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EX-32.1 - CERTIFICATION OF CEO PER SECTION 906 - GATEWAY ENERGY CORP/NEgatewayexhib321-123109a.htm
EX-31.1 - CERTIFICATION OF CEO PER SECTION 302 - GATEWAY ENERGY CORP/NEgatewayexhib311-123109a.htm
EX-31.2 - CERTIFICATION OF CONTROLLER PER SECTION 302 - GATEWAY ENERGY CORP/NEgatewayexhib312-123109a.htm
EX-32.2 - CERTIFICATION OF CONTROLLER PER SECTION 906 - GATEWAY ENERGY CORP/NEgatewayexhib322-123109a.htm

 
 

 
 
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K/A
 
(Amendment No. 3)
 
X ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009
 
    TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE EXCHANGE ACT OF 1934
Commission File No. 0-6404
 
 
Gateway Energy Corporation
(Exact name of registrant as specified in its charter)
 
Delaware
44-0651207
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification Number)
1415 Louisiana Street, Suite 4100, Houston, Texas 77002
(Address and Zip Code of principal executive offices)
(713) 600-1044
(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
Preferred Stock Purchase Rights
(Title of Class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes _____   No __X__   
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.Yes __X__      No  _____     
 
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.
 
Check whether the issuer (1) 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  _____ 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes _____     No  _____
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation SK is not contained herein, and will not 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-K or any amendment to this Form 10-K.   ______
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act)
 
Yes _____     No    __ X __
 
The aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity, as of June 30, 2009, the last business day of the registrant’s most recently completed second fiscal quarter, was $7,370,908.
 
The number of shares outstanding of the issuer's common equity as of March 16, 2010, was 19,397,125.
 
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:  None
 
 
 
 

 
 
 
 
 
                                                                INDEX

       
     
PAGE
       
PART I.                                                                                                                               
   4
 
Item 1.
    Business                                                                                                      
   4
 
Item 1A.
    Risk Factors                                                                                                      
   6
 
Item 1B.
    Unresolved Staff Comments                                                                                                      
   6
 
Item 2.
    Properties                                                                                                      
   6
 
Item 3.
    Legal Proceedings                                                                                                      
   7
PART II.                                                                                                                               
   7
 
Item 5.
    Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities
   7
 
Item 6.
    Selected Financial Data                                                                                                      
   7
 
Item 7.
    Management’s Discussion and Analysis of Financial Condition and Results of Operations
   7
 
Item 7A.
    Quantitative and Qualitative Disclosures About Market Risk                                                                                                      
 19
 
Item 8.
    Financial Statements and Supplementary Data                                                                                                      
 19
 
Item 9.
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 19
 
Item 9A.
Controls and Procedures                                                                                                      
 19
 
Item 9B.
Other Information                                                                                                      
 21
PART III.                                                                                                                               
 21
 
Item 10.
    Directors, Executive Officers and Corporate Governance                                                                                                      
 21
 
Item 11.
    Executive Compensation                                                                                                      
 23
 
Item 12.
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 26
 
Item 13.
    Certain Relationships and Related Transactions, and Director Independence
 28
 
Item 14.
    Principal Accountant Fees and Services                                                                                                      
 28
PART IV.                                                                                                                               
 29
 
Item 15.
    Exhibits and Financial Statement Schedules                                                                                                      
 29
SIGNATURES.                                                                                                                               
 30
 
2

 
 
 

 

EXPLANATORY NOTE

This Amendment No. 3 to the Annual Report on Form 10-K for the year ended December 31, 2009 amends the Item 9A(T) Controls and Procedures paragraphs to include a conclusion on internal control over financial reporting as of December 31, 2009.  Please see Part II, Item 9A(T). Controls and Procedures.  This amended Form 10-K also contains currently dated certifications pursuant to Section 302 and 906 of the Sarbanes-Oxley Act of 2002 as Exhibits 31.1, 31.2, 32.1, and 32.2.
 
Except as described above, no other information in the original filing has been updated and this Amendment continues to speak as of the date of the original filing.  Other events occurring after the original filing or other disclosures necessary to reflect subsequent events have been or will be addressed in other reports filed with or furnished to the SEC subsequent to the date of the original filing.  Accordingly, this Form 10-K/A should be read in conjunction with such reports.
 

3
 

 
 

 

FORWARD-LOOKING STATEMENTS

Statements made in this Annual Report on Form 10-K and other reports and proxy statements filed with the Securities and Exchange Commission, communications to shareholders, press releases and oral statements made by representatives of the Company contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that relate to possible future events, our future performance, and our future operations. In some cases, you can identify these forward-looking statements by the use of words such as “may,” “will,” “should,” “anticipates,” “believes,” “expects,” “plans,” “future,” “intends,” “could,” “estimate,” “predict,” “potential,” “continue,” or the negative of these terms or other similar expressions. These statements are only our predictions. Actual results could differ materially from those projected in such forward-looking statements as a result of the risk factors set forth below in the section entitled “Factors Affecting Future Results” and elsewhere in this document.  Therefore, we cannot guarantee future results, levels of activities, performance, or achievements. We are under no duty to update any of the forward-looking statements after the date of this document to conform them to actual results or to changes in our expectations.

PART I
 
ITEM 1.  BUSINESS
 
General
 
Gateway Energy Corporation (the “Company,” or “Gateway”), 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. Gateway conducts all of its business through its wholly owned subsidiary companies, Gateway Pipeline Company, Gateway Offshore Pipeline Company, Gateway Energy Marketing Company and Gateway Processing Company and CEU TX NPI, L.L.C.  Gateway-Madisonville Pipeline, L.L.C, previously known as Gateway-ADAC Pipeline, L.L.C., is 67% owned by Gateway Pipeline Company and 33% owned by Gateway Processing Company.  The Company acquired the minority interest (33%) from the prior owner on July 3, 2008 and the Company now owns 100% of this venture. Access to the Company’s annual reports on Form 10-K and10-KSB, quarterly reports on Form 10-Q and Form 10-QSB, the Company’s Code of Ethics, and current reports on Form 8-K are available at the Company’s website, www.gatewayenergy.com.

 
In the following discussion, “Mcf” refers to thousand cubic feet of natural gas;  “Bbl” refers to barrel of liquid hydrocarbons 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 one million British thermal units.  “Mcfe” refers to thousand cubic feet equivalent.  Liquid hydrocarbons are converted to Mcf equivalents using the ratio of 1.0 barrel of liquid hydrocarbons to 6.0 Mcf of natural gas.
 
Description of Business
 
Gateway Energy Corporation owns and operates natural gas gathering, transportation and distribution systems in Texas, Texas state waters and in federal waters of the Gulf of Mexico off the Texas and Louisiana coasts.  These systems include approximately 280 miles of pipeline ranging in diameter from 1 inch to 20 inches through which the Company gathers natural gas and liquid hydrocarbons from producing properties owned by others, transports gas and liquid hydrocarbons and distributes natural gas to various markets.  If the Company assumes title along with possession of the gas, it sells the gas directly to industrial end 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 or Mcf.  Liquid hydrocarbons are transported for a fee per Bbl.
 
Because the Company’s operating margin is generated under back-to-back purchase and sales contracts, or under contracts that have a stated fee per unit of production (Mcf, MMBtu, or Bbl) gathered or transported, the Company’s operating margin is relatively insensitive to the changes in commodity prices of natural gas and oil.  The primary impact of the level of natural gas and oil commodity prices on the Company is their impact on drilling activities.  High prices tend to generate greater cash flow for producers and thus greater enthusiasm to accelerate drilling; low prices tend to have the opposite effect.  When the drilling is successful and located near the Company’s pipelines, there is an increased possibility for new business.
 
Business Growth Strategy

Beginning in 2005, the Company began a restructuring program to position it for growth with a renewed focus on its core compentencies.  The Company is currently undertaking a two prong growth strategy, focused on optimizing the deployment of its existing assets, and aggressively seeking out acquisition opportunities to leverage our industry expertise and infrastructure to expand in the midstream sector of the natural gas industry.
 
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·  
Optimization of Existing Assets – The Company has valuable core assets in the midstream sector that it is actively seeking to optimize.  The Company’s Madisonville business has the potential to expand due to the Company’s position as the exclusive gas transporter for the largest producer and the only gas treating company in the area, as well as through its 9.1% net profits interest in certain production in the Madisonville Field.  In addition, the Company’s current throughput volume of its offshore pipeline assets is significantly less than its maximum daily throughput capacity, allowing the Company to solicit a significant amount of new gathering and transportation business without substantial capital outlay.

·  
Acquisition Opportunities – The Company has positioned itself to aggresively seek out acquisition opportunities in the midstream sector.  Significant improvements in the Company’s operating results, financial position, and available credit facility enable the Company to actively investigate and pursue these potential acquisitions.

Major Customers and Suppliers
 
The Company purchases natural gas from several producers and suppliers, and during the years ended December 31, 2009 and 2008, one company supplied 100% of the total  natural gas purchased.    Gross sales to customers representing 10% or more of total revenue for the years ended December 31, 2009 and 2008 are as follows:
 
     
Year Ended December 31,
 
     
2009
   
2008
 
                                              
Dart Container  Corporation                                                             
    60%       53%  
 
Owens Corning                                                             
    36%       27%  
 
Saint Gobain Containers                                                             
    0%       16%  

 
Although these sales constitute a significant portion of total revenues, they represent a much less significant portion of the Company’s operating margin because of back-to-back purchase contracts to supply these major customers.  The Company believes that the loss of a major customer would not have a material adverse effect on its financial statements due to the small impact any one customer has on the Company’s operating margin.  However, the loss of revenues from more than one major producer concurrently could potentially have a material impact on earnings.
 
Competition
 
The natural gas industry is highly competitive.  The Company competes against other companies in the gathering, transporting, processing and marketing business for gas supplies and for customers.  Competition for gas supplies is primarily based on the availability of transportation facilities, cost-effectiveness of processing facilities, service and satisfactory price.  In marketing, there are numerous competitors, including affiliates of intrastate and interstate pipelines, major producers, brokers and marketers.  Most of our 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.
 
Because of the significantly higher costs to construct pipelines in marine environments and the difficulty of installing new onshore separation/dehydration and terminal facilities, it is likely that any new well that is completed within two miles of the Company's existing offshore systems will be connected to Gateway’s nearby system.  Since the Company became actively involved as the operator of these offshore systems, it has been successful in connecting every new, available well completed within that distance.
 
Regulation
 
The transportation and sale 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.
 
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Environmental and Safety Concerns
 
The Company's operations are subject to environmental risks normally incidental to the construction and operation of pipelines, plants and other facilities for gathering, processing, transporting and distributing natural gas and liquid hydrocarbons.  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.
 
Employees
 
As of December 31, 2009, the Company had six full-time employees.
 
ITEM 1A.  RISK FACTORS
 
This item is not applicable for smaller reporting companies such as Gateway.

ITEM 1B.  UNRESOLVED STAFF COMMENTS
 
The Company does not have any unresolved staff comments to disclose in this Item.

ITEM 2.  PROPERTIES
 
Onshore Properties
 
The Company owns two active onshore pipeline systems in Texas.  One system is a fourteen-mile delivery system that transports natural gas for sale to industrial users in Waxahachie, Ellis County, Texas.  The other system is a 10-inch, 10 mile pipeline located near Madisonville, Madison County, Texas which transports natural gas from the Madisonville treating facility to two major pipelines.
 
At December 31, 2009, the Company’s onshore systems were comprised of approximately 24 miles of six-inch to ten-inch pipelines and related meters, regulators, valves and equipment.  The systems are properly maintained and are capable of transporting natural gas under prescribed pressures.
 
On January 7, 2010, the Company purchased the Hickory Creek Gathering System in the Barnett Shale, Denton County, Texas.  Refer to Note 14 to the Consolidated Financial Statements for further discussion.
 
Offshore Properties
 
Gateway Offshore Pipeline Company owns pipelines that service producers in Texas and Louisiana offshore waters and Galveston Bay.  These systems and related facilities are in waters up to 650 feet in depth and provide the Company the capability to gather and transport gas and liquid hydrocarbons to various markets.  The Company’s offshore systems consist of approximately 266 miles of three-inch to 16-inch diameter pipelines and related equipment which transport the natural gas and liquid hydrocarbons primarily under fee-based contracts.
 
Net Profits Interest
 
On December 22, 2008, the Company acquired a 9.1% net profits interest in certain identified leases and wells owned and operated by Redwood Energy Production, L.P. ("Redwood") in the Madisonville Field insofar as they cover the Rodessa/Sligo interval, together with all interests acquired by Redwood in any additional oil and gas leases or rights to acquire oil and gas leases within a specified area of mutual interest ("AMI") and any interests acquired by Redwood in sands, zones, formations, horizons or in and to the depths acquired by Redwood in leases above or below the Rodessa/Sligo interval. Redwood is a subsidiary of GeoPetro Resources Company. There are currently four wells drilled in the AMI by Redwood in the Rodessa zone at approximately 12,000 feet.
 
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 800,000 Mcfe per day, which significantly exceeds the current daily throughput of approximately 50,000 Mcfe per day.
 
6
 
 
 
 

 
 
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 1415 Louisiana Street, Suite 4100, Houston, Texas 77002.
 
ITEM    3.  LEGAL PROCEEDINGS
 
From time to time the Company is involved in litigation concerning its properties and operations.  There is no known or pending litigation expected to have a material effect on the Company’s financial statements.
 
ITEM    4.  (REMOVED AND RESERVED)
 

PART II
 
ITEM    5.  MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 
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 closing prices shown reflect the highest and lowest inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
 
 
Quarter Ended
High
Low
 
 
March 31, 2009
$0.61
$0.26
 
 
June 30, 2009
  0.39
  0.30
 
 
September 30, 2009
  0.45
  0.29
 
 
December 31, 2009
  0.40
  0.32
 
         
  Quarter Ended                     High                      Low  
 
March 31, 2008
$0.90
$0.60
 
 
June 30, 2008
  0.90
  0.68
 
 
September 30, 2008
  0.85
  0.46
 
 
December 31, 2008
  0.52
  0.30
 
 
Holders
 
As of December 31, 2009, there were 1,567 shareholders of the Company's common stock.
 
Dividends
 
There have been no dividends declared on the Company's common stock during the years ended December 31, 2009 and 2008.  The Company does not intend to pay dividends on its common stock in the near future.
 
