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EX-31 - GATEWAY ENERGY CORP/NEgatewayenergycorp-exhibit311.htm
EX-32 - GATEWAY ENERGY CORP/NEgatewayenergycorp-exhibit321.htm
 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C.  20549

 

 FORM 10-Q

 

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

 OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2011

OR

[  ]  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

 

For the transition period from

 __________to __________

 

                                  Commission File No.     000-6404                                 

 

GATEWAY ENERGY CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

44-0651207

(State or other jurisdiction of

 incorporation or organization)

 

(I.R.S. Employer Identification

 Number)

 

1415 Louisiana Street, Suite 4100

Houston, TX  77002

(Address of principal executive offices)

 

(713) 336-0844

(Issuer's telephone number)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                 Yes   X           No ___

  

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  X  No ___ 

  

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 

Accelerated filer                    

 

Non-accelerated filer   

 

Smaller reporting company 

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)  Yes______ No   X  

 

As of May 12, 2011, the Issuer had 23,480,853 shares of its common stock outstanding.

 

 

1

 


 
 

 

GATEWAY ENERGY CORPORATION AND SUBSIDIARIES

INDEX TO QUARTERLY REPORT

ON FORM 10-Q

 

 

Part  I – Financial Information

                                                                                                         

Item 1.  Financial Statements

   

 

 

Consolidated Balance Sheets (Unaudited) as of March 31, 2011 and December 31, 2010

   3

 

 

 

Consolidated Statements of Operations (Unaudited) for the three month periods ended March 31, 2011 and March 31, 2010

4

 

 

 

Consolidated Statements of Cash Flows (Unaudited) for the three month periods ended March 31, 2011 and March 31, 2010

5

 

 

 

Notes to Consolidated Financial Statements (Unaudited)

6

 

Item 2. 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

11

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk.

15

 

Item 4.

 

Controls and Procedures

15

 

 

 

 

 

 

Part II - Other Information

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings 

15

 

Item 1A.

 

Risk Factors

15

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds 

16

 

Item 3.

 

Defaults Upon Senior Securities 

16

 

Item 4.

 

(Removed and Reserved) 

16

 

Item 5.

 

Other Information 

16

 

Item 6.

 

Exhibits 

16

 

 

 

 

 

 

Signatures

 

17

 

Certification Pursuant to Section 302

 

 

 

 

 

 

Certification Pursuant to Section 906

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

                   


 

 

 

 

 

 

 

2

 


 
 

 

ITEM 1.     FINANCIAL STATEMENTS

GATEWAY ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

 

 

 

 

 

 

 

March 31, 2011

 

 

December 31, 2010

 

ASSETS

 

(Unaudited)

 

 

 

 

Current Assets

 

 

 

 

 

 

     Cash and cash equivalents                                             

 

$

378,568

 

 

$

238,547

 

     Cash deposits       

 

 

250,000

 

 

 

250,000

 

     Accounts receivable trade                                                                

 

 

715,334

 

 

 

815,178

 

     Prepaid expenses and other assets                                                 

 

 

206,477

 

 

 

224,606

 

     Total current assets                                                                                   

 

 

1,550,379

 

 

 

1,528,331

 

 

 

 

 

 

 

 

 

 

 Property and Equipment, at cost

 

 

 

 

 

 

 

 

     Gas distribution, transmission and gathering                         

 

 

11,315,546

 

 

 

11,310,810

 

     Office furniture and other equipment                                       

 

 

163,421

 

 

 

158,029

 

  

 

 

11,478,967

 

 

 

11,468,839

 

     Less accumulated depreciation, depletion and amortization

 

 

(3,387,580

)

 

 

(3,262,877

)

  

 

 

8,091,387

 

 

 

8,205,962

 

 

 

 

 

 

 

 

 

 

 Other Assets

 

 

 

 

 

 

 

 

     Deferred tax assets, net                                                           

 

 

2,704,167

 

 

 

2,658,204

 

     Intangible assets, net of accumulated amortization of $524,650 and    $479,373 as of March 31, 2011 and December 31, 2010, respectively

 

 

1,475,950

 

 

 

1,521,227

 

     Other                                                                                         

 

 

111,233

 

 

 

156,474

 

  

 

 

4,291,350

 

 

 

4,335,905

 

           Total assets                                                                                    

 

$

13,933,116

 

 

$

14,070,198

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

 

 Current Liabilities

 

 

 

 

 

 

 

 

     Accounts payable                                                                                         

 

$

527,077

 

 

$

600,403

 

     Accrued expenses and other liabilities                                   

 

 

334,499

 

