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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[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
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(Exact name of registrant as specified in its charter)
Delaware 44-0651207
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(State or other jurisdiction of (IRS Employer
incorporation or organization) 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
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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 (ss.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. X
-----
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 [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act)
Yes X No
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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:
Part III of this Annual Report incorporates by reference
information in the Proxy Statement for the Annual Meeting of
Stockholders of Gateway Energy Corporation.
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INDEX
PAGE
PART I. ................................................................... 3
Item 1. Business............................................ 3
Item 1A. Risk Factors........................................ 5
Item 1B. Unresolved Staff Comments........................... 5
Item 2. Properties.......................................... 5
Item 3. Legal Proceedings................................... 6
PART II. .................................................................. 6
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters and Issuer Purchases of
Equity Securities................................ 6
Item 6. Selected Financial Data............................. 6
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............. 7
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk...................................... 18
Item 8. Financial Statements and Supplementary Data......... 18
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 18
Item 9A. Controls and Procedures............................. 18
Item 9B. Other Information................................... 19
PART III. ................................................................. 19
Item 10. Directors, Executive Officers and Corporate
Governance....................................... 19
Item 11. Executive Compensation.............................. 19
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters....... 19
Item 13. Certain Relationships and Related Transactions, and
Director Independence............................. 20
Item 14. Principal Accountant Fees and Services.............. 20
PART IV. .................................................................. 20
Item 15. Exhibits and Financial Statement Schedules.......... 20
SIGNATURES. ............................................................... 22
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2
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; "Tcf" refers to trillion 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.
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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.
o 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.
o 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
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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.
4
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.
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 13 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
5
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 Rodesso/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.
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
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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.
6
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.
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.
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.
7
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.
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:
o 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.
o 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.
o 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.
o Includes an example that provides additional explanation on
estimating fair value when the market activity for an asset has
declined significantly.
o 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.
o Applies to all fair value measurements when appropriate.
8
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:
o 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;
o The circumstances under which an entity should recognize events or
transactions occurring after the balance sheet date in its financial
statements; and
o 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.
9
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.
Results of Operations
General
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. The Company defines
operating margin as revenues, less the cost of purchased gas and operating and
maintenance expenses. A reconciliation of operating margin to operating income
is presented in Note 11 to the Consolidated Financial Statements. 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
10
Onshore operating margin for the year ended December 31, 2009
decreased $526,000 from the prior year, mainly due to decreased throughput
volumes on the Company's Madisonville pipeline system and lower sales volumes on
the Waxahachie distribution system.
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 decreased throughput
volumes on the Company's Madisonville pipeline system 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. These increases were 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. If the
price of natural gas and production in the Madisonville Field continues to
increase, the Company will recognize an increased margin 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. As a result
of the sale, the Company recognized a pre-tax gain of $363,781.
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. As a result of
the sale, the Company recognized a pre-tax gain of $101,539.
11
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
Income (loss) from
discontinued operations,
net of taxes ............. (155,897) 194,480 356,903
Gain on disposal of
discontinued operations,
net of taxes ............. 318,180 -- --
Basic and diluted loss per
share from discontinued
operations ............... $ (0.01) $ -- $ --
Basic and diluted income
per share from gain on
disposal of discontinued
operations ............... 0.02 0.01 0.01
------------ ------------ ------------
Total .................... $ 0.01 $ 0.01 $ 0.01
============ ============ ============
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............. (178,758) 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............ 318,180 -- 1,241,722
12
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.
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
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.
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 activites of $2,316,381 during the same period of the
previous year.
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 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
13
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.
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
14
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:
o operating a significantly larger combined organization and adding
operations;
o 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;
o 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;
o the loss of significant producers or markets;
o the diversion of management's attention from other business
concerns;
o the failure to realize expected profitability or growth;
o the failure to realize any expected synergies and cost savings;
o coordinating geographically disparate organizations, systems and
facilities;
o 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.
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:
o our lender may be unable or otherwise fail to meet its funding
obligations;
o our lender may elect to not renew the credit facility upon maturity;
o 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.
15
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.
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
16
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:
o 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;
o inadvertent damage from motor vehicles, construction or farm
equipment;
o leaks of natural gas and other hydrocarbons;
o operator error; and
o 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.
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.