On December 7, 2009, the Company entered into a Credit Agreement with Meridian Bank.  This agreement restricts the Company’s ability to pay dividends.
 
ITEM 6.  SELECTED FINANCIAL DATA
 
This item is not applicable for smaller reporting companies such as Gateway.
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
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.
 
Critical Accounting Policies
 
The following accounting policies are considered by management to be the most critical to the fair presentation of the Company’s financial condition, results of operations and cash flows.  The policies are consistently applied in the preparation of the accompanying consolidated financial statements; however, certain reclassifications have been made to the prior period statements to be consistent with the current presentation.
 
7
 
 
 
 

 
 
 
Revenue Recognition Policy
 
Revenues from the sales of natural gas are generated under purchase and sales contracts that are priced at the beginning of the month based upon established gas indices.  The Company purchases and sells the gas using the same index to minimize commodity price risk.  Revenues from the sales of natural gas are recognized at the redelivery point, which is the point at which title to the natural gas transfers to the purchaser.  Transportation revenues are generated under contracts which have a stated fee per unit of production (Mcf, MMBtu, or Bbl) gathered or transported.  Transportation revenues onshore are recognized at the redelivery point, which is the point at which another party takes physical custody of the natural gas or liquid hydrocarbons.  Transportation revenues offshore are recognized at the Company’s receipt point.
 
Property and Equipment
 
Property and equipment is stated at cost, plus capitalized interest costs on major 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.  For the year ended December 31, 2009, property and equipment included $78,056 of equipment financed under a capital lease, net of $21,944 of accumulated amortization.  Depreciation and amortization is calculated 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.
 
For the years ended December 31, 2009 and 2008, depreciation, depletion and amortization expense was $608,394 and $621,252, respectively.  Property, plant and equipment and identifiable intangible assets are reviewed for impairment, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 360, “Property, Plant, and Equipment,” whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  If the sum of the expected undiscounted cash flows is less than the carrying value of the related asset or group of assets, a loss is recognized for the difference between the fair value and carrying value of the asset or group of assets.  Impairments of long-lived assets recorded during the years ended December 31, 2009 and 2008 was $77,942 and $0, respectively.  The impairment was recorded for Net Profits Interest (“NPI”) assets.

 
The Company determined an impairment evaluation was necessary for the Net Profits Interest due to the accumulation of costs by the producer significantly in excess of what was originally expected and due to the history of operating losses by the producer.  The Company estimated future cash flows and evaluated the likelihood of different outcomes using a probability weighted approach.  To determine the fair value of the different outcomes, we determined the sum of the undiscounted estimated future cash flows expected to result from the use of the asset.  Upon completion of the evaluation using the probability weighted outcomes, it was determined that an impairment of $77,942 was necessary.
 

ASC Topic 820, “Fair Value Measurements” establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.  The NPI impairment was based on Level 3, unobservable inputs, including conversations with the producer of the net profits interest concerning future plans for the Madisonville field as well as preliminary results from their annual reserve report.  Additionally, no revenue had been recognized during 2009 for the interest.  The adjusted value of the NPI is $701,482.

Asset Retirement Obligation
 
The Company provides for future asset retirement obligations under the provisions of FASB ASC Topic 410, “Asset Retirement and Environmental Obligations,” related to the Shipwreck offshore production platform because, eventually, law or regulation will require its abandonment.  The present value of the estimated future asset retirement obligation, as of the date of acquisition, was capitalized to gas gathering, processing and transportation equipment.  The present value of the estimated future asset retirement obligation, as of the balance sheet date, is presented as a noncurrent liability.  Until the platform is ultimately sold or retired, the Company will recognize (i) depreciation expense on the additional capitalized costs; (ii) accretion expense as the present value of the future asset retirement obligation increases with the passage of time, and; (iii) the impact, if any, of changes in estimates of the liability.
 
8
 
 
 
 

 
 

Refer to Note 8 to the Consolidated Financial Statements for discussion of change in estimate.

Refer to Note 12 to the Consolidated Financial Statements for discussion of sale, effective June 30, 2009, of the Shipwreck platform.

Goodwill and Other Intangibles
 
FASB ASC Topic 350, “Intangibles, Goodwill, and Other” addresses the methods used to capitalize, amortize and to assess the impairment of intangible assets.  In evaluating the Company’s intangibles, management considered all of the criteria set forth in FASB ASC Topic 350 for determining useful life.  Management performs our annual impairment test for intangible assets in the fourth quarter of each fiscal year or when changes in circumstance indicate impairment.  No impairments were indicated as a result of impairment reviews for intangible assets in the year ended December 31, 2008.  During the third quarter of 2009, intangible assets related to contracts with producers were impaired due to the abandonment of platforms by the producers.  As such, the Company recognized approximately $52,000 of impairment for the year ended December 31, 2009.
 

Use of Estimates
 
The preparation of financial statements in conformity with U.S. 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.  Management’s significant estimates include depreciation of long-lived assets, depletion of gas reserves, amortization of deferred loan costs, valuation of the asset retirement obligation liability, valuation of the fair value of the Company’s long-lived assets, and valuation of stock based compensation.  Actual results could differ from those estimates.
 
Accounting Pronouncements and Recent Regulatory Developments
 
The FASB issued ASC Topic 820, “Fair Value Measurements and Disclosures”. This topic:
 
·  
Affirms that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction.
 
 
·  
Clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active.
 
 
·  
Eliminates the proposed presumption that all transactions are distressed (not orderly) unless proven otherwise. The topic instead requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence.
 
 
·  
Includes an example that provides additional explanation on estimating fair value when the market activity for an asset has declined significantly.
 
 
·  
Requires an entity to disclose a change in valuation technique (and the related inputs) resulting from the application of the topic and to quantify its effects, if practicable.
 
 
·  
Applies to all fair value measurements when appropriate.
 
ASC Topic 820 must be applied prospectively and retrospective application is not permitted. ASC Topic 820 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. An entity early adopting ASC Topic 820 must also early adopt ASC Topic 320, “Investments, Debt, and Equity Securities”. The Company adopted ASC Topic 820 as it applies to financial assets and liabilities as of June 30, 2009 and the adoption did not have a material impact on its consolidated financial statements.
 
9
 
 
 
 

 

The FASB issued ASC Topic 825, “Financial Instruments”, and ASC Topic 270, “Interim Reporting”. They require an entity to provide disclosures about fair value of financial instruments in interim financial information. This also amends ASC Topic 270 to require those disclosures in summarized financial information at interim reporting periods. Under this topic, a publicly traded company shall include disclosures about the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. In addition, an entity shall disclose in the body or in the accompanying notes of its summarized financial information for interim reporting periods and in its financial statements for annual reporting periods the fair value of all financial instruments for which it is practicable to estimate that value, whether recognized or not recognized in the statement of financial position, as required by ASC Topic 825.

ASC Topic 825 and ASC Topic 270 are effective for interim periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. However, an entity may early adopt these interim fair value disclosure requirements only if it also elects to early adopt ASC Topic 820, ASC Topic 320 and ASC Topic 958.  The Company adopted ASC Topic 820 as it applies to financial assets and liabilities as of January 1, 2008 and the adoption did not have a material impact on its consolidated financial statements.

The FASB has issued ASC Topic 855, “Subsequent Events” (“ASC Topic 855”). ASC Topic 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Specifically, ASC Topic 855 provides:
 
·  
The period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements;
 
 
·  
The circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and
 
 
·  
The disclosures that an entity should make about events or transactions that occurred after the balance sheet date.
 
ASC Topic 855 is effective for interim or annual financial periods ending after June 15, 2009, and shall be applied prospectively.  The Company has adopted and will follow the guidance in ASC Topic 855 for all prospective subsequent event transactions and disclosures.

The FASB issued ASC Topic 105, the “FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (“ASC Topic 105”). ASC Topic 105 establishes the FASB Accounting Standards Codification (Codification) as the single source of authoritative U.S. generally accepted accounting principles (U.S. GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. ASC Topic 105 and the Codification are effective for financial statements issued for interim and annual periods ending after September 15, 2009.

The Codification supersedes all existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification will become nonauthoritative. Following ASC Topic 105, the FASB will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead, the FASB will issue Accounting Standards Updates, which will serve only to: (a) update the Codification; (b) provide background information about the guidance; and (c) provide the basis for conclusions on the change(s) in the Codification.

The Company will utilize ASC Topic 105 as authoritative guidance over accounting transactions.

The SEC has published a Final Rule, Modernization of Oil and Gas Reporting. The new disclosure requirements include provisions that permit the use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserves volumes. The new requirements also will allow companies to disclose their probable and possible reserves to investors. In addition, the new disclosure requirements require companies to: (a) report the independence and qualifications of its reserves preparer or auditor; (b) file reports when a third party is relied upon to prepare reserves estimates or conducts a reserves audit; and (c) report oil and gas reserves using an average price based upon the prior 12-month period rather than year-end prices.
 
10
 
 
 
 

 

The new disclosure requirements are effective for registration statements filed on or after January 1, 2010, and for annual reports on Forms 10-K and 20-F for fiscal years ending on or after December 31, 2009. A company may not apply the new rules to disclosures in quarterly reports prior to the first annual report in which the revised disclosures are required.

The adoption of this rule had no effect on the financial statements.

Results of Operations
 
General
 
The Company evaluates its segments based on operating margin, which is defined as revenues less cost of purchased gas and operating and maintenance expenses.  Such amounts are before general and administrative expense, depreciation, depletion and amortization expense, interest income or expense or income taxes.  Operating margin is not a GAAP measure but the components of operating margin are computed by using amounts that are determined in accordance with GAAP.  A reconciliation of operating margin to operating income is presented in Note 11 to the Consolidated Financial Statements.
 
The Henry Hub closing monthly index price for natural gas during the year ended December 31, 2009 averaged $3.99 per MMBtu, compared to $9.02 for the same period of the prior year.  In the accompanying financial statements, the Company’s revenues from sales of natural gas, along with the cost of natural gas purchased, decreased proportionately from prior year levels.  Because the Company buys and sells gas under purchase and sales contracts that are priced at the beginning of the month, based upon established gas indices to minimize commodity price risk, the Company’s net operating margin is relatively insensitive to fluctuations in the market price of gas.  Accordingly, the Company evaluates each of its activities based on the operating margin it produces.   Management reviews and evaluates the operations of three main segments—Onshore operations, Offshore operations and Net Profits Interest.
 
During 2009, the Company sold its Shipwreck, Crystal Beach, and Pirates Beach assets in the Gateway Offshore Pipeline subsidiary.  The Company presented the operating results of those assets in its statement of operations for the years ended December 31, 2009 and 2008 as discontinued operations.
 
Total Operations
 
 
Year Ended December 31,
 
2009
 
2008
 
2007
Revenues                                                
$6,707,974
 
$13,882,476
 
$10,282,336
Operating margin                                                
2,737,919
 
2,469,763
 
2,046,199
Depreciation, depletion, and amortization
608,394
 
621,252
 
405,632
 
Operating margin for the year ended December 31, 2009 increased $268,000 from the prior year.  Offshore operating margin increased $804,000, Onshore operating margin decreased $526,000 and the Net Profits Interest decreased by $10,000.
 
 
Operating margin for the year ended December 31, 2008 increased $424,000 from the prior year.  Offshore operating margin increased $492,000, Onshore operating margin decreased $74,000 and the Net Profits Interest increased by $5,000.
 
Onshore Operations
 
Year Ended December 31,
 
2009
 
2008
 
2007
Revenues                                                
$4,419,676
 
$12,373,321
 
$9,352,113
Operating margin                                                
622,206
 
1,148,036
 
1,221,871
Depreciation and amortization
150,935
 
194,455
 
207,966
 
Onshore operating margin for the year ended December 31, 2009 decreased $526,000 from the prior year, primarily caused by continuing lower throughput volumes on the Company’s Madisonville pipeline system due to the natural decline of the Madisonville field and lower sales volumes on the Waxahachie distribution system due to a permanent plant shutdown in December 2008.  
 
11
 
 
 
 

 
 
 
The Company expects operating margins to increase on its Onshore segment as throughput volumes on the Madisonville pipeline system will be increasing during 2010 as well contributions from the newly acquired Hickory Creek Gathering System.
 
 
Onshore operating margin for the year ended December 31, 2008 decreased $74,000 from the prior year, mainly due to continuing lower throughput volumes on the Company’s Madisonville pipeline system due to the natural decline of the Madisonville field,offset by higher margins on the Company’s Waxahachie distribution system.
 
Offshore Operations
 
Year Ended December 31,
 
2009
 
2008
 
2007
Revenues                                                
$2,293,298
 
$1,504,155
 
$930,223
Operating margin                                                
2,120,713
 
1,316,727
 
824,328
Depreciation and amortization
416,114
 
420,891
 
193,214
 
Offshore operating margin for the year ended December 31, 2009 increased $804,000 compared to 2008 due to increased throughput volumes on the Company’s East Cameron 359 pipeline system.  The East Cameron 359 pipeline operating margin for the for the year ended December 31, 2009 was favorably impacted by temporary volumes as an alternate pipeline for several producers while the main Sea Robin pipeline used was temporarily out of service.  This increase was partially offset by reduced volumes at several systems that have not fully recovered from the hurricanes in 2008.
 
Offshore operating margin for the year ended December 31, 2008 increased $492,000 compared to 2007 due to the August 2007 acquisition of all Gulfshore Midstream’s Offshore pipeline assets, as well as increased throughput volumes on the Company’s Bolivar pipeline system.

Net Profits Interest Operations
 
Year Ended December 31,
 
2009
 
2008
 
2007
Revenues                                                
$(5,000)
 
$5,000
 
$         -
Operating margin                                                
(5,000)
 
5,000
 
           -
Depletion                                                
34,462
 
783
 
           -

The Net Profits Interest operating margin for the year ended December 31, 2009 was $(5,000).  The negative operating margin is due to a reversal of revenue recognized during the fourth quarter of 2008.  The Company purchased this Net Profits Interest in the Madisonville Field on December 22, 2008.  Unless the price of natural gas increases or the operator completes pre-announced workovers to increase production in the Madisonville Field, the Company will not recognize revenue from this interest.