 

 

296,609

 

     Notes payable - insurance                                                     

 

 

139,645

 

 

 

159,882

 

           Total current liabilities              

 

 

1,001,221

 

 

 

1,056,894

 

 

 

 

 

 

 

 

 

 

     Long term notes payable - insurance, less current maturities     

   

-

     

24,145

 

     Long term debt

 

 

2,550,000

 

 

 

2,550,000

 

           Total liabilities                                                                                   

 

 

3,551,221

 

 

 

3,631,039

 

 

 

 

 

 

 

 

 

 

 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;

 

 

 

 

 

 

 

 

        23,480,853 shares issued and outstanding  at March 31, 2011 and December 31, 2010, respectively

 

 

5,870,213

 

 

 

5,870,213

 

    Additional paid-in capital                                                                            

 

 

17,395,621

 

 

 

17,387,746

 

    Accumulated deficit                                               

 

 

(12,883,939

)

 

 

(12,818,800

)

           Total stockholders’ equity                                            

 

 

10,381,895

 

 

 

10,439,159

 

           Total liabilities and stockholders’ equity                                   

 

$

13,933,116

 

 

$

14,070,198

 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

3

 


 

 

GATEWAY ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

   

 

Three Months Ended March 31,

 

 

2011

2010

Operating revenues

 

 

 

 

Sales of natural gas

 

$

1,237,830

 

 

$

1,407,489

 

 

Transportation of natural gas and liquids

 

 

385,085

 

 

 

422,868

 

 

Reimbursable and other

 

 

141,218

 

 

 

128,144

 

 

 

 

 

1,764,133

 

 

 

1,958,501

 

 

Operating costs and expenses

 

 

 

 

 

 

 

 

 

Cost of natural gas purchased

 

 

1,062,190

 

 

 

1,264,376

 

 

Operation and maintenance

 

 

107,605

 

 

 

104,365

 

 

Reimbursable costs

   

107,251

     

107,412

   

General and administrative

 

 

365,742

 

 

 

462,453

 

 

Acquisition costs

 

 

-

 

 

 

43,453

 

 

Consent solicitation costs

 

 

-

 

 

 

98,870

 

 

Depreciation, depletion and amortization

 

 

169,979

 

 

 

197,331

 

 

     

1,812,767

     

2,278,260

   

Operating loss

 

 

(48,634

)

 

 

(319,759

)

 

 

 

 

 

 

 

 

 

 

 

Other income (expense)

 

 

 

 

 

 

 

 

 

Interest income

 

 

518

 

 

 

7,901

 

 

Interest expense

 

 

(41,170

)

 

 

(41,344

)

 

Other income (expense), net

 

 

(3,322

)

 

 

(14,569

 

             Other expense, net

 

 

(43,974

)

 

 

(48,012

)

 

 

 

 

 

 

 

 

 

 

 

Loss before income taxes

 

 

(92,608

)

 

 

(367,771

)

 

 

 

 

 

 

 

 

 

 

 

Income tax benefit

 

 

27,469

 

 

 

133,378

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(65,139

)

 

$

(234,393

)

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted loss per share

 

$

                -

 

 

$

(0.01

)

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of basic and diluted common shares outstanding:

 

 

 23,480,853

 

 

 

19,400,689

 

 

 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

4

 


 

 

GATEWAY ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

 

 

 

 

 

Three Months Ended

March 31,

 

 

 

2011

   

2010

 

Cash flows from operating activities

 

 

 

 

 

 

Net loss                                                                                        

 

$

(65,139

)

 

$

(234,393

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation, depletion and amortization

 

 

169,979

 

 

 

197,331

 

Deferred tax benefit

 

 

(27,469

)

 

 

(163,504

)

Stock based compensation expense, net of forfeitures                                           

 

 

7,875

 

 

 

18,713

 

Amortization of deferred loan costs                                                                       

 

 

5,058

 

 

 

7,091

 

Net change in operating assets and liabilities, resulting from changes in:

 

 

 

 

 

 

 

 

Accounts receivable trade                                                                                

 

 

99,844

 

 

 

249,388

 

Prepaid expenses, deposits and other assets                                                      

 

 

45,750

 

 

 

45,026

 

Accounts payable                                                                                

 

 

(73,326

)

 

 

91,443

 

Accrued expenses and other liabilities                                                             

 

 

31,959

   

 

14,460

 

Net cash provided by operating activities

 

 

194,531

   

 

225,555

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

Capital expenditures and acquisitions                                                                    

 

 

(10,128

)

 

 

(3,737,705

)