17
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
As of December 31, 2009, an evaluation was carried out under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the
"Exchange Act")). Based upon that evaluation, the Chief Executive Officer and
the Chief Financial Officer concluded that the design and operation of these
disclosure controls and procedures were effective to ensure that information
required to be disclosed by us in the reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in applicable rules and forms.
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
believes that, as of December 31, 2009, the Company maintained effective
internal control over financial reporting.
18
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
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.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Incorporated by reference to the Gateway Energy Corporation Proxy
Statement for the Annual Meeting of Stockholders, under the captions "ELECTION
OF DIRECTORS," "EXECUTIVE OFFICERS OF THE COMPANY" "GOVERNANCE OF THE COMPANY"
and "SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE".
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to the Gateway Energy Corporation Proxy
Statement for the Annual Meeting of Stockholders, under the caption "EXECUTIVE
COMPENSATION."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Incorporated by reference to the Gateway Energy Corporation Proxy
Statement for the Annual Meeting of Stockholders, under the captions "SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT".
Securities Authorized for Issuance Under Equity Compensation Plans
=========================== ========================= ========================= =========================
Number of securities
remaining available for
future issuance under
Number of securities to Weighted-average equity compensation
be issued upon exercise exercise price of plans (excluding
of outstanding options, outstanding options, securities reflected in
warrants and rights warrants and rights column (a))
Plan Category (a) (b) (c)
--------------------------- ------------------------- ------------------------- -------------------------
Equity compensation
plans approved by
security holders 1,278,947 $ 0.45 1,302,720
=========================== ========================= ========================= =========================
19
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
Incorporated by reference to the Gateway Energy Corporation Proxy
Statement for the Annual Meeting of Stockholders, under the caption "CERTAIN
RELATIONSHIPS AND TRANSACTIONS WITH RELATED PERSONS" and "GOVERNANCE OF THE
COMPANY".
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Incorporated by reference to the Gateway Energy Corporation Proxy
Statement for the Annual Meeting of Stockholders, under the caption "INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM."
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.
20
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.
23.1 Consent of Pannell Kerr Forster of Texas, P.C.
31.1 Section 302 Certification of Chief Executive Officer
31.2 Section 302 Certification of Chief Financial Officer
32.1 Section 906 Certification of Chief Executive Officer
32.2 Section 906 Certification of Chief Financial Officer
21
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/ Robert Panico
--------------------------------
Robert Panico
President & CEO
Date: March 24, 2010
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Title Date
/s/ John A. Raasch Director March 24, 2010
------------------------------
John A. Raasch
/s/ Gordon Wright Director March 24, 2010
------------------------------
Gordon Wright
/s/ William A. Henry Director March 24, 2010
------------------------------
William A. Henry
/s/ Charles O. Buckner Director March 24, 2010
------------------------------
Charles O. Buckner
/s/ J. Darby Sere Director March 24, 2010
------------------------------
J. Darby Sere
/s/ Steven W Cattron Director March 24, 2010
------------------------------
Steven W Cattron
/s/ Robert Panico Chief Executive March 24, 2010
------------------------------ Officer, President
Robert Panico and Director
(Principal Executive
Officer)
/s/ Christopher M. Rasmussen Chief Financial March 24, 2010
------------------------------ Officer and
Christopher M. Rasmussen Secretary (Principal
Financial and
Accounting Officer)
22
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.
/s/ Pannell Kerr Forster of Texas, P.C.
----------------------------------------
Pannell Kerr Forster of Texas, P.C.