Discontinued Operations

On June 30, 2009, the Company sold its Shipwreck gathering system consisting of an offshore platform and related pipelines, as well as a related onshore facility known as the Crystal Beach terminal (the “Shipwreck/Crystal Beach Assets”).  In a separate transaction, the Company also sold its Pirates’ Beach gathering system (the “Pirates’ Beach Assets”).

The Shipwreck/Crystal Beach Assets were sold to Impact Exploration & Production, LLC for consideration consisting of $200,000, payable in four quarterly installments, and the assumption of liabilities, including abandonment and retirement obligations, with an effective date of June 30, 2009.  We have received the first installment on the note as of December 31, 2009, but are uncertain as to the timing of the collection of the remaining three installments.  As such, we have calculated the gain on sale of assets according to ASC Topic 605 “Revenue Recognition” using the cost recovery method.  As a result of the sale, the Company recognized a pre-tax gain of $213,780 and a pre-tax deferred gain of $150,000, which will be deferred and recognized as the remaining installments are received.
 
12
 
 
 
 

 
 

 
The Pirates’ Beach Assets were sold to Emerald Gathering and Transportation, L.L.C. for consideration consisting of $300,000, of which $50,000 was paid at closing, with the balance payable in five monthly installments, and the assumption of liabilities, including abandonment and retirement obligations, with an effective date of June 1, 2009.  We are reasonably certain as to the collection of the installments on the note and recognized the full amount of the gain up front.  As a result of the sale, the Company recognized a pre-tax gain of $101,539.

Accordingly, prior period financial statement amounts have been adjusted to give effect to these dispositions as discontinued operations.

The following are the results of operations of the Crystal Beach Terminal and Shipwreck and Pirates’ Beach gathering systems for the periods presented:

 
 
                                                                      Years Ended December 31,        
              2009       2008                           2007  
                     Operating revenues (1)
          $ 131,964      $ 750,110       $               1,007,065  
                         Operating costs and
                            expenses (2)
      337,359       432,652              412,227  
In                      Income (loss) from
                            discontinued operations,
                            net of taxes
       (155,897)       194,480             356,903  
                     Gain on disposal of
                       discontinued
                       operations, net of taxes
      217,380       -            -  
                               
B                      Basic and diluted loss per
                           share from discontinued
                           operations
    $  (0.01)     $ -     $    -  
                               
B                      Basic and diluted income
                           per share from gain on
                           disposal of discontinued
                           operations
           0.01       0.01            0.01  
Total
    $ -     $ 0.01     $     0.01  
                               
W                    Weighted average number
                           of common shares
                           outstanding:
                             
Basic
      19,303,488       19,126,587       17,781,059  
Diluted
      19,303,488       19,330,409       17,956,541  

 
(1)  
This revenue is based on billings to producers for transportation services.

(2)  
This cost is comprised of operations and maintenance expense, depreciation expense, and accretion expenses.

Operations Support and Other Income (Expense)
 
Year Ended December 31,
 
2009
 
2008
 
2007
 
           
General and administrative                                                
$2,405,400
 
$2,424,045
 
$2,044,342
Interest income                                                
      30,408
 
      29,119
 
     114,265
Interest expense                                                
    (116,699)
 
     (157,091)
 
       (95,599)
Gain on sale of intangible asset
   -
 
    -
 
     286,579
Noncontrolling interest                                                
   -
 
      (28,824)
 
      (94,060)
Other income (expense), net                                                
    (48,750)
 
 1,731,155
 
     55,119
Income tax benefit (expense)                                                
  159,157
 
    (375,764)
 
1,906,678
Discontinued operations, net of tax
  (155,897)
 
    194,480
 
   605,946
Gain on disposal of discontinued operations, net of taxes
   217,380
 
    -
 
1,241,722
 
 
13
 

 
 
 

 
The following table represents a comparison of the major categories of general and administrative expenses for the years ended December 31, 2009, 2008, and 2007.
 
     
   
Year Ended December 31,
 
   
  2009
   
  2008
   
   2007
 
Salaries and employee related costs                                                              
  $   810,147     $    883,436     $     614,214  
                        Accounting, tax, and legal costs
      411,960          321,383           279,194  
                        Insurance costs                                                              
      389,347       422,976        509,613  
                        Investor relation costs                                                              
      145,590          174,167           149,174  
                        Board expenses
      183,157          204,349            108,468  
                        Consulting fees
      169,145          102,523            147,451  
                        Other general and administrative costs
      296,054           315,211            236,228  
                        Total general and administrative costs
  $ 2,405,400     $   2,424,045     $    2,044,342  

 
General and administrative expenses for the year ended December 31, 2009 decreased $19,000 compared to 2008, or 1%, primarily due to decreased insurance, salary, bonuses, and license fees, offset by increased consulting and auditing fees.
 
General and administrative expenses for the year ended December 31, 2008 increased $380,000 compared to 2007, or 19%, primarily due to an increase in wages and salaries due to the hiring of new personnel, board of directors expenses, and non-cash stock compensation expenses, offset by decreased insurance and consulting expenses.
 
Interest income for all years presented fluctuates directly with the average cash balances.
 
Interest expense fluctuates directly with the amount of outstanding long-term debt and the amount of borrowings under the Company’s bank revolving credit agreement.
 
Interest expense for the year ended December 31, 2009 decreased $40,000 compared to 2008 primarily because of the decreased outstanding balance on the Company’s revolving credit facility, which was used to acquire the minority interest in the Madisonville pipeline, as well as the net profits interest in the Madisonville Field and the amortization of fees associated with the credit facility.
 
Other expense for the year ended December 31, 2009 was primarily comprised of a $47,000 write off of an Oklahoma tax refund deemed uncollectible.  Other income for the year ended December 31, 2008 was primarily comprised of $1,697,327 in insurance proceeds from damage to the Company’s Crystal Beach asset from Hurricane Ike.

Liquidity and Capital Resources
 
The Company had available cash of $2,086,787 at December 31, 2009.
 
Net cash provided by continuing operating activities totaled $521,096 for the year ended December 31, 2009, compared to net cash provided by continuing operating activities of $2,316,381 during the same period of the previous year.  The significant decrease in cash flow from operating activities is primarily due to the decrease in net income from 2008 to 2009 of $1,033,652, decrease in deferred tax expense from 2008 to 2009 of $535,990, and additional cash used related to changes in operating assets and liabilities of $306,327.
 
Absent significant acquisitions or development projects, the Company will continue to fund its operations through internally-generated funds and available cash and bank borrowings as needed.  The Company believes its cash flows from such sources will be sufficient to fund its ongoing operations for the foreseeable future.
 
Going forward, the Company’s strategy is to maximize the potential of currently-owned properties, to construct new pipeline systems, and to acquire properties that meet its economic performance hurdles.  The Company is actively seeking additional outside capital to allow it to accelerate the implementation of its growth strategy, and such new capital may take several forms.  There is no guarantee that we will be able to raise outside capital or be able to sell assets on terms favorable to the Company.  Without a significant infusion of new capital, we believe we can finance the construction of new facilities and generate new cash flows to the Company, but only at a pace that can be supported by cash flows and our existing financing agreements.
 
14
 
 
 
 

 
 
During 2009, the Company executed premium finance agreements for its insurance premiums.  The total of the notes were $525,079 with an interest rate of 6.5%.  The notes require monthly principal and interest payments.  The amount of the monthly payment varies depending on any changes in coverage and policy renewal periods.  The loans were refinanced in early 2009 resulting in a credit of $194,819.  Additionally, due to the sale of the Crystal Beach, Pirates Beach, and Shipwreck assets, the Company was granted a refund in insurance of $147,763.  Total credits received from refinancing and the asset sales were $342,582.  These notes were repaid during December 2009.
 
On December 7, 2009, the Company entered into a Credit Agreement (the “Agreement”) with Meridian Bank, Texas (“Meridian”), regarding a revolving credit facility provided by Meridian to the Company.  The original borrowing base under the new Agreement had been established at $3 million, which may be increased at the discretion of the Lender to an amount not to exceed $6 million.  This credit facility replaces the Company’s prior credit facility.  The credit facility is secured by all of the Company’s assets and originally has a term of 39 months, maturing on April 30, 2012.  The credit facility contains financial covenants defining various financial measures and levels of these measures with which the Company is in compliance.  Interest on outstanding balances will accrue at the Wall Street Journal prime rate, plus one and a half percent, with a minimum rate of 5.50%.  Unused borrowing base fees are 0.50% per year of the average for the period of calculation of an amount determined daily equal to the difference between the borrowing base and the aggregate outstanding principal balance of the facility.  This amount is paid quarterly.  As of December 31, 2009, there was a zero balance on the facility.
 
At December 31, 2009, the Company had $900,000 in outstanding letters of credit for gas purchases.
 
Natural gas prices as represented by the Henry Hub closing monthly index price for natural gas during the year ended December 31, 2009 averaged $3.99 per MMBtu, compared to $9.02 for the same period of the prior year.  The Company’s operating margin is not significantly affected by the price of natural gas since gas gathering and transportation are generally based on fee arrangements and sales of natural gas are made under back-to-back purchase and sales arrangements.  However, natural gas prices can affect exploration and development which can result in higher or lower volumes available for gathering and transportation.
 
Off-Balance Sheet Arrangements
 
The Company has no off-balance sheet arrangements at December 31, 2009; however, see Note 9 to the consolidated financial statements regarding Commitments and Contingencies.
 
Factors Affecting Future Results
 
The principal objective of the Company is to enhance stockholder value through the execution of certain strategies.  These strategies include, among other things: (i) focusing on gathering, transporting, and distributing natural gas; (ii) expanding the Company’s asset base in the existing core geographic areas; and (iii) acquiring or constructing properties in one or more new core areas.
 
We have a history of operating losses.

During 2009, we operated our business at an operating loss.  There are many factors influencing our operations that are beyond our control that may cause future losses. We cannot control the extent or timing of producer investment near our Offshore pipeline systems. The ultimate success of our Madisonville pipeline facilities and net profits interest depends upon the continued success of the producer in the area, and the continued successful operation of the Madisonville plant.

We depend on key personnel who would be difficult to replace and our business will likely be harmed if we lose their services.

Robert Panico has served as the Company's President and Chief Executive Officer since May 2005.  Mr. Panico had been a Vice President of the Company since 1997.  Christopher Rasmussen has served as the Company's Chief Financial Officer since June 2005.  Due to the Company’s cash flow constraints, Messrs. Panico and Rasmussen will be responsible for substantially all of the management duties of the Company.  The loss of either of these individuals as an employee of the Company could have a material adverse effect on the Company’s operations and ability to satisfy its reporting requirements under the applicable securities laws.
 
15
 
 
 
 

 

The Company faces significant competition.

The Company's ability to generate long-term value for the common stockholder is dependent in part upon the successful acquisition of additional assets that complement the Company's core business at costs that provide for reasonable returns.  There are many companies participating in the midstream segment of the natural gas industry, many with resources much 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’s cost of capital may be greater than its competitors which would adversely affect the ability of the Company to compete.

The Company must provide services to its customers, primarily producers, at a competitive price.  Therefore, in order to be successful the Company must maintain 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 margin, enabling fixed overhead costs to be spread over a larger asset base.  However, there can be no assurance that the Company will be successful in this endeavor.

To the extent that we make acquisitions in the future and our acquisitions do not perform as expected, our future financial performance may be negatively impacted.
 
Our business strategy includes making acquisitions. As a result, from time to time, we evaluate and pursue assets and businesses that we believe complement our existing operations or expand our operations into new regions where our growth strategy can be applied. We cannot assure you that we will be able to complete acquisitions in the future or achieve the desired results from any acquisitions we do complete. In addition, failure to successfully assimilate our acquisitions could adversely affect our financial condition and results of operations.

Our acquisitions potentially involve numerous risks, including:
     
 
• 
operating a significantly larger combined organization and adding operations;
     
 
• 
difficulties in the assimilation of the assets and operations of the acquired businesses, especially if the assets acquired are in a new business segment or geographic area;
     
 
• 
the risk that natural gas reserves expected to support the acquired assets may not be of the anticipated magnitude or may not be developed as anticipated;
     
 
• 
the loss of significant producers or markets;
     
 
• 
the diversion of management’s attention from other business concerns;
     
 
• 
the failure to realize expected profitability or growth;
     
 
• 
the failure to realize any expected synergies and cost savings;
     
 
• 
coordinating geographically disparate organizations, systems and facilities;
     
 
• 
a decrease in liquidity as a result of using significant amounts of available cash or borrowing capacity to finance an acquisition.

Further, unexpected costs and challenges may arise whenever businesses with different operations or management are combined, and we may experience unanticipated delays in realizing the benefits of an acquisition. Our capitalization and results of operation may change significantly following an acquisition, and you may not have the opportunity to evaluate the economic, financial and other relevant information that we will consider in evaluating future acquisitions.
 
16
 
 
 
 

 

Due to current economic conditions, our ability to obtain funding under our revolving credit facility could be impaired.
 
We operate in a capital-intensive industry and rely on our revolving credit facility to finance a significant portion of our capital expenditures. Our ability to borrow under our revolving credit facility may be impaired because of deterioration in the financial markets, including issues surrounding the solvency of many institutional lenders and recent failures of several banks.

Specifically, we may be unable to obtain adequate funding under our revolving credit facility because:
     
 
• 
our lender may be unable or otherwise fail to meet its funding obligations;
     
 
• 
our lender may elect to not renew the credit facility upon maturity;
     
 
• 
each time we draw on our revolving credit facility, if any of the representations or warranties or certain covenants included in the agreement are false in any material respect, the lenders may refuse to provide funding; and
     
If we are unable to access funds under our revolving credit facility, we will need to meet our capital requirements, including some of our short-term capital requirements, using other sources. Due to current economic conditions, alternative sources of liquidity may not be available on acceptable terms, if at all. If the cash generated from our operations or the funds we are able to obtain under our revolving credit facility or other sources of liquidity are not sufficient to meet our capital requirements, then we may need to delay or abandon capital projects or other business opportunities, which could have a material adverse effect on our results of operations and financial condition.

We are exposed to the credit risk of our customers and other counterparties, and a general increase in the nonpayment and nonperformance by counterparties could have an adverse impact on our cash flows, results of operations and financial condition.