Net cash used in investing activities                                                            

 

 

(10,128

)

 

 

(3,737,705

)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds from borrowings                                                                                    

 

 

-

     

2,500,000

 

Payments on borrowings                                                                                    

 

 

(44,382

)

 

 

(43,996

Restricted cash for credit facility                                                                             

 

 

-

     

650,000

 

Deferred financing costs                                                                                    

 

 

-

     

(26,611

)

Net cash provided by (used in) financing activities

 

 

(44,382

)

 

 

3,079,393

 

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

 

140,021

     

(432,757

)

Cash and cash equivalents at beginning of period                                                       

 

 

238,547

 

 

 

2,086,787

 

Cash and cash equivalents at end of period                                                               

 

$

378,568

 

 

$

1,654,030

 

 

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

 

Cash paid for interest                                                                                    

 

$

40,848

 

 

$

24,446

 

                 

      Cash paid for taxes                                                                               

 

$

-

 

 

$

-

 

                 

Trade note payable for insurance premiums

 

$

-

 

 

$

195,263

 

Exercise of stock options

 

$

-

 

 

$

1,432

 


 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

5

 


 

GATEWAY ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

(Unaudited)

 

  (1)  Interim Financial Information

 

Business and Organization

 

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 (“OTCBB”) section under the symbol GNRG.  Gateway is engaged in the midstream natural gas business.  The Company owns and operates natural gas distribution, transmission and gathering systems located onshore in the continental United States and offshore in federal and state waters of the Gulf of Mexico.

 

Gateway conducts all of its business through its wholly owned subsidiary companies, Gateway Pipeline Company, Gateway Offshore Pipeline Company, Gateway Energy Marketing Company, Gateway Processing Company, Gateway Pipeline USA Corporation 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.   Access to the Company’s annual reports on Form 10-K, 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.

 

                Basis of Presentation

 

                The Company has prepared the accompanying unaudited consolidated financial statements in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) instructions to Form 10-Q and Item 310(b) of regulation S-K.  These financial statements should be read together with the financial statements and notes in the Company’s 2010 Form 10-K filed with the SEC on March 18, 2011.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted.  The accompanying financial statements reflect all adjustments and disclosures, which, in the Company’s opinion, are necessary for fair presentation.  All such adjustments are of a normal recurring nature.  The results of operations for the interim periods are not necessarily indicative of the results of the entire year.  Certain reclassifications have been made to the prior year’s financial statements to conform to the current period’s presentation.

                 

                All of the Company’s operations are in the continental U.S. and offshore in federal and state waters of the Gulf of Mexico.  Management separately reviews and evaluates the operations of each of its gas distribution, transmission and gathering systems individually, however these operations are aggregated into one reportable segment due to the fact that all of the Company’s operations are subject to similar economic and regulatory conditions and operate in the same industry group such that they are likely to have similar long-term prospects for financial performance.

 

                Glossary

 

                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; and 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 and Estimates

 

                Use of Estimates

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) 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, amortization of deferred loan costs, deferred tax valuation allowance, valuation of assumed liabilities, intangible lives, impairment and valuation of the fair value of long-lived assets, purchase price allocations and valuation of stock based transactions.  Actual results could differ from those estimates.

6

 


 

GATEWAY ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

(Unaudited)

 

                 

                Revenue Recognition

 

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 and are recognized at the point such revenues are earned pursuant to the terms of the applicable transportation contract, which can vary.

 

                Concentrations of Credit Risk

 

                The Company maintains all cash in deposit accounts, which at times may exceed federally insured limits.  Additionally, the Company maintains credit on account for customers. The Company has not experienced material losses in such accounts and believes its accounts are fully collectable.  Accordingly, no allowance for doubtful accounts has been provided.

                 

                During the three months ended March 31, 2011 and 2010, one company, Shell Energy North America L.P. supplied 97.3% and 100%, respectively, of the total natural gas purchased.  Due to the nature of the Company’s operations and location of its gas distribution, transmission and gathering systems, the Company is subject to concentration of its sources of revenue into a few significant customers.  Revenues from customers representing 10% or more of total revenue for the three months ended March 31, 2011 and 2010, are as follows:  

  

 

Three Months Ended March 31,

 

 

2011

 

2010

 

                    Dart Container Corporation                        

44.1%

 

44.1%

 

                    Owens Corning                       

23.0%

 

24.0%

 

 

The loss of either of our contracts with Dart Container Corporation or Owens Corning could have a material adverse effect on our business, results of operations and financial condition.  The Company’s accounts receivable are not collateralized.  