Houston, Texas
March 24, 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
Current Assets
Cash and cash equivalents ........................................ $ 2,086,787 $ 1,789,029
Restricted cash .................................................. 900,000 --
Accounts receivable trade, net ................................... 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
------------ ------------
Total current liabilities ................................... 975,241 2,181,854
------------ ------------
Long-term capital lease, less current maturities .................... -- 9,187
Non-current liabilities of discontinued operations .................. -- 2,318,315
------------ ------------
Total liabilities ........................................... $ 975,241 $ 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 .............................................. (10,124,436) (9,904,952)
------------ ------------
Total stockholders' equity .................................. 12,120,673 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
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
------------ ------------
6,983,849 14,458,010
------------ ------------
Operating loss ..................................................... (275,875) (575,534)
Other income (expense)
Interest income ................................................. 30,408 29,119
Interest expense ................................................ (116,699) (157,091)
Other income (expense), net ..................................... (178,758) 1,731,155
------------ ------------
Other income (expense) ....................................... (265,049) 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 ........................ 318,180 --
------------ ------------
Income from discontinued operations ................................ 162,283 194,480
Net income (loss) .................................................. $ (219,484) $ 817,541
------------ ------------
Basic and diluted income (loss) per share:
Continuing operations ........................................... $ (0.02) $ 0.03
Discontinued operations ......................................... 0.01 0.01
------------ ------------
Net income ...................................................... $ (0.01) $ 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
Common Stock Additional
--------------------------- Paid-in Accumulated Non-controlling
Shares Amounts 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 .......................... -- -- -- (219,484) -- (219,484)
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2009 ...... 19,397,125 $ 4,849,281 $ 17,395,828 $(10,124,436) $ -- $ 12,120,673
============ ============ ============ ============ ============ ============
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 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
(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 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; "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)
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 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.
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.
F-8
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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.
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.
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 requisit
service period.
F-9
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
During the second quarter of 2009, the Company made a stock grant of
189,876 restricted shares of common stock to the Company's Board of Directors.
The value of the stock grant was $0.315 per share and was included in stock
based compensation expense.
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:
o The risk-free interest rate is based on the five-year Treasury bond at
date of grant.
o 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.
o The market price volatility of the Company's common stock is based on
daily, historical prices for the last three years.
o 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:
Weighted
Weighted Average
Average Contractual Intrinsic
Exercise Terms (in Value of
Shares Price years) 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
========= =========
F-10
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table represents stock option activity for the year ended December
31, 2008:
Weighted
Weighted Average
Average Contractual Intrinsic
Exercise Terms (in Value of
Shares Price years) 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.
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.
Year Ended 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 162,283 194,480
Net income attributable to noncontrolling
interests................................. -- (28,824)
Net income (loss) attributable to controlling
interests................................. $ (219,484) $ 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 0.01
----------- -----------
Net loss.................................. $ (0.01) $ 0.04
=========== ===========
F-11
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Accounting Pronouncements and Recent Regulatory Developments
The FASB issued ASC Topic 820, "Fair Value Measurements and
Disclosures". This topic:
o 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.
o 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.
o 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.
o Includes an example that provides additional explanation on estimating
fair value when the market activity for an asset has declined
significantly.
o 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.
o 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.
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:
o 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;
o The circumstances under which an entity should recognize events or
transactions occurring after the balance sheet date in its financial
statements; and
o The disclosures that an entity should make about events or transactions
that occurred after the balance sheet date.
F-12
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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.
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.
F-13
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Acquisition of Madisonville Field Net Profits Interest
Effective December 22, 2008, the Company, through its wholly-owned
subsidiary CEU TX NPI, L.L.C., purchased a 9.1% net profits interest in the
Madisonville Field. The interest was purchased for $762,450.
(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.
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) Income Taxes
The provision (benefit) for income taxes consisted of the following:
2009 2008
------------ ------------
Current expense (benefit):
U.S
Federal................................ $ -- $ --
State.................................. 36,069 35,000
------------ ------------
Total U.S.................................. 36,069 35,000
------------ ------------
Total current................................. $ 36,069 $ 35,000
------------ ------------
F-14
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Deferred expense (benefit):
U.S
Federal................................ $ (197,181) $ 309,339
State.................................. 1,955 31,425
------------ ------------
Total U.S.................................. (195,226) 340,764
------------ ------------
Total deferred................................ (195,226) 340,764
------------ ------------
Total provision (benefit) for income taxes.... $ (159,157) $ 375,764
============ ============
A reconciliation between the provision for income taxes and income
taxes computed by applying the statutory rate is as follows:
2009 2008
------------ ------------
Tax provision at statutory rate at 35%........ $ (183,914) $ 337,818
Add (deduct):
State income taxes, net of federal taxes... 25,095 44,232
Change in deferred tax rate/true up........... -- (6,707)
Other non-deductible expenses................. (338) 421
------------ ------------
$ (159,157) $ 375,764
============ ============
The provision tax effects of temporary differences that give rise to
the deferred tax assets and liabilities as of December 31, were as follows:
2009 2008
------------ ------------
Deferred tax assets:
Net operating loss carryforwards........... $ 1,650,332 $ 1,427,247
AMT tax credit............................. 54,297 54,297
Property and equipment..................... 197,655 --
Stock options.............................. 96,056 60,831
Asset retirement obligation................ -- 826,479
State NOL.................................. 41,009 41,009
Accrued bonus.............................. 7,130 --
Less: Current deferred tax asset........... (7,130) --
Less: Valuation allowance.................. (41,009) (41,009)
------------ ------------
Total deferred tax asset......... 1,998,340 2,368,854
Deferred tax liabilities:
Identified intangible assets............... (146) --
Property, plant, and equipment............. -- (558,757)
Discontinued operations.................... (97,642) --
Casualty gain/loss......................... (605,097) (605,097)
------------ ------------
Total deferred tax liability..... (702,885) (1,163,854)
------------ ------------
Net deferred tax asset........... $ 1,295,455 $ 1,205,000
============ ============
The Company uses FASB ASC Topic 740 "Income Taxes" for presentation of
its income taxes. The Company currently does not have any uncertain tax
positions. 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.