Risks of nonpayment and nonperformance by our counterparties are a major concern in our business. We are subject to risks of loss resulting from nonpayment or nonperformance by our customers and other counterparties. Many of our customers finance their activities through cash flow from operations, the incurrence of debt or the issuance of equity. In connection with the recent economic downturn, commodity prices have declined sharply, and the credit markets and availability of credit have been constrained. Additionally, many of our customers’ equity values have declined substantially, increasing their cost of equity capital. The combination of lower cash flow due to commodity prices, a reduction in borrowing bases under reserve-based credit facilities and the lack of available debt or equity financing may result in a significant reduction in our customers’ liquidity and ability to pay or otherwise perform on their obligations to us. Furthermore, some of our customers may be highly leveraged and subject to their own operating and regulatory risks, which increases the risk that they may default on their obligations to us. Any increase in the nonpayment and nonperformance by our counterparties, either as a result of recent changes in financial and economic conditions or otherwise, could have an adverse impact on our operating results and could adversely affect our liquidity.

Because of the natural decline in production from existing wells in our operating regions, our future success depends on our ability to continually obtain new sources of natural gas supply, which depends in part on certain factors beyond our control. Any decrease in supplies of natural gas could adversely affect our revenues and operating income.
 
Our gathering and transmission pipeline systems are connected to natural gas fields and wells, from which the production will naturally decline over time, which means that our cash flows associated with these wells will also decline over time. To maintain or increase throughput levels on our pipeline systems and our processing plants, we must continually obtain new natural gas supplies. We may not be able to obtain additional contracts for natural gas supplies. The primary factors affecting our ability to connect new supplies of natural gas and attract new customers to our gathering and transmission lines include: (i) the level of successful drilling activity near our systems and (ii) our ability to compete for the attachment of such additional volumes to our systems.

Fluctuations in energy prices can greatly affect production rates and investments by third parties in the development of new natural gas reserves. Drilling activity generally decreases as natural gas prices decrease. We have no control over the level of drilling activity in the areas of our operations, the amount of reserves underlying the wells or the rate at which production from a well will decline. In addition, we have no control over producers or their production decisions, which are affected by, among other things, prevailing and projected energy prices, rig availability, demand for hydrocarbons, the level of reserves, geological considerations, governmental regulations and the availability and cost of capital.
 
17
 
 
 
 

 
 
 
The current pricing environment, particularly in combination with the constrained capital and credit markets and overall economic downturn, has resulted in a decline in drilling activity by some producers in each of our segments. Lower drilling levels over a sustained period would have a negative effect on the volumes of natural gas we gather and process.

We generally do not obtain reservoir engineering reports evaluating reserves dedicated to our pipeline systems; therefore, volumes of natural gas transported on our pipeline systems in the future could be less than we anticipate, which may cause our revenues and operating income to be less than we expect.
 
We generally do not obtain reservoir engineering reports evaluating natural gas reserves connected to our pipeline systems due to the unwillingness of producers to provide reserve information as well as the cost of such evaluations. Accordingly, we do not have estimates of total reserves dedicated to our systems or the anticipated life of such reserves. If the total reserves or estimated life of the reserves connected to our pipeline systems is less than we anticipate and we are unable to secure additional sources of natural gas, then the volumes of natural gas transported on our pipelines in the future could be less than we anticipate. A decline in the volumes of natural gas transported on our pipeline systems may cause our revenues to be less than we expect which could have a material adverse effect on our business, financial condition and our ability to make cash distributions to you.

Our business involves many hazards and operational risks, some of which may not be fully covered by insurance. If a significant accident or event occurs that is not fully insured, our operations could be temporarily or permanently impaired, and our liabilities and expenses could be significant.

Our operations are subject to the many hazards inherent in the gathering, compression, treating, processing, and transportation of natural gas and liquids, including:
     
 
• 
damage to pipelines, pipeline blockages and damage to related equipment and surrounding properties caused by hurricanes, tornadoes, floods, fires, extreme weather conditions and other natural disasters and acts of terrorism;
     
 
• 
inadvertent damage from motor vehicles, construction or farm equipment;
     
 
• 
leaks of natural gas and other hydrocarbons;
     
 
• 
operator error; and
     
 
• 
fires and explosions.

These risks could result in substantial losses due to personal injury and/or loss of life, severe damage to and destruction of property and equipment and pollution or other environmental damage and may result in curtailment or suspension of our related operations. In addition, mechanical malfunctions, undetected leaks in pipelines, faulty measurement or other errors may result in significant costs or lost revenues. Our operations are primarily concentrated in the Texas Gulf Coast, Louisiana Gulf Coast and in the east and north Texas regions, and a natural disaster or other hazard affecting any of these areas could have a material adverse effect on our operations. For example, although we did not suffer significant damage, Hurricane Ike and Hurricane Gustav damaged gathering systems, processing facilities and NGL fractionators along the Gulf Coast in September 2008, which curtailed or suspended the operations of various energy companies with assets in the region. There can be no assurance that insurance will cover all damages and losses resulting from these types of natural disasters. We are not fully insured against all risks incident to our business. In accordance with typical industry practice, we generally do not have any property insurance on any of our underground pipeline systems that would cover damage to the pipelines. We are not insured against all environmental accidents that might occur, other than those considered to be sudden and accidental. If a significant accident or event occurs that is not fully insured, our operations could be temporarily or permanently impaired, and our liabilities and expenses could be significant.
 
18
 
 
 
 

 

Due to our limited asset diversification, adverse developments in our gathering, transportation, processing and related businesses would have a significant impact on our results of operations.
 
Substantially all of our revenues are generated from our gathering, processing and transportation business, and as a result, our financial condition depends upon prices of, and continued demand for, natural gas and liquid hydrocarbons. Furthermore, substantially all of our assets are located in the Texas Gulf Coast, Louisiana Gulf Coast and in the east and north Texas regions. Due to our limited diversification in asset type and location, an adverse development in one of these businesses or in these areas would have a significantly greater impact on our cash flows, results of operations and financial condition than if we maintained more diverse assets.

We are subject to risks associated with climate change.

There is a growing belief that emissions of greenhouse gases (GHGs) may be linked to climate change. Climate change and the costs that may be associated with its impacts and the regulation of GHGs have the potential to affect our business in many ways, including negatively impacting the costs we incur in providing our products and services, the demand for and consumption of our products and services (due to change in both costs and weather patterns), and the economic health of the regions in which we operate, all of which can create financial risks.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
This item is not applicable for smaller reporting companies such as Gateway.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
See index to Consolidated Financial Statements beginning on page F-1 of this Form 10-K.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
None

ITEM 9A(T).  CONTROLS AND PROCEDURES
 
Disclosure Controls and Procedures


Based on their evaluation as of the end of the period covered by this annual report, the Company’s principal executive officer and principal financial officer initially concluded that the company’s disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e)  under the Securities Exchange Act of 1934 (the “Exchange Act”) were effective such that the information relating to Gateway required to be disclosed in reports that it files or submits under the Exchange Act (1) was recorded, processed, summarized and reported within the time periods specified in Securities and Exchange commission rules and forms, and (2) was accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

As described elsewhere herein, in November 2010 we determined that our financial statements for the year ended December 31, 2009 contained accounting errors in our gain recognition procedures for the gain on sale of discontinued operations.  As a result, management determined that a restatement was required of our financial statements for the year ended December 31, 2009.  Because of this error, our principal executive officer and our principal financial officer have subsequently concluded that our disclosure controls and procedures were not effective at December 31, 2009 as a result of a material weakness in our internal control over financial reporting which led to the restatement of our financial statements.  This weakness was a result of our incorrect conclusion regarding the correct method of accounting for gain recognition in connection with the sale of discontinued operations.  A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of our annual or interim financial statements would not be prevented or detected.  We have outlined procedures designed to address this material weakness, as discussed below in Management’s Report on Internal Control over Financial Reporting.
 
19
 
 
 
 

 


Management’s Report on Internal Control over Financial Reporting

                Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15f under the Exchange Act. Our internal control system is designed to provide reasonable assurance to our management and board of directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:

-           Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;

-           Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and

-           Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2009. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on management's assessment and those criteria, management initially concluded internal controls over financial reporting were effective as of December 31, 2009.  Subsequent to year end, however, we have determined that a certain portion of the gain on sale of discontinued operations, totalling $150,000 recorded in June 30, 2009, should have been deferred until installments on the note were realizable.  As a result of this error, we have restated our consolidated balance sheet at December 31, 2009 and consolidated statement of operations for the year ended December 31, 2009.  Because of this accounting error, our management has determined that as of December 31, 2009 there was a material weakness in our internal controls over financial reporting as a result of our inability to properly record the gain on sale of discontinued operations.  Because of this error, our principal executive officer and our principal financial officer have subsequently concluded that our internal control over financial reporting was not effective as of December 31, 2009.We have implemented procedures discussed below designed to prevent these specific errors from occurring in the future.

We have taken or plan to take the following initiatives: (1) conduct thorough research on accounting rules on special transactions such as the calculation of gain or loss on sale of discontinued operations and (2) implement a qualitative review analysis of special transactions by the audit committee of our board of directors.

We have discussed this material weakness and our planned remediation steps with the audit committee of our board of directors and believe that such procedures, once fully implemented, will prospectively mitigate this material weakness.

This annual report does not include an attestation report of the Company's independent registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company’s registered public accounting firm pursuant to the temporary rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report.

Changes in Internal Control over Financial Reporting

Except as previously noted, there was no change in the Company's internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and Rule 15d-15(d) of the Exchange Act that occurred during the period covered by this report and that has materially affected, or is reasonable likely to materially affect, the Company's internal control over financial reporting.
 
20
 
 
 
 

 


ITEM 9B.  OTHER INFORMATION
 
None
PART III
 
ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
Directors
 
Charles O. Buckner, 65, has served on the Board of Directors since 2008 and currently serves as the Chairman of the Audit Committee.  Mr. Buckner is a private investor, retired from the public accounting firm of Ernst & Young LLP in 2002 after 35 years of service in a variety of client services and administrative roles, including chairmanship of Ernst & Young’s United States energy practice.  Mr. Buckner presently serves as director of Patterson-UTI, a public company providing contract drilling and pressure pumping services to exploration and production companies, and Energy Partners, Ltd., a publicly held company with oil and natural gas exploration and production on the continental shelf in the Gulf of Mexico.  Mr. Buckner served as a director of Horizon Offshore, Incorporated, a marine construction services company for the offshore oil and gas industry from 2003 to 2007, and Whittier Energy Corporation, a publicly held company with domestic onshore oil and natural gas exploration and production from 2003 to 2007.  Mr. Buckner is a Certified Public Accountant and holds a Bachelor of Business Administration from the University of Texas and a Masters of Business Administration from the University of Houston.
 
Steven W. Cattron, 53, has served on the Board of Directors since 2005, and currently serves as the Chairman of the Board.  He currently is owner of Cattron Enterprises, Inc., a professional consulting practice focused on improving profitability of small- to medium-sized companies.  Prior to that, he was President and Chief Operating Officer of Missouri Gas Energy, a natural gas distribution company serving Western Missouri as well as Vice President of Sales and Marketing and Regulatory Affairs for Kansas City Power and Light, an electric company serving western Missouri and eastern Kansas.
 
William A. Henry, 67, has served on the Board of Directors since 2008, and currently serves as Vice President of Brown, Williams, Morhead and Quinn, an energy consulting firm.  He primarily is focused on gas storage, LNG projects and gas marketing programs.  Mr. Henry retired as Vice President of Freeport LNG Development, LP in August 2009.  At Freeport LNG he was in charge of pipeline design and construction, responsible for obtaining all federal, state and local permits for the terminal and pipeline, public relations and land acquisitions.  Prior to that, he served as president of several operating divisions for Enron, including Northern Border Pipeline and Peoples Natural Gas, a gas distribution company and served as executive vice president for Reliant/NorAm Energy.  Mr. Henry has a B.S. in Petroleum Engineering from Louisiana State University and an Associate Degree from Harvard Business School.
 
Robert Panico, 53, has served on the Board of Directors since 2005.  Mr. Panico was elected as the Company’s President and Chief Executive Officer in May 2005.  Mr. Panico served as a Vice President of the Company from 1997 to 2005.  Mr. Panico has over 31 years of oil and gas industry experience.  Mr. Panico previously served as Director of Duke Energy Field Services and was responsible for the South Texas region.  Mr. Panico also has been employed with Williams, American Oil and Gas, Tenneco and United Energy Resources and has extensive experience in business development, mergers and acquisitions, gas storage and natural gas processing.  Mr. Panico has an engineering degree from the University of South Florida and currently serves on the Board of Directors for the Texas Pipeline Association.
 
John A. Raasch, 77, has served on the Board of Directors since 2004 and currently serves as the Chairman of the Nominating Committee.  He was Senior Vice President of Wachovia Securities until his retirement on December 31, 2003 after 33 years of service.  Mr. Raasch served as Interim President and Chief Executive Officer of Gateway Energy Corporation from October 2004 through May 2005.
 
J. Darby Seré, 62, has served on the Board of Directors since 2005.  Mr. Seré is currently President, Chief Executive Officer and Chairman of GeoMet, Inc., a coal bed methane exploration and development company.  Mr. Seré has over 35 years of experience in the oil and gas business, including 18 years as Chief Executive Officer of two publicly held exploration and production companies.  Mr. Seré served as President, Chief Executive Officer, and a Director of Bellwether Exploration Company from 1988 to 1999, where he also served as Chairman of the Board from 1997 to 1999, and was a co-founder and President, Chief Executive Officer and Director of Bayou Resources, Inc. from 1982 to 1987.  Mr. Seré was Manager of Acquisitions, Vice President–Acquisitions and Engineering and Executive Vice President of Howell Corporation / Howell Petroleum Corporation from 1977 to 1981.  Mr. Seré began his career as a staff reservoir engineer for Chevron Oil Co. in 1970.  Mr. Seré holds a Bachelors degree in Petroleum Engineering from Louisiana State University and a Masters of Business Administration from Harvard University.
 
21
 
 
 
 

 
 
 
Gordon L. Wright, 67, has served on the Board of Directors since 2005 and currently serves as the Chairman of the Compensation Committee.  Mr. Wright has over 40 years experience in the oil and gas industry and presently is the President of Gordon L. Wright Petroleum Consulting Company.  In the course of his career he has been directly involved in projects in over 22 foreign countries as well as major producing provinces in the United States.  Mr. Wright is former President and Chief Executive Officer of CMS NOMECO Oil & Gas Co., a privately held international and domestic energy company.  Mr. Wright also served as President and Chief Executive Officer of CGAS, Inc., an Appalachian independent oil and gas producer.  Mr. Wright holds a Bachelor of Science degree in Petroleum Engineering from West Virginia University and is a veteran of the Vietnam Conflict.
 