                 

                Earnings Per Share

 

Basic earnings per share is computed by dividing net income or loss by the weighted average number of common shares outstanding during the period.  Diluted earnings per share is computed by dividing net income or loss by the weighted average number of shares outstanding, after giving effect to potentially dilutive common share equivalents outstanding during the period.  Potentially dilutive common share equivalents are not included in the computation of diluted earnings per share if they are anti-dilutive.  For the three months ended March 31, 2011 and 2010, all potentially dilutive common shares arising from outstanding stock options and restricted stock have been excluded from diluted earnings per share as their effects were anti-dilutive.  

 

(3)  

Business Combinations

 

                Acquisition of Hickory Creek Gathering System

 

Gateway acquired the Hickory Creek Gathering System (“Hickory Creek”) from Hickory Creek Gathering L.P. and Range Texas Production, LLC on January 7, 2010, for a cash purchase price of $3,737,705, and began consolidating its results on that date.  The transaction was accounted for in accordance with FASB ASC Topic 805 “Business Combinations.”  As the results of Hickory Creek’s operations for the period from January 1, 2010 – January 7, 2010 were not material, the Company has not included them in the pro forma presentation below.  Hickory Creek’s results are included in the Company’s consolidated results for all of both periods ended March 31, 2011 and 2010.  The Company incurred approximately $43,000 in acquisition costs during the three months ended March 31, 2010, related to due diligence associated with evaluating the asset and legal fees.

7

 


 
 

GATEWAY ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

(Unaudited)

 

 

                Acquisition of Pipeline from Laser Midstream

 

On September 22, 2010, Gateway entered into an Asset Sales Agreement with Laser Pipeline Company, LP (“Laser”) pursuant to which it agreed to acquire from Laser four pipelines and related assets for $1,100,000 in cash.  Transfer of ownership occurred and consolidation of the pipelines began on the closing date of October 18, 2010.  The transaction was accounted for in accordance with FASB ASC Topic 805 “Business Combinations”.  The Company recognized $79,514 and $55,770 in revenue and operating margin, respectively, for the three months ended March 31, 2011, from these assets.  

 

                Pro Forma Results of Operations

 

                The following unaudited pro forma consolidated results of operations for the three months ended March 31, 2010, are presented as if the Laser acquisition had been made on January 1, 2010.  The operations of the Laser acquisition have been included in the statement of operations since October 18, 2010, the closing date of the acquisition.  The pro forma consolidated results of operations include adjustments to give effect to the effective change in depreciation rates as well as certain other adjustments.

 

For the Three Months Ended March 31, 2010

 

 

GATEWAY

     

LASER

   

 

PRO FORMA ADJUSTMENTS(1)

 

 

 

TOTAL

 

Revenues

$

1,958,501

   

$

79,389

   

$

-

 

 

$

2,037,890

 

Operating costs

 

1,515,297

     

4,665

   

 

5,000

 

 

 

1,524,962

 

Operating margin

 

443,204

     

74,724

   

 

(5,000

)

 

 

512,928

 

Other expenses

 

810,975

     

22,318

   

 

8,161

 

 

 

841,454

 

Income (loss) before income taxes

 

(367,771

)

   

52,406

   

 

(13,161

)

 

 

(328,526

)

Income tax benefit (expense)

 

133,378

     

(17,818

)

 

 

4,475

 

 

 

120,035

 

Net income (loss)

$

(234,393

)

 

$

34,588

   

$

(8,686

)

 

$

(208,491

)

 

 

 

     

 

   

 

 

 

 

 

 

 

Basic and diluted earnings (loss) per share

$

(0.01

)

 

$

-

   

$

-

 

 

$

(0.01

)

 

(1) The pro forma adjustments include additional operating expenses expected based on Gateway’s pipeline integrity and maintenance plan and additional expenses or modifications to depreciation, insurance, interest, and other related costs.

 

(4)           Stock-Based Compensation Plans

 

                The Company’s 2007 Equity Incentive Plan (“2007 Plan”) provides for stock-based compensation for officers, employees and non-employee directors.  The 2007 Plan was approved by shareholders during May 2007 and makes available 2,000,000 shares for award. 

 

The Company made no awards of stock-based compensation during the three months ended March 31, 2011.  During the three months ended March 31, 2011, the Company had forfeitures of 50,000 unvested stock options and 16,667 shares of unvested restricted stock.  As of March 31, 2011, 312,778 shares of the Company’s Common Stock were issuable under outstanding stock option grants under the 2007 Plan (which is in addition to 40,000 shares issuable under outstanding stock option grants under the Company’s former 1998 Stock Option Plans).  The Company also has 249,998 shares of unvested restricted stock outstanding under the 2007 Plan.  There are 1,387,224 shares available for issuance under future grants of awards under the 2007 Plan.