As of December 31, 2009, the Company has federal net operating loss
carryforward of approximately $4,861,105 which may be applied against future
taxable income which expires beginning in 2010 through 2029. As of December 31,
2009, the Company has a valuation allowance of $41,009 for its Oklahoma net
operating loss carryforward. The Company currently does not have any operations
in Oklahoma.
F-15
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Topic 740 requires the Company to periodically assess whether it is
more likely than not that it will generate sufficient taxable income to realize
its deferred income tax assets. In making this determination, it considers all
available positive and negative evidence and make certain assumptions. It
considers, among other things, the deferred tax liabilities; the overall
business environment; the historical earning and losses; and its outlook for
future years.
The Company did not utilize any of its Net Operating Loss for the
period ended December 31, 2009, however it did utilize $40,907 of its Net
Operating Loss for the period ended December 31, 2008. The Company also recorded
a casualty gain of $1,697,327 in 2008 due to hurricane Ike that is being
deferred for federal income tax purposes. The Company has partially replaced
this property. The Company has forecasted taxable income for the tax year 2010.
In 2009, the Company sold its Pirates Beach and Shipwreck gathering
system consisting of an offshore platform and related pipelines, as well as a
related onshore facility known as the Crystal Beach terminal, which represent a
disposal of a segment of its business. Discontinued operations decreased net
loss by $162,283 ($259,925 less tax effect of $97,642). See Footnote 12 to the
Consolidated Financial Statements.
We feel that we have sufficient positive evidence to conclude that it
is more likely than not that our net deferred tax assets will be realized. We
will assess the need for a deferred tax valuation allowance on an ongoing basis
considering factors such as those mentioned above as well as other relevant
criteria.
For the years ended December 31, 2009 and 2008, the Company paid taxes
of $42,746 (federal taxes of $0 and state taxes of $42,746) and $36,447 (federal
taxes of $0 and state taxes of $36,447) respectively.
(6) Common Stock Option and Warrant Plans
Stock-Based Employee Compensation Plans
The Company has two share-based compensation plans, our 1999 Stock
Option Plan ("1999 Plan") covers employees only and our 2007 Equity Incentive
Plan ("2007 Plan") covers officers, employees and non-employee directors. The
2007 Plan was approved by the shareholders during May 2007 and provides for
2,000,000 shares to be made available under the plan. Generally, the options are
exercisable within three years of the date of grant and expire between five and
ten years after the date of grant. All options or warrants issued have exercise
prices of not less than 100% of the fair market value on date of grant.