Executive Officers of the Company
 
Christopher M. Rasmussen, 37, has served as the Company’s Chief Financial Officer, Treasurer and Secretary since 2005.  He was the Senior Financial Accountant for the Company between 1999 and 2005, at which time he left the Company for a period of nine months and was a senior accountant of Apache Corporation, before returning to assume his current position with the Company.
 
Section 16(a) Beneficial Ownership Reporting Compliance
 
Section 16 of the Exchange Act requires our directors and certain of our officers, and persons who own more than 10% of a registered class of our equity securities, to file initial reports of ownership and reports of changes in ownership with the SEC.  SEC regulations also require these persons to furnish us with a copy of all Section 16(a) forms they file.  Based solely on our review of the copies of the forms furnished to us and written representations from our officers who are required to file Section 16(a) forms and our directors, we believe that all Section 16(a) filing requirements were met during fiscal 2009, except that, according to public records, Charles Oliver Buckner, a director of the Company,  filed one Form 4 late during fiscal 2009, which covered one open market purchase of 31,646 shares of our common stock by Mr. Buckner on May 20, 2009.
 
Audit Committee
 
The Board of Directors has established an Audit Committee.  The primary purpose of the Audit Committee is to protect the interests of the Company's stockholders and directors by assisting the Board of Directors in fulfilling its responsibilities over the financial policies and reporting process, internal controls structure and compliance with legal and regulatory requirements. The Audit Committee recommends to the Board the appointment of the independent auditors, and periodically reviews and evaluates their performance and independence from management. The Audit Committee acts under the authority of the Audit Committee Charter adopted by the Board of Directors on March 22, 2006, a copy of which can be found on the Company website, www.gatewayenergy.com.
 
Messrs. Buckner, Cattron and Seré  comprise the Audit Committee and each is independent from the Company as defined by Nasdaq listing standards.  Mr. Buckner, the Chairman of the Audit Committee and Mr. Seré are each a financial expert as defined in Item 407(d)(5) of Regulation S-K. Under the Regulations, a financial expert is a person who possesses all of the following attributes:
 
·  
an understanding of financial statements and generally accepted accounting principles;
 
·  
an ability to assess the general application of such principles in connection with the accounting for estimates, accruals and reserves;
 
·  
experience preparing, auditing, analyzing or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by the Company’s financial statements, or experience actively supervising one or more persons engaged in such activities;
 
·  
an understanding of internal controls and procedures for financial reporting; and
 
·  
an understanding of audit committee functions.
 
 
22
 
 
 
 

 
 
 
Designation as an audit committee financial expert does not impose any duties, obligations or liability on an individual that are greater than those imposed on all members of the audit committee, nor does it affect the duties, obligations or liability of any other member of the committee or the Board of Directors.
 
Code of Ethics
 
The Company has adopted a Code of Ethics for all officers, directors and employees of the Company. It is available for inspection on the Company's website, www.gatewayenergy.com, or by mail free of charge by written request to: Gateway Energy Corporation, ATTN: Christopher M. Rasmussen, Chief Financial Officer, 1415 Louisiana Street, Suite 4100, Houston, Texas 77001. The Company intends to satisfy its disclosure requirements with respect to any amendment to, or waiver from, a provision of the Code of Ethics by posting such information on its Internet website.
 
ITEM 11.   EXECUTIVE COMPENSATION
 
For 2009, the Board of Directors and the Compensation and Stock Option Committee ("Compensation Committee") determined that the salary for Robert Panico, the Company’s Chief Executive Officer (“CEO”), would be increased by $0 to approximately $175,000 and he would receive a discretionary bonus of $23,265 in recognition of the Company's results for 2009. Similarly, the Compensation Committee awarded Christopher M. Rasmussen, the CFO, a $11,250 bonus and increased his annual salary by $3,750 to $128,750.
 
Summary Compensation Table
 
The following table contains information on the compensation earned by the Company’s CEO and each of the Company’s other most highly compensated executive officers whose compensation exceeded $100,000 in 2009 (the “Named Executive Officers”).
 
Name and
Principal
Position
Year
Salary
Bonus
Stock
Awards
Option
Awards
Non-Equity
Incentive
Plan Compen-sation
Nonqualified Deferred Compensa-tion Earnings
All
Other
Compensation
Total
Robert Panico, President and Chief Executive Officer
2009
2008
$175,000
175,000
$ 23,265
24,500
--
--
$56,353
56,302
--
--
--
--
 $5,873
5,873
$260,491
261,675
 
Christopher M.
Rasmussen,
Chief Financial
Officer, Treasurer
and Secretary
2009
2008
$128,750
125,500
$11,250
11,250
--
--
$27,565
24,765
--
--
--
--
$4,221
4,117
$171,796
165,632
 
 
23
 

 
 
 

 
 
 
Outstanding Equity Awards at Fiscal Year-End

The following table provides information regarding outstanding awards of stock options to the Named Executive Officers that have been granted but not vested or exercised as of December 31, 2009.

 
Option Awards
Stock Awards
Name
Number of Securities Underlying Unexercised Options (#) Exercisable
Number of Securities Underlying Unexercised Options (#) Unexercisable
Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options
Option Exercise Price
Option Expiration Date
Number of Shares or Units of Stock that Have Not Vested
Market Value of Shares or Units of Stock that Have Not Vested
Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights that Have Not Vested
Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights that Have Not Vested
Robert Panico
 
 
 
 
 
 
TOTAL
  30,000
  30,000
  35,000
150,000
150,000
  92,105
  --
487,105
 
 
 
 
 
  50,000
150,000
   46,053
 228,000
 474,053
 
 
 
 
 
$0.5000
$0.2625
$0.3400
$0.3600
$0.4500
$0.8500
$0.3160
 
 
 
02/06/2011
04/02/2012
03/30/2013
05/24/2011
03/15/2012
03/21/2013
05/21/2014
 
 
 
 
 
 
 
 
 
Christopher M.
Rasmussen
 
 
TOTAL
 
  50,000
  70,000
  21,930
--
141,930
 
 
    35,000
    43,859
  142,000
  220,859
 
 
 
$0.3600
$0.4500
$0.8500
$0.3160
 
05/24/2011
03/15/2012
03/21/2013
05/21/2014
 
 
 
 
 
 
 
 
 

Executive Employment Agreements
 
On August 23, 2006, the Company entered into employment agreements with its two officers, Messrs. Panico and Rasmussen. Under the agreements, which are for an indefinite period, these individuals are to be compensated in their positions as officers of the Company. The agreements provide for a minimum annual salary, that may be increased by the Board, of $139,920 and $90,000, for Messrs. Panico and Rasmussen, respectively.
 
The employment agreements provide for severance payments in the event the Company terminates the officer’s employment other than for cause, or if he resigns following certain adverse changes in the terms of his employment that constitute “good reason” under the agreement.  The employment agreements provide that the severance benefit for Messrs. Panico and Rasmussen will be a multiple of 1 ½ and 1, respectively, times an amount equal to the highest sum of the officer’s base salary plus annual incentive bonus earned, in each of the three most recently completed fiscal years of the Company, provided that in the event of a change of control which has occurred prior to the date of termination, such multiples increase to 2 and 1 ½ times, respectively.
 
A “change in control” means the occurrence of any of the following events and is deemed to have occurred on the date the first such event occurs:
 
·  
Change in Voting Power.  Any person or persons acting together which would constitute a “group” for purposes of Section 13(d) of the Exchange Act (other than the Company, or any Subsidiary, or any entity beneficially owned by any of the foregoing) beneficially own (as defined in Rule 13(d)-3 under the Exchange Act) without Board approval or consent, directly or indirectly, at least 30% of the total voting power of the Company entitled to vote generally in the election of the Board;
 
·  
Change in Board of Directors.  Either:
 
o  
the “current directors” cease for any reason to constitute at least a majority of the members of the Board (for these purposes, a “current director” means any current member of the Board, and any successor of a current director whose election or nomination for election by the Company’s stockholders was approved by at least a majority of the current directors then on the Board); or
 
o  
at any meeting of the stockholders of the Company called for the purpose of electing directors, a majority of the persons nominated by the Board for election as directors fail to be elected; or
 
 
24
 
 
 
 

 
 
 
·  
Liquidation, Merger or Consolidation. The stockholders of the Company approve an agreement providing for the merger or consolidation of the Company (a) in which the Company is not the continuing or surviving corporation (other than consolidation or merger with a wholly owned subsidiary of the Company in which all shares outstanding immediately prior to the effectiveness thereof are changed into or exchanged for the same consideration) or (b) pursuant to which the shares are converted into cash, securities or other property, except a consolidation or merger of the Company in which the holders of the shares immediately prior to the consolidation or merger have, directly or indirectly, at least a majority of the common stock of the continuing or surviving corporation immediately after such consolidation or merger, or in which the Board immediately prior to the merger or consolidation would, immediately after the merger or consolidation, constitute a majority of the board of directors of the continuing or surviving corporation; or
 
·  
Sale of Assets. The stockholders of the Company approve an agreement (or agreements) providing for the sale or other disposition (in one transaction or a series of transactions) of all or substantially all of the assets of the Company or a plan of complete liquidation of the Company.
 
The employment agreements also have customary non-competition provisions and customer and personnel non-solicitation provisions.
 
The Company believes that these provisions and agreements are necessary to both retain Messrs. Panico and Rasmussen and protect the Company's interests.
 
Compensation of Directors
 
The Company does not compensate employee-directors in their capacity as directors of the Company.  All Directors were reimbursed for reasonable travel and lodging expenses incurred while attending Board, Committee or Annual meetings.  In the year ended December 31, 2009, the compensation policy for non-employee directors (i.e. "Outside Directors") was as follows:
 
·  
Annual retainers payable $10,000 in cash and in stock valued at $10,000 as of the date of each Annual Meeting of Stockholders.
 
·  
An annual payment to the Chairman of the Board of $5,000.
 
·  
An annual payment to each member of the Audit Committee of $3,000.
 
·  
An annual payment to each member of the other committees of the Board of Directors of $1,500.
 
·  
A cash payment of $1,000 for each Board, Committee or Annual Meeting attended in person; provided that meetings held telephonically shall result in a cash payment of $125 per hour up to a maximum per meeting of $1,000 per day.
 
 
25
 
 
 
 

 
 
 
The following table contains information regarding the compensation earned by non-executive members of the Board of Directors during 2009:
 


Name
Fees Earned or Paid in Cash
Stock Awards
Option Awards
Non-Equity Incentive Plan Compensa-
tion
Nonqualified Deferred Compensation Earnings
All Other Compensa-tion
Total
Charles O.
Buckner
 
$17,500
$10,000
       
$27,500
Steven W. Cattron
 
$24,000
$10,000
       
$34,000
William A. Henry
 
$16,000
$10,000
       
$26,000
John A. Raasch
.
$16,000
$10,000
       
$26,000
J. Darby Seré
 
$19,000
$10,000
       
$29,000
Gordon L. Wright
 
$17,500
$10,000
       
$27,500


ITEM 12.
  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
The following table sets forth certain information, as of March 31, 2010, regarding the beneficial ownership of our common stock by:
 
 
each stockholder known to us to be the beneficial owner of more than 5% of our outstanding common stock;
 
 
each of our directors and each of our named executive officers; and
 
 
all of our directors and executive officers as a group.
 
The percentage of beneficial ownership for the table is based on approximately 19,397,125 shares of our common stock outstanding as of March 31, 2010.  To our knowledge, except under community property laws or as otherwise noted, the persons and entities named in the table have sole voting and sole investment power over their shares of our common stock.  Unless otherwise indicated, each beneficial owner listed below maintains a mailing address of c/o Gateway Energy Corporation, 1415 Louisiana Street, Suite 4100, Houston, Texas 77002.
 
The number of shares beneficially owned by each stockholder is determined under SEC rules and is not necessarily indicative of beneficial ownership for any other purpose.  Under these rules, beneficial ownership includes those shares of common stock over which the stockholder has sole or shared voting or investment power and those shares of common stock that the stockholder has the right to acquire within 60 days after March 31, 2010, including through the exercise of any equity award.  The “Percentage of Shares” column treats as outstanding all shares underlying equity awards held by the stockholder, but not shares underlying equity awards held by other stockholders.
 
Title of Class
Name and Address of Beneficial Owner
Amount and Nature of Beneficial Ownership
Percent of Class (1)
Common Stock
GEC Holdings, LLC
910 Oak Valley Drive
Houston, TX 77024
 
5,438,265 (2)
 
28.0%
Common Stock
Josh Buterin
365 Kaw Lane East
Lake Quivera, KS 66217
 
2,169,896(3)
 
11.2%

(1)
Based upon 19,397,125  shares of Common Stock outstanding as of March 31, 2010.
(2)
Based upon GEC Holdings, LLC Form 13D  filed on March 18, 2010. Includes 2,292,070 shares for which GEC Holdings has sole dispositive power.
(3)
This amount is included in the number of shares beneficially owned by GEC Holdings, LLC.  Mr. Buterin's ownership is based on a disclosure made by Pevow in his preliminary proxy statement filed on March 18, 2010.
 
 
26
 

 
 
 

 
 
 
 
Title of Class
Name of Beneficial Owner
Amount and Nature of
Beneficial Ownership
Percent of Class
Common Stock
Charles O. Buckner, Director
     87,760 (1)
*
Common Stock
Steven W. Cattron, Chairman
      53,936 (2)
*
Common Stock
William A. Henry, Director
      52,410 (3)
*
 
Common Stock
Robert Panico, Director, Chief Executive Officer and President
         880,208 (4)(5)
4.5%
Common Stock
John A. Raasch, Director
   1,281,409 (6)
6.6%
Common Stock
J. Darby Seré, Director
        73,936 (7)
*
Common Stock
Gordon L. Wright, Director
         53,410 (8)
*
 
Common Stock
Christopher M. Rasmussen, Chief Financial Officer, Treasurer and Secretary
              416,789 (9) (10)
2.1%
 
All directors, officers as a group (8 persons)
2,899,858
14.9%
 
_______________________________
 
 
*Indicates less than 1% ownership.
 
(1) Information obtained from Mr. Buckner’s Form 4 filed with the SEC on September 14, 2009.
 