 

Compensation expense, net of forfeiture adjustments, related to non-qualified stock option and restricted stock for the three months ended March 31, 2011 and 2010 was $7,875 and $18,713, respectively.  The Company considers all awards of stock-based compensation as a single award with an expected life equal to the average expected life of component awards and amortizes the fair value of the award over the requisite service period. 

8

 


 
 

GATEWAY ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

(Unaudited)

 

 

Compensation expense and forfeiture adjustments related solely to stock options was $3,480 and $1,022, respectively, for the three months ended March 31, 2011, compared to $18,713 in compensation expense for the three months ended March 31, 2010.  At March 31, 2011, there was $24,778 of total unrecognized compensation expense related to unvested stock option awards which is expected to be recognized over a remaining weighted-average period of four years.

 

                The following table represents stock option activity for the three months ended March 31, 2011:

 

 

Shares

 

Weighted Average Exercise Price

 

Weighted Average Contractual Terms (in years)

 

Intrinsic Value of Options as of March 31, 2011

Options outstanding, beginning of period

402,778

$

0.35

 

4.20

 

 

Options granted

            -

 

                 -

 

                    -

   

Options canceled

(50,000)

$

0.30

 

                    -

 

 

Options exercised

                 -

 

                 -

 

                    -

   

Options outstanding, end of period

352,778

$

0.36

 

3.90

$

                        -  

Options exercisable, end of period

56,667

$

0.46

 

2.17

$

                        -  

 

 

The market value of the Company’s common stock, as quoted on the OTCBB, on March 31, 2011 was $0.26 per share.

 

Compensation expense for restricted stock is recognized on a straight-line basis over the vesting period.  The Company recognized $5,417 in compensation expense related to restricted stock grants during the three months ended March 31, 2011.  The Company had no compensation expense related to restricted stock grants during the three months ended March 31, 2010.  Compensation expense related to restricted stock grants is based upon the market value of the shares on the date of the grant.  As of March 31, 2011, unrecognized compensation cost related to restricted stock awards was $56,250, which is expected to be recognized over the remaining weighted average period of two years.

 

                The following table represents restricted stock activity for the three months ended March 31, 2011:

 

 

 

 

Shares

   

 

Weighted Average Grant Date Fair Value

 

 

 

Intrinsic Value as of March 31, 2011

Non-vested, beginning of period

 

266,665

   

 

     $         0.30

 

 

 

 

  Granted

 

-

   

 

-

 

 

 

 

  Vested

-

   

 

-

 

 

 

 

  Forfeited

 

(16,667

)

 

 

    $         0.30

 

 

 

 

Non-vested, end of period

 

249,998

   

 

$         0.30

 

$

-

 

 

 

 

9

 


 
 

GATEWAY ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

(Unaudited)

 

(5)           Debt

                Trade Notes Payable

 

During 2010, the Company executed premium finance agreements for its insurance premiums.  The total original principal amount of the notes issued in connection with these agreements was $428,367, with an interest rate of 4.95%.  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. As of March 31, 2011, there was $139,645 outstanding under these notes.

 

                 

                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.  The original borrowing base under the Agreement had been established at $3.0 million, which may be increased at the discretion of Meridian to an amount not to exceed $6.0 million.  The credit facility is secured by all of the Company’s assets and has an original term of 39 months maturing on April 30, 2012.  The credit facility contains financial covenants defining various financial measures, with which the Company is in compliance.  Interest on outstanding balances accrues at the Wall Street Journal prime rate, plus one and one-half percent, with a minimum rate of 5.50% and is payable monthly.  The principal is due upon maturity.  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 March 31, 2011, there was a $2,550,000 outstanding balance on the facility.

 

(6)          Commitments and Contingencies

 

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.

 

(7)        Financial Instruments

 

The carrying amount of cash and cash equivalents, trade receivables, trade payables and short-term borrowings approximate fair value because of the short maturity of those instruments.  The carrying amount of the Company’s revolving credit facility approximates fair value because of its variable interest rate.  The fair value of the Company’s financial instruments is based upon current borrowing rates available for financings with similar terms and maturities, and is not representative of the amount that could be settled, nor does the fair value amount consider the tax consequences, if any, of settlement.