The following table summarizes employee stock option and warrant
information for the years ended December 31, 2009 and 2008:
December 31, 2009 December 31, 2008
------------------------------------- ---------------------------------------
Options/ Weighted average Options/ Weighted average
warrants exercise price warrants exercise price
---------------- ----------------- ------------------ -----------------
Outstanding at beginning of period.. 1,018,947 $0.53 750,000 $0.44
Granted............................. 387,500 0.32 268,947 0.80
Canceled/expired/reclassified....... (147,500) -- -- --
--------- ---------
Outstanding at end of period........ 1,258,947 0.46 1,018,947 0.53
========= =========
Options exercisable at end of period 624,649 0.45 410,000 0.40
========= =========
Options available for grant at the end of
period........................... 1,302,720 1,542,720
========= =========
Non-Employee Common Stock Options and Warrants
The Company has a stock option plan under which non-employee directors
and another party have been granted nonqualified stock options or warrants to
purchase the Company's common stock. Generally, the options are exercisable
immediately and expire ten years after the date of grant, or 12 months after
cessation of service on the Company's Board if sooner, in the case of director
options. All options or warrants issued have exercise prices of not less than
100% of the fair market value on date of grant.
F-16
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following is a summary of the status of the Company's non-employee
options and warrants for the years ended December 31, 2009 and 2008:
December 31, 2009 December 31, 2008
------------------------------------- ---------------------------------------
Options/ Weighted average Options/ Weighted average
warrants exercise price warrants exercise price
---------------- ---------------- ------------------ -----------------
Outstanding and exercisable at
beginning of period.............. 20,000 $0.27 40,000 $0.37
Canceled/Expired.................... -- (20,000) 0.48
--------- ---------
Outstanding and exercisable at end of
period........................... 20,000 0.27 20,000 0.27
========= =========
Options available for grant at end of
period........................... 1,302,720 1,542,720
========= =========
At December 31, 2009, the Company had a combined total of 1,278,947
common stock options and warrants outstanding, 644,649 of which were
exercisable. At December 31, 2008, the Company had a combined total of 1,038,947
common stock options and warrants outstanding, 430,000 of which were
exercisable.
Employee Benefit Plan
The Company manages its staffing under an employee leasing agreement
with Administaff, Inc. ("Administaff"). Employees of the Company are eligible to
participate in a 401(k) plan sponsored by Administaff. During 2003, the Company
participated in an Administaff single employer 401(k) plan under which the
Company matched 50% of employee contributions to the plan up to a maximum 3% of
each employee's base salary. Effective January 1, 2004, the Company adopted an
Administaff multiple employer 401(k) plan in order to comply with the provisions
of Revenue Procedure 2002-21. Under the new multiple-employer plan, the Company
will make a safe-harbor contribution of 3% of each employee's base salary
regardless of the employee's contribution. The Company believes it is in
substantial compliance with the Employee Retirement Income and Security Act of
1974 and other laws that would govern the plan. Prior to its association with
Administaff, the Company had a predecessor 401(k) plan, and the Company has
requested a ruling from the IRS on the former plan qualification status in order
to allow employees to rollover investment balances into the Administaff plan.
The Company's contributions to the 401(k) plan were $12,413 and
$15,151 for the years ended December 31, 2009 and 2008, respectively.
(7) Leases
Capital Lease
At December 31, 2009, the Company had one capital lease for equipment
installed at the sales point of the Madisonville Pipeline Facilities, for a term
of 84 months, maturing May 28, 2010. Interest expense is being recognized over
the life of the lease at an imputed annual rate of 10%. At the end of the lease
term, the Company owns the equipment, or at its option, the Company may buy out
the lease at a fixed price at either of two interim dates. The equipment cost of
$100,000 is reflected in the accompanying balance sheet as gas gathering,
processing and transportation equipment. The related depreciation of $21,944 is
reflected in accumulated depreciation and amortization. Future minimum lease
payments, as well as the present value of the net minimum lease payments as of
December 31, 2009, are as follows:
Year Ending
December 31, 2010
Total minimum lease payments $ 9,750
Less amount representing estimated executory costs (such
as taxes, maintenance and insurance) including profit
thereon, included in total minimum lease payments (160)
-----------
Net minimum lease payments 9,590
Less amount representing interest (402)
-----------
Present value of net minimum lease payments $ 9,188
===========
Current maturities of capital lease payments 9,188
Long-term capital lease payments, less current maturities $ --
===========
F-17
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Operating Leases
On January 15, 2008, the Company entered into a lease agreement with
Wedge International for office space. The term of the agreement is five years
commencing on April 1, 2008. The monthly lease payment is $12,527. The future
minimum operating lease payments as of December 31, 2009, are as follows:
Year Ending
December 31,
------------
2010 $ 153,422
2011 153,422
2012 150,502
2013 37,581
-----------
Total future minimum lease payments $ 494,927
===========
The Company also has various month-to-month equipment operating leases. Rent
expense for all leases totaled $153,422 and $142,472 for the years ended
December 31, 2009 and 2008, respectively.