(2) Information obtained from Mr. Cattron’s Form 4 filed with the SEC on May 22, 2009.
 
(3) Information obtained from Mr. Henry’s Form 4 filed with the SEC on September 2, 2009.
 
(4) Information obtained from Mr. Panico’s Form 4s filed with the SEC on May 22, 2009 and February 4, 2010.
 
(5) Includes 20,706 shares of Common Stock beneficially owned directly, 3,344 shares of Common Stock beneficially owned indirectly and 856,158 shares of Common Stock purchasable pursuant to exercisable stock options.
 
(6) Information obtained from Mr. Raasch’s Form 4 filed with the SEC on September 16, 2009.
 
(7) Information obtained from Mr. Seré’s Form 4 filed with the SEC on June 1, 2009.
 
(8) Information obtained from Mr. Wright’s Form 4 filed with the SEC on May 22, 2009.
 
(9) Information obtained from Mr. Rasmussen’s Form 4s filed with the SEC on September 11, 2008 and May 22, 2009.
 
(10) Includes 29,000 shares of Common Stock beneficially owned directly and 362,789 shares of Common Stock purchasable pursuant to exercisable stock options.
 
 

____________________________________________________________________________________________________________________________________________
 
27
 

 
 

 
 
 
Securities Authorized for Issuance Under Equity Compensation Plans
 

Plan Category
Number of securities to be issued upon exercise of outstanding options, warrants and rights
(a)
Weighted-average exercise price of outstanding options, warrants and rights
(b)
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
(c)
Equity compensation
plans approved by
security holders
 1,258,947
 $  0.46
 1,421,053

 
ITEM 13.
  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
 
Since January 1, 2009 there have no transactions, nor are there any currently proposed transactions, between the Company and any related persons which exceed $120,000.00 and in which any related person had or will have a direct or indirect material interest.
 
With the exception of Robert Panico, each of our directors satisfies the independence requirements of the SEC and Nasdaq listing standards.
 
ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES
 
Audit Fees
 
For the year ended December 31, 2009, the Company expects to pay PKF aggregate fees of $130,301 for auditing the annual financial statements included in the Company's Form 10-KSB and reviewing the quarterly financial statements included in the Company's Forms 10-QSB.
 
For the year ended December 31, 2008, the Company expects to pay PKF aggregate fees of $130,519 for auditing the annual financial statements included in the Company's Form 10-KSB and reviewing the quarterly financial statements included in the Company's Forms 10-QSB.
 
Audit Related Fees
 
The Company did not pay any fees for audit related services.
 
Tax Fees
 
The Company did not pay any fees for financial information systems design and implementation relating to the Company's fiscal years ended December 31, 2008, and 2009.  The Company paid PKF fees of $25,037 for non-audit related services, primarily for preparation of federal and state income tax returns in 2008 and paid FittsRoberts $42,394 in 2009 for the same services.
 
All Other Fees
 
The Company did not pay any fees for financial information systems design and implementation or for other non-audit related services for the fiscal years ended December 31, 2008 and 2009.  The Audit Committee of the Board of Directors is charged with approving in advance non-audit services proposed to be provided by PKF to ensure that such services do not compromise the accountants' independence from the Company.
 
28
 
 
 
 

 
 
 
PART IV
 
ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
(a)  
EXHIBITS
The following Exhibits are filed herewith or incorporated herein by reference.

Exhibit                                           Description of Document
3.1
Restated Certificate of Incorporation dated May 26, 1999, incorporated by reference to Form 10-KSB for the year ended February 28, 1999.
3.2
Amendment to Restated Certificate of Incorporation dated August 16, 2001, incorporated by reference to Form 10-KSB for the year ended December 31, 2001.
3.3
Bylaws, as amended May 26, 2008, incorporated by reference to Form 8-K filed on March 28, 2008.
4.1
Form of the Common Stock Certificate, incorporated by reference to Form 10-KSB for the year ended February 28, 1999.
4.2
Rights Agreement dated as of February 26, 2010, between Gateway Energy Corporation and American Stock Transfer and Trust Company, LLC, as Rights Agent, which includes as Exhibit A, the Summary of Rights to Purchase Preferred Stock, incorporated by reference to Form 8-K filed on March 1, 2010.
10.1
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.
10.2
1998 Stock Option Plan, incorporated by reference to Form 10-KSB for the year ended February 28, 1999.
10.3
1998 Outside Directors’ Stock Option Plan, incorporated by reference to Form 10-KSB for the year ended February 28, 1999.
10.4
Employment Agreement dated August 22, 2006 with Robert Panico, incorporated by reference to Form 8-K filed on August 25, 2006.
10.5
Employment Agreement dated August 22, 2006 with Christopher Rasmussen, incorporated by reference to Form 8-K filed on August 25, 2006.
10.6
Form of Indemnification Agreement, incorporated by reference to Fomr 8-K filed on August 25, 2006.
10.7
Purchase Agreement dated July 26, 2005 between Gateway Pipeline Company and Madisonville Gas Processors, LP for the sale of certain Madisonville pipeline facility assets, incorporated by reference to Form 10-KSB for the year ended December 31, 2005.
10.8
 
Purchase Agreement dated December 22, 2006 between Gateway Processing Company and HNNG Development, LLC for the sale of that certain First Amended and Restated Agreement to Develop Natural Gas Treatment Projects Using Mehra Gas Treating Units, dated January 1, 2004, as amended January 1, 2005, by and between Advanced Extraction, incorporated by reference to Form 8-K filed on December 12, 2006.
10.9
2007 Equity Incentive Plan, incorporated by reference to Form 10-KSB for the year ended December 31, 2007.
10.10
Member Interest Purchase Agreement dated April 13, 2007 between Gateway Energy Corporation and Navitas Assets, L.L.C. for the sale of Fort Cobb Fuel Authority, L.L.C., incorporated by reference to Form 8-K filed on April 16, 2007.
10.11
Purchase Agreement dated September 6, 2007 between Gateway Offshore Pipeline Company and Gulfshore Midstream Pipelines, Ltd. for the sale of certain pipeline facility assets, incorporated by reference to Form 8-K filed on September 7, 2007.
10.12
Member Interest Purchase Agreement dated July 3, 2008 between Gateway Processing Company and Allen Drilling Acquisition Company for the purchase of a one-third interest in Gateway-ADAC Pipeline, L.L.C., incorporated by reference to Form 8-K filed on July 3, 2008.
10.13
Assignment of Member Interest Agreement dated December 22, 2008 between Gateway Energy Corporation and Constellation Energy Commodities Group, Inc. for the purchase of a net profits interest in certain leases and wells in the Madisonville Field, incorporated by reference to Form 8-K filed on December 22, 2008.
10.14
Purchase Agreement dated July 6, 2009 between Gateway Offshore Pipeline Company and Impact E&P for the sale of the Shipwreck gathering system and related Crystal Beach terminal, and purchase agreement dated July 6, 2009 between Gateway Offshore Pipeline Company and Emerald for the sale of the Pirates Beach gathering system, incorporated by reference to Form 8-K filed on July 6, 2009.
10.15
Loan Agreement, dated December 7, 2009, among Gateway Energy Corporation, Gateway Pipeline Company, Gateway Offshore Pipeline Company, Gateway Processing Company, Gateway Energy Marketing Company and Meridian Bank, incorporated by reference to Form 8-K filed on December 10, 2009.
10.16
Purchase and Sale Agreement, dated January 7, 2010, by and among Gateway Pipeline Company, Hickory Creek Gathering, L.P., and Range Operating Texas, LLC., incorporated by reference to Form 8-K filed on January 11, 2010.
31.1
Section 302 Certification of Chief Executive Officer
31.2
Section 302 Certification of Controller
32.1
Section 906 Certification of Chief Executive Officer
32.2                 Section 906 Certification of Controller
 
 
29

 
 
 

 

SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
                                                                                                                                 GATEWAY ENERGY CORPORATION
  (Registrant)
 
                                                                  By:            /s/  Frederick Pevow                                           
                                                                                           Frederick Pevow
                                                                                                                                                           President & CEO

Date:    January 5, 2011
 
30

 
 

 

GATEWAY ENERGY CORPORATION

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 
PAGE
   
 Report of Independent Registered Public Accounting Firm
 
F-2
 Consolidated Balance Sheets, December 31, 2009 and 2008
F-3
 Consolidated Statements of Operations for the Years Ended
    December 31, 2009 and 2008
 
F-4
 Consolidated Statements of Stockholders' Equity for the Years Ended
    December 31, 2009 and 2008
 
F-5
 Consolidated Statements of Cash Flows for the Years Ended
    December 31, 2009 and 2008
 
F-6
  Notes to Consolidated Financial Statements
F-7

All financial schedules have been omitted as required information is either not applicable or has been included in the financial statements or notes to the financial statements.






The accompanying notes are an integral part of these financial statements.
 
F-1
 
 
 
 
 

 
 



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


Board of Directors and Shareholders
Gateway Energy Corporation

We have audited the accompanying consolidated balance sheets of Gateway Energy Corporation and Subsidiaries (the “Company”) as of December 31, 2009 and 2008 and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the two year period ended December 31, 2009.  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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purposes of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the two year period ended December 31, 2009 in conformity with U.S. generally accepted accounting principles.

As discussed in Note 13, the Company restated its previously issued consolidated financial statements for 2009 to correct a misstatement in the amount of their gain on sale of discontinued operations.


/s/ Pannell Kerr Forster of Texas, P.C.

Houston, Texas
March 24, 2010

(Except for Note 13 for which the
date is November 15, 2010)


 
The accompanying notes are an integral part of these financial statements.
 
F-2
 

 
 

 
 

 
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
 
 
                                                                                                                                                                                                                                                      
                                                                                                                                      December 31,    
      2009       2008  
                                                                                                                                   ASSETS     (restated)           
 Current Assets                
Cash and cash equivalents                                                                                         
  $ 2,086,787     $ 1,789,029  
Restricted cash                                                                                         
    900,000       -  
Accounts receivable trade                                                                                         
    1,101,100       969,859  
Notes receivable                                                                                         
    148,088       -  
Prepaid expenses and other assets                                                                                         
    41,941       121,398  
Current assets of discontinued operations                                                                                         
    -       1,805,167  
           Total current assets                                                                                   
    4,277,916       4,685,453  
                   
 Property and Equipment, at cost
                 
Gas gathering, processing and transportation                                                                                         
    8,855,967       8,843,142  
Net profits production interest                                                                                         
    701,482       763,909  
Office furniture and other equipment                                                                                         
    150,500       143,654  
      9,707,949       9,750,705  
Less accumulated depreciation, depletion, and amortization
    (2,785,241 )     (2,371,704 )
      6,922,708       7,379,001  
 Other Assets
                 
Deferred tax assets, net                                                                                         
    1,295,455       1,205,000  
Intangible assets, net of accumulated amortization of $345,567 and $222,082 as of December 31, 2009 and 2008, respectively
    563,032       765,337  
Other                                                                                         
    36,803       136,657  
Non-current assets of discontinued operations                                                                                         
    -       2,519,253  
      1,895,290       4,626,247  
           Total assets                                                                                   
  $ 13,095,914     $ 16,690,701  
                   
LIABILITIES AND STOCKHOLDERS' EQUITY
                 
 Current Liabilities
                 
Accounts payable                                                                                         
  $ 660,504     $ 776,519  
Accrued expenses and other liabilities                                                                                         
    305,549       323,100  
Current maturities of long-term debt                                                                                         
    -       1,062,000  
Current maturities of capital lease                                                                                         
    9,188       20,235  
Deferred gain on sale of discontinued operations
    100,800       -  
Total current liabilities                                                                                   
    1,076,041       2,181,854  
                   
 Long-term capital lease, less current maturities                                                                                             
    -       9,187  
 Non-current liabilities of discontinued operations                                                                                             
    -       2,318,315  
           Total liabilities                                                                                   
  $ 1,076,041     $ 4,509,356  
                   
 Commitments and contingencies                                                                                             
    -       -  
                   
 Stockholders' Equity
                 
Preferred stock – $1.00 par value; 10,000 shares authorized;
                 
no shares issued and outstanding                                                                                     
    -       -  
Common stock – $0.25 par value; 35,000,000 shares authorized;
                 
19,397,125 and 19,207,249 shares issued and outstanding at December 31, 2009 and 2008, respectively
    4,849,281       4,801,812  
Additional paid-in capital                                                                                         
    17,395,828       17,284,485  
Accumulated deficit                                                                                         
    10,225,236       (9,904,952 )
 Total stockholders equity     12,019,873        12,181,345   
 Total liabilities and stockholders' equity    $ 13,095,914       $ 16,690,701   
 
 
 The accompanying notes are an integral part of these financial statements.
 
F-3
 

 
 

 
 

 
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
   
Year Ended December 31,
 
   
                      2009
   
                         2008
 
Operating revenues
 
(restated)
       
   Sales of natural gas
  $ 4,183,830     $ 12,033,817  
   Transportation of natural gas and liquids
    2,342,479       1,788,070  
   Treating and other
    181,665       60,589  
      6,707,974       13,882,476  
Operating costs and expenses
               
   Cost of natural gas purchased
    3,586,046       10,979,136  
   Operation and maintenance
    384,009       433,577  
   General and administrative
    2,405,400       2,424,045  
   Depreciation, depletion and amortization
    608,394       621,252  
   Impairment expense
    130,008       -  
      7,113,857       14,458,010  
Operating loss
    (405,883 )     (575,534 )
                 
Other income (expense)
               
   Interest income
    30,408       29,119  
   Interest expense
    (116,699 )     (157,091 )
   Other income (expense), net
    (48,750 )     1,731,155  
      Other income (expense)
    (135,041 )     1,603,183  
                 
Income (loss) from continuing operations before income taxes and discontinued operations
    (540,924 )     1,027,649  
                 
Provision for income taxes
               
      Current income tax expense
    36,069       35,000  
      Deferred income tax expense (benefit)
    (195,226 )     340,764  
      (159,157 )     375,764  
                 
Income (loss) from continuing operations
    (381,767 )     651,885  
Net income attributable to non-controlling interest
    -       (28,824 )
Income (loss) from continuing operations attributable to controlling interest
    (381,767 )     623,061  
                 
Discontinued operations, net of taxes
               
   Income (loss) from discontinued operations, net of taxes
    (155,897 )     194,480  
   Gain on disposal of assets, net of taxes
    217,380       -  
Income from discontinued operations
    61,483       194,480  
                 
Net income (loss)
  $ (320,284 )   $ 817,541  
                 
Basic and diluted income (loss) per share:
               
   Continuing operations
  $ (0.02 )   $ 0.03  
   Discontinued operations
    -       0.01  
   Net income
  $ (0.02 )   $ 0.04  
Weighted average number of common shares outstanding:
               
   Basic
    19,303,488       19,126,587  
   Diluted
    19,303,488       19,330,409  
 
 

 The accompanying notes are an integral part of these financial statements.
 