10

 


 

GATEWAY ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

(Unaudited)

 

 

Item  2.   Management's Discussion and Analysis of Financial Condition and Results of Operations

 

This Quarterly Report on Form 10-Q contains 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.  Our actual results could and likely will differ materially from these forward-looking statements for many reasons, including the risks described in our Annual Report on Form 10-K for the year ended December 31, 2010, and our quarterly reports on Form 10-Q.  We cannot guarantee future results, levels of activities, performance, or achievements. We undertake 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.

 

                Critical Accounting Policies

 

A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows.

 

                Use of Estimates

 

                The preparation of financial statements in conformity with U.S. GAAP 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, amortization of deferred loan costs, deferred tax valuation allowance, valuation of assumed liabilities, intangible lives, impairment and valuation of the fair value of long-lived assets, purchase price allocations and valuation of stock based transactions.  Actual results could differ from those estimates.

 

                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 and are recognized at the point such revenues are earned pursuant to the terms of the applicable transportation contract, which can vary.

 

                Results of Operations

 

                General

 

                All of our operations are in the continental U.S. and offshore in federal and state waters of the Gulf of Mexico.  We separately review and evaluate the operations of each of our gas distribution, transmission and gathering systems individually, however these operations are aggregated into one reportable segment due to the fact that all of our operations are subject to similar economic and regulatory conditions and operate in the same industry group such that they are likely to have similar long-term prospects for financial performance.

 

 

The Henry Hub monthly, INSIDE FERC price for natural gas (as quoted in the Platts Gas Daily Price Guide) during the three months ended March 31, 2011, averaged $4.11 per MMBtu, compared to $5.30 for the same period of the prior year.  

 

                 

 

11

 


 

 

Three Months Ended March 31, 2011 Compared to Three Months Ended March 31, 2010

 

   

 

Three Months Ended March 31,

 

 

2011

2010

Operating revenues

 

 

 

 

Sales of natural gas

 

$

1,237,830

 

 

$

1,407,489

 

 

Transportation of natural gas and liquids

 

 

385,085

 

 

 

422,868

 

 

Reimbursable and other

 

 

141,218

 

 

 

128,144

 

 

 

 

 

1,764,133

 

 

 

1,958,501

 

 

Operating costs and expenses

 

 

 

 

 

 

 

 

 

Cost of natural gas purchased

 

 

1,062,190

 

 

 

1,264,376

 

 

Operation and maintenance

 

 

107,605

 

 

 

104,365

 

 

Reimbursable costs

   

107,251

     

107,412

   

General and administrative

 

 

365,742

 

 

 

462,453

 

 

Acquisition costs

 

 

-

 

 

 

43,453

 

 

Consent solicitation costs

 

 

-

 

 

 

98,870

 

 

Depreciation, depletion and amortization

 

 

169,979

 

 

 

197,331

 

 

     

1,812,767

     

2,278,260

   

Operating loss

 

 

(48,634

)

 

 

(319,759

)

 

 

 

 

 

 

 

 

 

 

 

Other income (expense)

 

 

 

 

 

 

 

 

 

Interest income

 

 

518

 

 

 

7,901

 

 

Interest expense

 

 

(41,170

)

 

 

(41,344

)

 

Other income (expense), net

 

 

(3,322

)

 

 

(14,569

 

             Other expense, net

 

 

(43,974

)

 

 

(48,012

)

 

 

 

 

 

 

 

 

 

 

 

Loss before income taxes

 

 $

(92,608

)

 

 $

(367,771

)

 

 

Revenues

 

Our total revenues were $1,764,133 for the three months ended March 31, 2011, which represented a decrease of $194,368 from the $1,958,501 of total revenues we recognized for the three months ended March 31, 2010. 

 

During the three months ended March 31, 2011, revenues from sales of gas on our Waxahachie delivery system decreased by $169,659, as compared to the same period for the prior year.  This decrease primarily resulted from a 22.6% decline in average gas prices received, reducing revenues by $318,525.  However, a 13.7% increase in sales volumes at Waxahachie offset $148,866 of this decline.  The decrease in revenue due to lower gas prices from our Waxahachie system, however, was offset by reductions in the cost of purchased gas, as volumes are bought and sold pursuant to ‘back-to-back” contracts based on monthly price indices. 

 

Our transportation revenues decreased by $37,783 during the three months ended March 31, 2011, as compared to the same period of the prior year.  Revenues of $79,389 from our newly acquired Laser operations were more than offset by net decreases of $117,172 attributable to production declines on natural gas wells connected to our gathering systems.  We believe that transportation revenues will eventually increase on some of our gathering systems due to new drilling and workover activities, but doubt meaningful activities will occur during the remainder of 2011.  Revenues from reimbursable costs and other revenue was relatively flat for the three months ended March 31, 2011, compared to the three months ended March 31, 2010.