(8) Change in Estimate
The Company calculates the Asset Retirement Obligation ("ARO")
liability and related expenses utilizing a methodology that is in accordance
with ASC Topic 410. The calculation provides for an ARO liability based on an
estimated fair value of the asset. ASC Topic 410 requires the Company to review
the liability periodically and adjust fair values and other assumptions based on
current market conditions.
Prior to the sale of the Shipwreck Platform and based on the current
market value of the asset along with the recent interest and inflation rate
activity, the Company had adjusted these aforementioned assumptions.
Specifically, subsequent to hurricane Ike and in light of the recent decline in
energy prices experienced during 2008, the fair value of the cost to abandon the
facility was increased. Additionally, the life of the platform was reevaluated
to better approximate the estimated time until the potential abandonment occurs.
The production which flows through the platform was also a factor in the change
in assumptions. It is projected to increase significantly which increases the
value and life of the asset.
The adjustment, recorded during the fourth quarter of 2008, increased
the book value of the asset and corresponding liability. The increase in the
liability, as discussed above, better depicts the fair value of the abandonment
of the asset. The adjustment itself is considered a change in estimate as
defined by FASB ASC Topic 250, "Accounting Changes and Error Corrections," which
requires disclosure in the financial statements.
(9) 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.
(10) Financial Instruments
The carrying amount of cash and cash equivalents, trade and insurance
receivables, trade payables and short-term borrowings approximate fair value
because of the short maturity of those instruments. The carrying amount of the
term note 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.
(11) Segments, Major Customers and Concentrations
All of the Company's operations are in the domestic U.S., including
the Gulf of Mexico in Texas and federal waters. The Company's management reviews
and evaluates the operations separately of the three main segments, Onshore
Operations, Offshore Operations, and Net Profits Interest. Each segment is an
aggregation of operations subject to similar economic and regulatory conditions
F-18
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
such that they are likely to have similar long-term prospects for financial
performance. Onshore Operations include natural gas gathering, transportation
and distribution activities in Texas. Offshore Operations include natural gas
and liquid hydrocarbon gathering and transportation activities in the Gulf of
Mexico in Texas and Louisiana as well as federal waters. Net Profits Interest
include the 9.1% net profits interest in the Madisonville Field. The principal
markets for the Onshore segment are affiliates of large intrastate and
interstate pipeline companies and industrial customers; and for the Offshore
segment they are affiliates of large intrastate and interstate pipeline
companies.
The accounting policies of the reportable segments are the same as
those described in Note 2 to the Consolidated Financial Statements. The Company
evaluates the segments based on operating margin, 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, which is its nearest comparable GAAP
financial measure, is included in the tables below.
Summarized financial information for the years indicated of the
Company's reportable segments from continuing operations:
Year Ended December 31,
-------------------------------------
2009 2008
---------------- -----------------
Onshore Operations
Revenues...................................................... $ 4,419,676 $ 12,373,321
Cost of natural gas purchased................................. 3,586,046 10,979,136
Operation and maintenance expense............................. 211,424 246,149
------------ ------------
Operating margin......................................... 622,206 1,148,036
General and administrative expense............................ 729,370 993,997
Depreciation, depletion and amortization expense.............. 150,935 194,455
------------ ------------
Operating loss........................................... (258,099) (40,416)
Interest expense.............................................. 3,165 6,030
Capital expenditures.......................................... 7,940 18,794
Total assets.................................................. $ 4,086,347 $ 4,510,918
Offshore Operations
Revenues...................................................... $ 2,293,298 $ 1,504,155
Operation and maintenance expense............................. 172,585 187,428
------------ ------------
Operating margin.......................................... 2,120,713 1,316,727
General and administrative expense............................ 1,560,773 1,416,921
Depreciation, depletion and amortization expense.............. 416,114 420,891
------------ ------------
Operating income (loss).................................. 143,826 (521,085)
Capital expenditures.......................................... 4,885 --
Total assets.................................................. $ 4,934,508 $ 9,139,741
Net Profits Interest
Revenues...................................................... $ (5,000) $ 5,000
------------ ------------
Operating margin.......................................... (5,000) 5,000
General and administrative expense............................ 109,967 1,638
