,310
<TOTAL-LIABILITY-AND-EQUITY> 10,457,997
<SALES> 5,979,413
<TOTAL-REVENUES> 6,107,915
<CGS> 3,910,131
<TOTAL-COSTS> 3,538,694<F1>
<OTHER-EXPENSES> 83,686
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 137,515
<INCOME-PRETAX> (1,562,111)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,562,111)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,562,111)
<EPS-BASIC> (0.10)
<EPS-DILUTED> (0.10)
<FN>
<F1>INCLUDES $777,230 OF NON-CASH EXPENSES.
</FN>
</TABLE>