 

                Operating Margin

 

                Operating margin, which we define as revenues less the cost of purchased gas, operating and maintenance expenses and reimbursable costs generated by our pipeline systems, was $487,087 for the three months ended March 31, 2011, which represented an increase of $4,739 from the $482,348 of operating margin we recognized for the three months ended March 31, 2010. 

 

12

 


 

 

Our newly acquired operations from Laser contributed $55,770 to operating margin for the current period.  In addition, the Waxahachie system generated a quarter-to-quarter increase of $34,783 in operating margin contribution to $159,763 for the current period.  Increases in operating margin on the Waxahachie system were primarily attributable to increased sales volumes to industrial customers due to strengthening economic conditions.   The High Island Block A-389 gathering system offshore in the Gulf of Mexico generated $28,350 of operating margin during the three month period ended March 31, 2011.  The High Island A-389 system was non-operational during the same period in 2010 due to damage caused by Hurricane Ike.  The High Island A-389 system was repaired and recommenced operations in April 2010. 

 

Operating margin contribution from the Hickory Creek, Madisonville, and all gathering systems other than High Island A-389 decreased by an aggregate of $114,164 for the current period compared to the prior period.  The decreases in operating margin on these other systems were attributable to the aforementioned production declines from gas wells connected to these systems.  Sizable production declines from the wells connected to our Hickory Creek gathering system are typical of newly fractured horizontal wells located in the Barnett Shale.  However, the rate of decline from wells connected to our Hickory Creek gathering system should decrease over time.

 

                General and Administrative

 

                General and administrative expenses were $365,742 for the three months ended March 31, 2011, which represented a decrease of $96,711 from the $462,453 in such expenses we recognized for the three months ended March 31, 2010. We reduced professional fees by $22,463 and reduced investor relations costs by $25,229 for the comparable quarterly periods.  General and administrative expenses for the three months ended March 31, 2011, included approximately $21,000 of legal fees, representing our share of costs to pursue damages against the owner of a ship which damaged our High Island A-389 system.  Our customers served by this system have agreed to bear all future costs in the pursuit of legal remedies in this matter.  We expect general and administrative expenses to remain lower in 2011, relative to the comparable 2010 periods, as we continue to manage our overall level of fixed costs.

 

                Acquisition Costs

                 

                Acquisition costs in 2010 were related to our Hickory Creek acquisition in January 2010.  See Note 3 in the accompanying notes to our consolidated financial statements.

 

                Consent Solicitation Costs

 

                Consent solicitation costs for the three months ended March 31, 2010 were for legal and proxy preparation costs incurred by the prior management and board of directors related to the consent solicitation initiated by our current CEO in 2010. 

 

                Other Income (Expense)

 

Our interest income fluctuates directly with the average amount of cash on deposit.

 

Our interest expense fluctuates directly with the amount of outstanding insurance notes payable and the amount of borrowings under the Company’s bank revolving credit agreement, and remained relatively constant between the two periods.

 

                Liquidity and Capital Resources

 

Going forward, the Company’s strategy is to maximize the potential of currently-owned properties, to construct new pipeline systems, and to acquire properties that meet its economic performance hurdles.  The Company is actively exploring its capital needs to allow it to accelerate the implementation of its growth strategy, and any new capital may take several forms.  There is no guarantee that the Company will be able to raise outside capital.  Without a significant infusion of new capital, the Company believes it 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 existing financing agreements.

 

The Company had available cash of $378,568 at March 31, 2011.

 

Net cash provided by operating activities totaled $194,531 for the three months ended March 31, 2011, compared to net cash provided of $225,555 during the same period of the previous year.  Although the Company’s net loss decreased from $234,393 for the three months ended March 31, 2010, to $65,139 for the three months ended March 31, 2011, after considering the changes in the Company’s operating assets and liabilities, the Company experienced a slight decrease in cash provided by operations between the two periods.

13

 


 
 

 

 

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.

 

During 2010, the Company executed premium finance agreements for its insurance premiums.  The total original principal amount of the notes was $428,367, with an interest rate of 4.95%.  The notes require monthly principal and interest payments.  The amount of the monthly payment varies depending on any changes in coverage and policy renewal period changes.  The Company expects it will be able to finance the renewal of the policy premiums related to these coverages at the date of policy renewals.         

 

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 Agreement had been established at $3.0 million, which may be increased at the discretion of Meridian to an amount not to exceed $6.0 million.   The credit facility is secured by all of the Company’s assets and originally has an original 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 accrues at the Wall Street Journal prime rate, plus one and a half percent, with a minimum rate of 5.50% payable monthly.  The principal is due upon maturity.  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 March 31, 2011, there was a $2,550,000 balance on the facility.