Depreciation, depletion and amortization expense.............. 34,462 783
------------ ------------
Operating income (loss).................................. (149,429) 2,579
Capital expenditures.......................................... 15,515 --
Total assets.................................................. $ 666,237 $ 768,125
F-19
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Corporate Operations
General and administrative expense............................ $ 5,290 $ 11,489
Depreciation.................................................. 6,883 5,123
------------ ------------
Operating loss............................................ (12,173) (16,612)
Interest expense.............................................. 113,534 151,061
Capital expenditures.......................................... 6,846 10,564
Total assets.................................................. $ 3,408,822 $ 2,271,917
Total
Revenues...................................................... $ 6,707,974 $ 13,882,476
Cost of natural gas purchased................................. 3,586,046 10,979,136
Operation and maintenance expense............................. 384,009 433,577
------------ ------------
Operating margin......................................... 2,737,919 2,469,763
General and administrative expense............................ 2,405,400 2,424,045
Depreciation, depletion and amortization expense.............. 608,394 621,252
------------ ------------
Operating loss............................................ (275,875) (575,534)
Interest expense.............................................. 116,699 157,091
Capital expenditures.......................................... 35,186 29,358
Total assets.................................................. $ 13,095,914 $ 16,690,701
Reconciliation to Net Income
Operating margin.............................................. $ 2,737,919 $ 2,469,763
Less:
Depreciation, depletion and amortization expense.............. 608,394 621,252
General and administrative.................................... 2,405,400 2,424,045
Interest expense.............................................. 116,699 157,091
Income tax expense............................................ - 375,764
Non-controlling interest...................................... - 28,824
Plus:
Interest income............................................... 30,408 29,119
Other income (expense), net................................... (178,758) 1,731,155
Income tax benefit............................................ 159,157 --
Discontinued operations, net of taxes......................... (155,897) 194,480
Gain on sale of discontinued operations, net of taxes......... 318,180 --
------------ ------------
Net income (loss)............................................. $ (219,484) $ 817,541
============ ============
For the years ended December 31, 2009 and 2008, the Company purchased
natural gas from one supplier. 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%
The Company's natural gas pipeline operations have a diverse customer
base in natural gas transmission, distribution and various other industries.
This diversity of customers may reduce the Company's overall exposure to credit
risk since the variety of customers may not be similarly affected by the changes
in economic or other conditions. The Company's accounts receivable are not
collateralized. The Company believes that the loss of a major customer would not
have a material adverse effect on its financial position, results of operations
or cash flows because such customer could be replaced readily.
F-20
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(12) 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. As a result
of the sale, the Company recognized a pre-tax gain of $363,781.
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. 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:
Year Ended December 31,
---------------------------------------
2009 2008
------------------- -------------------
Operating revenues (1)........ $ 131,964 $ 750,110
Operating costs and
expenses (2)................. 337,359 432,652
Income (loss) from
discontinued operations,
net of taxes................. (155,897) 194,480
Gain (loss) on disposal of
discontinued operations,
net of taxes................. 318,180 --
Basic and diluted income
(loss) per share from
discontinued operations...... $ (0.01) $ --
Basic and diluted income
per share from gain on
disposal of discontinued
operations................... 0.02 0.01
----------- -----------
Total.......................... $ 0.01 $ 0.01
=========== ===========
Weighted average number of
common shares outstanding:
Basic....................... 19,303,488 19,126,587
Diluted..................... 19,303,488 19,330,409
(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.
F-21
GATEWAY ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(13) Subsequent Events
The Company acquired the Hickory Creek Gathering System from Hickory
Creek Gathering L.P. and Range Texas Production, LLC on January 10, 2010 for a
cash purchase price of $3.9 million, adjusted to reflect a transaction effective
date of November 1, 2009.
The Hickory Creek Gathering System is located in Denton County, Texas,
in the core area of the Barnett Shale and currently services two significant
producers. There are currently 15 producing wells connected to the system with
throughput of approximately 11,000 MMBtu per day at a fixed gathering fee for
each MMBtu transported. The purchase price has been paid by the Company
utilizing a combination of available cash and the Company's existing line of
credit.
F-22