F-4
 
 
 
 

 
 

 
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the Years Ended December 31, 2009 and 2008


     
Additional
       
 
                     Common Stock                                           
Paid-in
          Accumulated
        Non-controlling
 
 
                Shares                      
     Amount
Capital
               Deficit                                
 
              Interest                                
 
          Total         
 
 
Balance at January 1, 2008
19,026,665
$4,756,665
       $16,460,763
          $(10,909,734)
  $816,222
       $11,123,916
 
Issuance of common stock for services
       10,000
         2,500
           6,500
        -
                       -
            9,000
 
Issuance of common stock and purchase of ADAC non-controlling interest
    100,000
      25,000
        673,981
                     187,241
               (845,046)
         41,176
 
Stock-based compensation expense
    -
    -
        100,891
                           -
                      -
       100,891
 
Issuance of common stock related to exercise of stock options
       70,584
      17,647
           42,350
                           -
                      -
        59,997
 
Net income
       -
             -
                    -          
                     817,541
                  28,824
           846,365
 
Balance at December 31, 2008
19,207,249
 4,801,812
         17,284,485
               (9,904,952)
                   -
         12,181,345
 
Stock-based compensation expense
-
    -
           98,812
                            -
                      -
          98,812
 
Issuance of common stock to directors
    189,876
      47,469
        12,531
                            -
                      -
          60,000
 
Net loss
                           -
    -
                     -
                    (320,284)
          -
           (320,284)
 
Balance at December 31, 2009
19,397,125
$4,849,281
$17,395,828
           $(10,225,236)
$                  -
       $ 12,019,873
 

 
 
The accompanying notes are an integral part of these financial statements.
 
F-5

 
 

 

GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
   
Year Ended December 31,
 
   
                        2009
   
2                     2008
 
Cash flows from operating activities – continuing operations:
           
Income (loss) from continuing operations
    (381,767 )      651,885  
Adjustments to reconcile income (loss) from continuing operations to net cash provided by operating activities:
               
Depreciation, depletion and amortization
    608,394       621,252  
Deferred tax expense (benefit)
    (195,226 )     340,764  
Stock based compensation expense
    158,812       169,888  
Impairment of intangible assets
    52,066       -  
Impairment of net profits interest
    77,942       -  
Amortization of deferred loan costs
    99,445       124,835  
Net change in cash and cash equivalents resulting from changes in:
               
Trade accounts receivable
    (131,241 )     882,990  
Prepaid expenses and other current assets
    390,189       (184,831 )
Accounts payable
    (96,144 )     (362,134 )
Accrued expenses and other liabilities
    (61,374 )     71,732  
Net cash provided by operating activities
    521,096       2,316,381  
Cash flows from investing activities – continuing operations
               
Capital expenditures
    (35,186 )     (29,358 )
Acquisition of minority interest and net profits interest
    -       (1,303,075 )
Property write-offs
    -       18,067  
Net cash used in investing activities
    (35,186 )     (1,314,366 )
Cash flows from financing activities – continuing operations
               
Proceeds from borrowings
    -       1,362,000  
Payments on borrowings
    (1,082,233 )     (1,067,370 )
Restricted cash for credit facility
    (900,000 )     -  
Deferred financing costs
    (42,102 )     (39,820 )
Net cash provided by (used in) financing activities
    (2,024,335 )     254,810  
Net increase (decrease) in cash and cash equivalents from continuing operations
    (1,538,425 )     1,256,825  
                 
Discontinued operations:
               
    Net cash provided by (used in) discontinued operating activities
    1,838,883       (1,170,934 )
    Net cash used in discontinued investing activities
    (2,700 )     (104,086 )
Net increase (decrease) in cash and cash equivalents from discontinued operations
    1,836,183       (1,275,020 )
                 
Cash and cash equivalents at beginning of year
    1,789,029       1,807,224  
Cash and cash equivalents at end of year
  $ 2,086,787     $ 1,789,029  
                 
Supplemental cash flow information
               
    Cash paid for interest – Continuing operations
  $ 51,851     $ 51,025  
                 
Supplemental schedule of noncash investing and financing activities
               
    Common stock issued for acquisition
    -       70,000  
    Common stock issued for services
    -       9,000  

 
 The accompanying notes are an integral part of these financial statements.
 
F-6
 

 
 

 
 
 
 
 
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(1)  
Nature of Business
 
Gateway Energy Corporation (the “Company,” or “Gateway”), 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. Gateway conducts all of its business through its wholly owned subsidiary companies, Gateway Pipeline Company, Gateway Offshore Pipeline Company, Gateway Energy Marketing Company and Gateway Processing Company and CEU TX NPI, L.L.C.  Gateway-Madisonville Pipeline, L.L.C, previously known as Gateway-ADAC Pipeline, L.L.C., is 67% owned by Gateway Pipeline Company and 33% owned by Gateway Processing Company.  The Company acquired the minority interest (33%) from the prior owner on July 3, 2008 and the Company now owns 100% of this venture. Access to the Company’s annual report on Form 10-K and Form 10-KSB, quarterly reports on Form 10-Q, the Company’s Code of Ethics, and current reports on Form 8-K are available at the Company’s website www.gatewayenergy.com.
 
In the following discussion, “Mcf” refers to thousand cubic feet of natural gas; “Mmcf” refers to million cubic feet of natural gas; “Bbl” refers to barrel of liquid hydrocarbons 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 one million British thermal units.  “Mcfe” refers to thousand cubic feet equivalent.  Liquid hydrocarbons are converted to Mcf equivalents using the ratio of 1.0 barrel of liquid hydrocarbons to 6.0 Mcf of natural gas.
 
(2)  
Summary of Significant Accounting Policies
 
A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows.
 
Principles of Consolidation
 
The Company consolidates the financial statements of its majority-owned and wholly-owned subsidiaries.  The portion of Gateway-ADAC Pipeline L.L.C. (through June 30, 2008) not owned by the Company is recorded as non-controlling interest.  All significant intercompany transactions have been eliminated in consolidation.
 
Effective December 22, 2008, the Company purchased 100% of the ownership interest in CEU TX NPI, L.L.C.  The entity owns the net profits interest in the Madisonville field.  The entity is a wholly-owned subsidiary of Gateway Energy Corporation and is consolidated as such.
 
The accompanying consolidated financial statements have been prepared by the Company.  In the opinion of management, such financial statements reflect all adjustments necessary for a fair presentation of the financial position and results of operations in accordance with U.S. generally accepted accounting principles.
 
Reclassifications

Certain reclassifications have been made to the December 31, 2008 financial statements to conform to the current period presentation.  These reclassifications had no effect on the total assets, liabilities, stockholders’ equity or net income for the year ended December 31, 2008.

Revenue Recognition Policy

Revenues from the sales of natural gas are generated under purchase and sales contracts that are priced at the beginning of the month based upon established gas indices.  The Company purchases and sells the gas using the same index to minimize commodity price risk.  Revenues from the sales of natural gas are recognized at the redelivery point, which is the point at which title to the natural gas transfers to the purchaser.  Transportation revenues are generated under contracts which have a stated fee per unit of production (Mcf, MMBtu, or Bbl) gathered or transported.  Onshore transportation revenues are recognized at the redelivery point, which is the point at which another party takes physical custody of the natural gas or liquid hydrocarbons.  Offshore transportation revenues are recognized at the Company’s receipt point.
 
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.
 
F-7
 
 
 
 

 
 
 
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 
 
Restricted Cash
 
The restricted cash balance of $900,000 as of December 31, 2009 is related to outstanding letters of credit for gas purchases.
 
Property and Equipment
 
Property and equipment is stated at cost, plus capitalized interest costs on major 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.  For the year ended December 31, 2009, property and equipment included $78,056 of equipment financed under a capital lease, net of $21,944 of accumulated amortization.  Depreciation and amortization 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 plant or other property and equipment are retired or sold, any resulting gain or loss is credited to or charged against operations.
 
For the years ended December 31, 2009 and 2008, depreciation, depletion and amortization expense was $608,394 and $621,252, respectively.  At December 31, 2009 there was $1,146,362 of fully depreciated assets still in use.  Property, plant and equipment and identifiable intangible assets are reviewed for impairment, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 360, “Property, Plant, and Equipment,” whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  If the sum of the expected undiscounted cash flows is less than the carrying value of the related asset or group of assets, a loss is recognized for the difference between the fair value and carrying value of the asset or group of assets.  Impairments of assets recorded during the years ended December 31, 2009 and 2008 was $77,942, related to Net Profits Interest, and $0, respectively.
 
The Company determined an impairment evaluation was necessary for the Net Profits Interest due to the accumulation of costs by the producer significantly in excess of what was originally expected and due to the history of operating losses by the producer.  The Company estimated future cash flows and evaluated the likelihood of different outcomes using a probability weighted approach.  To determine the fair value of the different outcomes, we determined the sum of the undiscounted estimated future cash flows expected to result from the use of the asset.  Upon completion of the evaluation using the probability weighted outcomes, it was determined that an impairment of $77,942 was necessary.
 
ASC Topic 820, “Fair Value Measurements” establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.  The NPI impairment was based on Level 3, unobservable inputs, including conversations with the producer of the net profits interest concerning future plans for the Madisonville field as well as preliminary results from their annual reserve report.  Additionally, no revenue had been recognized during 2009 for the interest.  The adjusted value of the NPI is $701,482.
 
The Company provides for future asset retirement obligations under the provisions of FASB ASC Topic 410, “Asset Retirement and Environmental Obligations,” related to the Shipwreck offshore production platform because, eventually, law or regulation will require its abandonment.  The present value of the estimated future asset retirement obligation, as of the date of acquisition, was capitalized to gas gathering, processing and transportation equipment.  The present value of the estimated future asset retirement obligation, as of the balance sheet date, is presented as a noncurrent liability.  Until the platform is ultimately sold or retired, the Company will recognize (i) depreciation expense on the additional capitalized costs; (ii) accretion expense as the present value of the future asset retirement obligation increases with the passage of time, and; (iii) the impact, if any, of changes in estimates of the liability.   The following table sets forth a reconciliation of the beginning and ending aggregate carrying amount of asset retirement obligations for the years ended December 31, 2009 and 2008:
 
                  
 
Year Ended December 31,
 
                          2009
 
2008
                                          Beginning balance
$    2,318,315
 
                      $        394,640
                                          Accretion
           65,549
 
                                  25,921
                                          Change in estimate
        -
 
                            1,897,754
                                          Sale of asset
     (2,383,864)
 
                                       -
                                          Ending balance
 $            -        
 
                      $      2,318,315

 
Refer to Note 8 for discussion of the change in estimate.
 
Refer to Note 12 for discussion of sale, effective June 30, 2009 of the Shipwreck platform.
 
 
F-8
 
                                                                
 
 

 


 
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 

 
Goodwill and Other Intangibles
 
FASB ASC Topic 350, “Intangibles, Goodwill, and Other” addresses the methods used to capitalize, amortize and to assess the impairment of intangible assets.  In evaluating the Company’s intangibles, management considered all of the criteria set forth in FASB ASC Topic 350 for determining useful life.  Management performs our annual impairment test for intangible assets in the fourth quarter of each fiscal year or when changes in circumstance indicate impairment.  No impairments were indicated as a result of impairment reviews for intangible assets in the year ended December 31, 2008.  During the third quarter of 2009, certain producers in contract with the Company at East Cameron 359 and 378A abandoned their platforms thus eliminating the value of the intangible assets.  As such, the Company recognized approximately $52,000 of impairment expense related specifically to the contracts of the producers stated above for the year ended December 31, 2009.  The following tables represent gross intangible assets and amortization expense for the year ended December 31, 2009 and estimated amortization expense for the next 5 years.
 
 
As of December 31, 2009
 
Gross Carrying Amount
 
Accumulated Amortization
Amortized intangible assets
     
     Contracts
$                908,599
 
                   $               (345,567)

Aggregate Amortization Expense:
For year ended 12/31/2009 
$                151,107

Estimated Amortization Expense:
For year ended 12/31/2010
$                141,638
For year ended 12/31/2011
$                137,230
For year ended 12/31/2012
$                120,952
For year ended 12/31/2013
$                103,081
For year ended 12/31/2014
$                  60,131

 
The weighted average amortization period is approximately two years for contract intangible assets.
 
Concentrations of Credit Risk
 
The Company maintains all cash in deposit accounts, which at times may exceed federally insured limits.  The Company has not experienced losses in such accounts.  The Company has not had any significant credit losses in the past and believes its accounts receivables are fully collectable. Accordingly, no allowance for doubtful accounts has been provided.
 
Casualty Loss

Gateway owns pipelines, a related 140' x 70' operating platform, and an onshore terminal facility ("Crystal Beach" facility) located in southeast Texas, east of Galveston. The Crystal Beach facility is connected to the Company's Shipwreck system, which provides separation of gas and liquid hydrocarbon services, dehydrates the gas for a fee, delivers pipeline quality gas to market and provides storage and truck loading services for the liquid hydrocarbons.

The Crystal Beach facility was damaged by hurricane Ike in September 2008. The Company reviewed the damage at the facility as well as other assets the Company owns during the fourth quarter of 2008. Initially, an estimated casualty loss of $51,344, which was 25% of the net book value of the facility, was recorded as a receivable as the Company had property insurance on the facility with a value of $2 million.
 
F-9
 
 
 
 

 

 
 
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 
During the first quarter of 2009, the Company received insurance proceeds in the amount of $2 million less the deductible of $250,000.  These proceeds were attributable to the damage at the Crystal Beach facility.  The Company recorded a receivable of $1.75 million for the receivable less the already recorded amount of $51,344.
 
In June 2009, the Company completed the sale of the Crystal Beach facility and related Shipwreck system (see Note 12).