 

At March 31, 2011, we had deposited $250,000 with a supplier as collateral for gas purchase costs.

 

                Off-Balance Sheet Arrangements

 

The Company has no off-balance sheet arrangements at March 31, 2011; however, see Note 6 to the consolidated financial statements regarding Commitments and Contingencies.

 

                Non-GAAP Financial Measure

 

We evaluate our operations using operating margin, which we define as revenues less cost of purchased gas, operating and maintenance expenses and reimbursable costs.  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 net loss, which is its nearest comparable GAAP financial measure, is included in the table below.

 

Reconciliation of Operating Margin to Net Loss

 

 

 

 

 

 

 

 

Three Month Ended March 31,

                                        2011

                       2010

Operating margin

 

$

487,087

 

 

$

482,348

 

Less:

 

 

 

 

 

 

 

 

Depreciation, depletion and amortization

 

 

169,979

 

 

 

197,331

 

General and administrative expenses

 

 

365,742

 

 

 

462,453

 

Acquisition costs

 

 

-

 

 

 

43,453

 

Consent solicitation costs

 

 

-

 

 

 

98,870

 

Interest expense

 

 

41,170

 

 

 

41,344

 

Other expense, net

 

 

3,322

 

 

 

14,569

 

Plus:

 

 

 

 

 

 

 

 

Interest income

 

 

518

 

 

 

7,901

 

Income tax benefit

 

 

27,469

 

 

 

133,378

 

                 

Net loss

 

$

(65,139

)

 

$

(234,393

)

 

 

14

 


 
 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

                As a “smaller reporting company”, we are not required to provide the information required by this Item.  

 

 

 

Item 4.  Controls and Procedures

                Management’s Report on Disclosure Controls and Procedures

 

                We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (our Principal Executive Officer  and Principal Financial Officer) to allow for timely decisions regarding required disclosure.

 

                As of March 31, 2011, the end of our quarter covered by this report, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer (our Principal Executive Officer and Principal Financial Officer), of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer (our Principal Executive Officer and Principal Financial Officer) concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

 

                Changes in Internal Control over Financial Reporting

 

As reported in our Form 8-K filed with the Securities Exchange Commission on March 7, 2011, on March 1, 2011, Jill R. Marlatt, our Controller, Treasurer, Secretary and Principal Financial Officer, tendered her resignation from all of the foregoing positions, effective March 18, 2011.  On March 2, 2011, the Board of Directors of the Company appointed Frederick M. Pevow as Interim Secretary and Treasurer of the Company (which offices are in addition to his previously existing offices of Chief Executive Officer and President) until such time as the Board of Directors can identify a permanent replacement for Ms. Marlatt.

 

In connection with Mr. Pevow’s above noted officer position appointments, he also assumed responsibility as our Principal Financial Officer, in addition to his previously existing responsibility as our Principal Executive Officer.

 

                In order to maintain appropriate controls and procedures in place upon Ms. Marlatt’s departure to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended, were recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information was accumulated and communicated to our management, including our Chief Executive Officer (our Principal Executive Officer  and Principal Financial Officer) to allow for timely decisions regarding required disclosure during our quarter ended March 31, 2011, the Company engaged third party financial reporting consultants to assist in the supervision of its accounting staff, provide oversight of entries recorded and assist management in the preparation of the Company’s consolidated unaudited financial statements in accordance with GAAP and the rules and regulations promulgated by the Securities and Exchange Commission.

 

Part II – OTHER INFORMATION

 

Item 1.   Legal Proceedings

                                  

                We know of no material, existing or pending legal proceedings against our company, nor are we involved as a plaintiff in any material proceeding or pending litigation.  There are no proceedings in which any of our directors, officers or affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest adverse to our interest.

 

Item 1A.  Risk Factors

                                  

                Please refer to the risk factors as previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

 

 

 

15

 


 
 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None

 

Item 3.

Defaults Upon Senior Securities

 

None

 

Item 4.   (Removed and Reserved)

 

Item 5.   Other Information

               

                None

 

Item 6.   Exhibits 

                               

                31.1    Section 302 Certification      

                32.1    Section 906 Certification

 

 

16

 


 

 

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

 

 

 

May 12, 2011

 

/s/ Frederick M. Pevow

(Date)

 

President and Chief Executive Officer

 

 

(Principal Executive Officer and Principal Financial Officer)

 

 

 

17