Income Taxes
 
The Company computes income taxes using the asset and liability method whereby deferred tax assets are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities from a change in tax rates is recognized in income in the period that includes the enactment date.  A valuation allowance is established against such assets where management is unable to conclude more likely than not that such asset will be realized.
 
Effective January 1, 2009, the Company adopted the interpretation within the ASC on Income Taxes which relates to Accounting for Uncertainty in Income Taxes.  The interpretation clarifies the accounting for uncertainty in income taxes recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained upon examination by the taxing authority.  Interest and/or penalties related to income tax matters are to be recognized in income tax expense. The adoption of this interpretation did not have a material effect on the Company’s financial position or results of operations. The Company’s tax years 2003 and forward are subject to examination.
 
Stock-Based Compensation
 
The Company’s 2007 Equity Incentive Plan provides for stock-based compensation for officers, employees and non-employee directors.
 
The Company accounts for stock based compensation under the provisions of FASB ASC Topic 718, “Compensation – Stock Compensation” (“ASC Topic 718”).  The options generally vest ratably over three years and expire between five and ten years.
 
Compensation cost related to non-qualified stock options recognized for the years ended Decmeber 31, 2009 and 2008 was $98,812 and $100,891, respectively.  The Company views all awards of share-based compensation as a single award with an expected life equal to the average expected life of component awards and amortize the fair value of the award over the requisite service period.
 
During the second quarter of 2009, the Company made a stock grant of 189,876 shares of common stock to the Company’s Board of Directors.  The value of the stock grant calculated based on the weighted average trading price was $0.315 per share and was included in stock based compensation expense at the time of the grant.

The Company receives a tax deduction for certain stock option exercises during the period the options are exercised, generally for the excess of the value of the stock over the strike price received on the date of exercise.  During the year ended December 31, 2009,  there were no options exercised.  In addition, the Company receives an additional tax deduction when restricted stock vests at a higher value than the value used to recognize compensation expense at the date of grant.  The Company records these deductions as a tax asset with a corresponding amount recorded as additional paid-in capital when the Company can receive a tax cash savings from these awards.  Due to the Company having significant unused net operating-loss carryforwards, the recording of this tax benefit is deferred until such tax savings is realized.
 
The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model. Expected volatility is estimated using the annualized historical stock prices to derive an expected term. The risk-free rate for periods within the contractual life of the option is based on the U.S. treasury yield curve in effect at the time of grant. The Company uses the Black-Scholes option pricing model to compute the fair value of stock options, which requires the Company to make the following assumptions:
 
F-10
 
 
 
 

 
 
 

GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
  
 
·  
The risk-free interest rate is based on the five-year Treasury bond at date of grant.
 
·  
The dividend yield on the Company’s common stock is assumed to be zero since the Company does not pay   dividends and has no current plans to do so in the future.
 
·  
The market price volatility of the Company’s common stock is based on daily, historical prices for the last three years.
 
·  
The term of the grants is based on the simplified method as described in ASC Topic 718.
 
In addition, the Company estimates a forfeiture rate at the inception of the option grant based on historical data and adjusts this prospectively as new information regarding forfeitures becomes available.
 
The following weighted-average assumptions were used in determining the fair value of stock options granted during years ended December 31, 2009 and 2008, using the Black-Sholes model.
 
   
 
2009
 
2008
                                      Risk-free interest rate (%)
2.19
 
2.80
                                      Dividend yield (%)
-
 
-
                                      Expected volatility (%)
   62
 
   66
                                      Option life (years)
3.50
 
3.50

 
At December 31, 2009, there was $87,514 of total unrecognized compensation cost related to non-vested stock option awards which is expected to be recognized over a weighted-average period of three years.
 
The following table represents stock option activity for the year ended December 31, 2009:

 
Shares
 
Weighted Average Exercise Price
 
Weighted    Average Contractual Terms (in years)
 
Intrinsic Value of Options
Options outstanding, beginning of period
1,038,947
 
          $0.53
 
3.43
   
Options granted                                                   
  387,500
 
    0.32
 
4.37
   
Options canceled                                                   
            (147,500)
 
          0.64
 
        -
     
Options outstanding, end of period
                 1,278,947
 
          $0.45
 
2.92
 
$   5,800
Options exercisable, end of period
                    644,649
 
          $0.44
 
2.10
 
$   4,400


The following table represents stock option activity for the year ended December 31, 2008:
 
Shares
 
Weighted Average Exercise Price
 
Weighted Average Contractual Terms (in years)
 
Intrinsic Value of Options
Options outstanding, beginning of period
790,000
 
$0.43
 
4.18
   
Options granted
268,947
 
          0.80
 
4.44
   
Options canceled
  (20,000)
 
  0.48
 
    -
   
Options outstanding, end of period
             1,038,947
 
$0.53
 
3.43
 
            $     21,650
Options exercisable, end of period
                430,000
 
$0.40
 
2.92
 
            $     18,983

The market value of the Company’s common stock on December 31, 2009 was $0.32 per share.

The weighted-average grant-date fair value of options granted during 2009 was $0.16 for year ended December 31, 2009.
 
F-11
 
 

 
 

 


 
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Earnings Per Share
 
Basic earnings per share is computed by dividing net earnings or net loss by the weighted average number of common shares outstanding during the period.  Diluted earnings per share is computed by dividing net earnings or net 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 years ended December 31, 2009 and 2008,  1,278,947 and 203,822 potentially dilutive common shares arising from outstanding stock options and warrants have been excluded from diluted earnings per share as their effects were anti-dilutive.
 
 
                        YearEnded December 31,             
  2009    2008
Weighted average number of common
     shares outstanding
19,303,488
                                             19,126,587
Effect of dilutive securities
      -
 
                           203,822
Weighted average dilutive common shares
     outstanding
19,303,488
 
                     19,330,409
     
Income (loss) from continuing operations
      (381,767)
                                                 651,885
Income from discontinued operations, net of
    taxes
        61,483
                                                 194,480
Net income attributable to noncontrolling
    interests
                                     -
 
                           (28,824)
Net income (loss) attributable to controlling
    interests
$      (320,284)
 
               $         817,541
 
Basic and diluted income per common
    share:
   
Continuing operations
$            (0.02)
                                      $              0.03
Less:  income attributable to
 noncontrolling interests
 
              -
 
                                                         -
Discontinued operations
               -
 
                                0.01
Net loss
                     $            (0.02)
 
                $              0.04

 
Accounting Pronouncements and Recent Regulatory Developments
 
The FASB issued ASC Topic 820, “Fair Value Measurements and Disclosures”. This topic:
 
·  
Affirms that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction.
 
 
·  
Clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active.
 
 
·  
Eliminates the proposed presumption that all transactions are distressed (not orderly) unless proven otherwise. The topic instead requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence.
 
 
·  
Includes an example that provides additional explanation on estimating fair value when the market activity for an asset has declined significantly.
 
 
·  
Requires an entity to disclose a change in valuation technique (and the related inputs) resulting from the application of the topic and to quantify its effects, if practicable.
 
 
·  
Applies to all fair value measurements when appropriate.
 
 
F-12
 

 
 

 

 
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
  
ASC Topic 820 must be applied prospectively and retrospective application is not permitted. ASC Topic 820 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. An entity early adopting ASC Topic 820 must also early adopt ASC Topic 320, “Investments, Debt, and Equity Securities”. The Company adopted ASC Topic 820 as it applies to financial assets and liabilities as of June 30, 2009 and the adoption did not have a material impact on its consolidated financial statements.

The FASB issued ASC Topic 825, “Financial Instruments”, and ASC Topic 270, “Interim Reporting”. They require an entity to provide disclosures about fair value of financial instruments in interim financial information. This also amends ASC Topic 270 to require those disclosures in summarized financial information at interim reporting periods. Under this topic, a publicly traded company shall include disclosures about the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. In addition, an entity shall disclose in the body or in the accompanying notes of its summarized financial information for interim reporting periods and in its financial statements for annual reporting periods the fair value of all financial instruments for which it is practicable to estimate that value, whether recognized or not recognized in the statement of financial position, as required by ASC Topic 825.

ASC Topic 825 and ASC Topic 270 are effective for interim periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. However, an entity may early adopt these interim fair value disclosure requirements only if it also elects to early adopt ASC Topic 820, ASC Topic 320 and ASC Topic 958.  The Company adopted ASC Topic 820 as it applies to financial assets and liabilities as of January 1, 2008 and the adoption did not have a material impact on its consolidated financial statements.

The FASB has issued ASC Topic 855, “Subsequent Events” (“ASC Topic 855”). ASC Topic 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Specifically, ASC Topic 855 provides:
 
·  
The period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements;
 
 
·  
The circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and
 
 
·  
The disclosures that an entity should make about events or transactions that occurred after the balance sheet date.
 
ASC Topic 855 is effective for interim or annual financial periods ending after June 15, 2009, and shall be applied prospectively.  The Company has adopted and will follow the guidance in ASC Topic 855 for all prospective subsequent event transactions and disclosures.

The FASB issued ASC Topic 105, the “FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (“ASC Topic 105”). ASC Topic 105 establishes the FASB Accounting Standards Codification (Codification) as the single source of authoritative U.S. generally accepted accounting principles (U.S. GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. ASC Topic 105 and the Codification are effective for financial statements issued for interim and annual periods ending after September 15, 2009.

The Codification supersedes all existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification will become nonauthoritative. Following ASC Topic 105, the FASB will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead, the FASB will issue Accounting Standards Updates, which will serve only to: (a) update the Codification; (b) provide background information about the guidance; and (c) provide the bases for conclusions on the change(s) in the Codification.

The Company will utilize ASC Topic 105 as authoritative guidance over accounting transactions.
 
F-13
 
 
 
 

 
 
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
  
The SEC has published a Final Rule, Modernization of Oil and Gas Reporting. The new disclosure requirements include provisions that permit the use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserves volumes. The new requirements also will allow companies to disclose their probable and possible reserves to investors. In addition, the new disclosure requirements require companies to: (a) report the independence and qualifications of its reserves preparer or auditor; (b) file reports when a third party is relied upon to prepare reserves estimates or conducts a reserves audit; and (c) report oil and gas reserves using an average price based upon the prior 12-month period rather than year-end prices.

The new disclosure requirements are effective for registration statements filed on or after January 1, 2010, and for annual reports on Forms 10-K and 20-F for fiscal years ending on or after December 31, 2009. A company may not apply the new rules to disclosures in quarterly reports prior to the first annual report in which the revised disclosures are required.

The adoption of this rule had no effect on the financial statements.

Use of Estimates
 
The preparation of financial statements in conformity with U.S. 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.  Management’s significant estimates include depreciation of long-lived assets, depletion of gas reserves, amortization of deferred loan costs, valuation of the asset retirement obligation liability, valuation of the fair value of the Company’s long-lived assets and valuation of stock based compensation.  Actual results could differ from those estimates.
 
(3)  
Business Combinations
 
Acquisition of Allen Drilling Acquisition Company

On July 3, 2008, Gateway Processing Company, a subsidiary of Gateway Energy Corporation (the "Company") closed on a Member Interest Purchase Agreement with Allen Drilling Acquisition Company ("ADAC"), effective as of July 1, 2008, regarding the purchase of ADAC's one-third interest in Gateway-ADAC Pipeline, LLC ("Gateway-ADAC") for $540,625 and 100,000 shares of Company common stock. Gateway-ADAC owns the Company's Madisonville pipeline, connecting the Madisonville gas treatment plant to two major pipelines.

Acquisition of Madisonville Field Net Profits Interest

On December 22, 2008, the Company acquired a 9.1% net profits interest for $779,424 in certain identified leases and wells owned and operated by Redwood Energy Production, L.P. ("Redwood") in the Madisonville Field insofar as they cover the Rodessa/Sligo interval, together with all interests acquired by Redwood in any additional oil and gas leases or rights to acquire oil and gas leases within a specified area of mutual interest ("AMI") and any interests acquired by Redwood in sands, zones, formations, horizons or in and to the depths acquired by Redwood in leases above or below the Rodessa/Sligo interval.  Redwood is a subsidiary of GeoPetro Resources Company. There are currently four wells drilled in the AMI by Redwood in the Rodessa zone at approximately 12,000 feet.  The investment is recorded as a net profits production interest under plant and equipment on the balance sheet and depleted based on a net reserves depletion rate.

(4)  
Debt
 
Trade Notes Payable
 
During 2009, the Company executed premium finance agreements for its insurance premiums.  The total of the notes were $525,079 with an interest rate of 6.5%.  The notes require monthly principal and interest payments.  The amount of the monthly payment varies depending on any changes in coverage and policy renewal periods.  The loans were refinanced in early 2009 resulting in a credit of $194,819.  Additionally, due to the sale of the Crystal Beach, Pirates Beach, and Shipwreck assets, the Company was granted a refund in insurance of $147,763.  Total credits received from refinancing and the asset sales were $342,582.  These notes were repaid during December 2009.
 
F-14
 
 
 
 

 

 
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 

Long-term Debt
 
Long-term debt at December 31 consisted of the following:
 
 
   2009
 
 2008
                                                 Revolving credit facility
                    $             -
 
 $1,062,000
                                                 Less current maturities
 -
 
  (1,062,000)
 
                    $             -
 
                              $         -
Revolving Credit Facility
 
On December 7, 2009, the Company entered into a Credit Agreement (the “Agreement”) with Meridian Bank, Texas (“Meridian”), regarding a revolving credit facility provided by Meridian to the Company.  The original borrowing base under the new Agreement had been established at $3 million, which may be increased at the discretion of the Lender to an amount not to exceed $6 million.  This credit facility replaces the Company’s prior credit facility.  The credit facility is secured by all of the Company’s assets and originally has a term of 39 months maturing on April 30, 2012.  The credit facility contains financial covenants defining various financial measures and levels of these measures with which the Company is in compliance.  Interest on outstanding balances will accrue at the Wall Street Journal prime rate, plus one and a half percent, with a minimum rate of 5.50%.  Unused borrowing base fees are 0.50% per year of the average for the period of calculation of an amount determined daily equal to the difference between the borrowing base and the aggregate outstanding principal balance of the facility.  This amount is paid quarterly.  As of December 31, 2009, there was a zero balance on the facility.
 
Letters of Credit
 
At December 31, 2009, the Company had $900,000 in outstanding letters of credit for gas purchases.
 
(5)