** **

**U. S. SECURITIES AND EXCHANGE COMMISSION**

**Washington, D. C. 20549**

 

** Form 10-QSB**

 

**ý**** QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THESECURITIES EXCHANGE ACT OF 1934**

 

                **For the quarterlyperiod ended September 30, 2001**

 

o**TRANSITIONREPORT UNDER SECTION 13 OR 15 (d) OF THE EXCHANGE ACT**

 

**For thetransition period from**

 __________**to**__________

 

 

**CommissionFile No. 1-4766**

 

 

**GATEWAY ENERGY CORPORATION**

(Exact name of smallbusiness issuer as specified in its charter)

 

 

| **Delaware**                              |   | **44-0651207**                        |
|-------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of          |   | (IRS Employer  Identification Number) |
| incorporation or  organization)           |   |                                  |
|                                      |   |                                  |
| **500 Dallas Street, Suite 2615**         |
| **Houston,  TX  77002**              |
| (Address of principal  executive offices) |

 

Issuer's telephone number: ** (713) 336-0844**

 

 

                Check whether theissuer (1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Exchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.  Yes ý Noo

 

APPLICABLE ONLY TOCORPORATE ISSUERS

 

                As of November 14,2001, the Issuer had 15,358,640 shares of its common stock outstanding.

 

Transitional Small Business Disclosure Format:  Yes oNo ý

 

**FORM 10-QSB**

**P****art  I**

** **

** **

 
| **Item  1.** | **Financial  Statements**                                                                                                               |
|-------------------|-----------------------------------------------------------------------------------------------------------------------------------------|
|              |                                                                                                                                    |
|              |                                                                                                                                    |
|              | Unaudited Consolidated  Balance Sheet as of September 30, 2001.                                                                         |
|              |
|              |                                                                                                                                    |
|              | Unaudited  Consolidated Statements of Operations for the three months and nine months  ended September 30, 2001 and September 30, 2000. |
|              |
|              |
|              |                                                                                                                                    |
|              | Unaudited Consolidated  Statements of Cash Flows for the nine months ended September 30, 2001 and  September 30, 2000.                  |
|              |
|              |
|              |                                                                                                                                    |
|              | Notes to  Consolidated Financial Statements                                                                                             |

                                  

 

**GATEWAY ENERGY CORPORATION AND SUBSIDIARIES****CONSOLIDATED BALANCE SHEET****September 30, 2001****(Unaudited)**

 
| **ASSETS**                                                                                                    |   |        |      |
|---------------------------------------------------------------------------------------------------------------|--------|-------------|-----------|
| Current Assets                                                                                                |   |        |      |
| Cash and cash equivalents                                                                                     |   | $           | 89,993    |   |
| Certificates of deposit                                                                                       |   | 671,164     |      |
| Trade accounts receivable                                                                                     |   | 1,185,713   |      |
| Note receivable – current portion                                                                        |   | 91,322      |      |
| Inventories                                                                                                   |   | 58,084      |      |
| Prepaid expenses and other assets                                                                             |   | 406,043     |      |
| Total current assets                                                                                          |   | 2,502,319   |      |
|                                                                                                          |   |        |      |
| Property and Equipment  - at cost                                                                        |   |        |      |
| Gas gathering, processing and  transportation                                                                 |   | 9,463,075   |      |
| Equipment and office furniture                                                                                |   | 669,830     |      |
|                                                                                                          |   | 10,132,905  |      |
| Less accumulated depreciation                                                                                 |   | 3,792,496   |      |
|                                                                                                          |   | 6,340,409   |      |
| Other Assets                                                                                                  |   |        |      |
| Notes receivable, less currrent portion                                                                       |   | 28,429      |      |
| Other                                                                                                         |   | 438,399     |      |
|                                                                                                          |   | 466,828     |      |
|                                                                                                          |   | $           | 9,309,556 |   |
| **LIABILITIES AND STOCKHOLDERS' EQUITY**                                                                      |   |        |      |
| Current Liabilities                                                                                           |   |        |      |
| Accounts payable                                                                                              |   | $           | 592,848   |   |
| Notes payable                                                                                                 |   | 617,001     |      |
| Current maturities of long-term debt                                                                          |   | 281,620     |      |
| Accrued expenses and other liabilities                                                                        |   | 153,285     |      |
| Total current liabilities                                                                                     |   | 1,644,754   |      |
|                                                                                                          |   |        |      |
| Long-term Debt, less current maturities                                                                       |   | 1,096,534   |      |
|                                                                                                          |   |        |      |
| 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; 15,358,640  shares issued and outstanding |   | 3,839,503   |      |
| Additional paid-in capital                                                                                    |   | 15,983,793  |      |
| Accumulated deficit                                                                                           |   | (13,255,028 | )         |
|                                                                                                          |   | 6,568,268   |      |
|                                                                                                          |   | $           | 9,309,556 |   |

The accompanying notes are an integral part of thisstatement.

## **GATEWAY ENERGY CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                   |   | **Three Months Ended  September 30,** |      | **Nine Months Ended  September 30,** |   |
|--------------------------------------------------------|--------|---------------------------------------|-----------|--------------------------------------|--------|
|                                                   |   | **2001**                              |      | **2000**                             |   | **2001** |   | **2000** |   |
| Operating  revenues                                    |   |                                  |      |                                 |   |   |   |   |   |
| Natural gas  sales                                     |   | $                                     | 2,408,804 |                                 | $      | 3,099,495 |   | $ | 8,726,349 |   | $ | 6,192,398 |   |
| Transportation and processing                          |   | 258,508                               |      | 102,737                              |   | 717,374 |   | 300,012 |   |
| Other                                                  |   | 134,260                               |      | 23,657                               |   | 396,358 |   | 68,502 |   |
|                                                   |   | 2,801,572                             |      | 3,225,889                            |   | 9,840,081 |   | 6,560,912 |   |
| Operating costs  and expenses                          |   |                                  |      |                                 |   |   |   |   |   |
| Cost of natural gas purchased                          |   | 1,724,111                             |      | 2,435,156                            |   | 7,215,861 |   | 4,989,940 |   |
| Operation and maintenance                              |   | 303,307                               |      | 207,513                              |   | 930,017 |   | 706,009 |   |
| Depreciation and amortization                          |   | 179,896                               |      | 171,796                              |   | 524,658 |   | 514,333 |   |
| Dry hole cost                                          |   | -                                     |      | -                                    |   | 89,940 |   | - |   |
| General and  administrative                            |   | 403,010                               |      | 519,876                              |   | 1,396,859 |   | 1,391,120 |   |
|                                                   |   | 2,610,324                             |      | 3,334,341                            |   | 10,157,335 |   | 7,601,402 |   |
| Operating income (loss)                                |   | 191,248                               |      | (108,452                             | )      | (317,254 | ) | (1,040,490 | ) |
|                                                   |   |                                  |      |                                 |   |   |   |   |   |
| Other income  (expense)                                |   |                                  |      |                                 |   |   |   |   |   |
| Interest income                                        |   | 10,959                                |      | 11,708                               |   | 34,930 |   | 41,776 |   |
| Interest expense                                       |   | (79,884                               | )         | (34,158                              | )      | (185,400 | ) | (101,182 | ) |
| Equity in earnings of partnership                      |   | -                                     |      | 26,790                               |   | - |   | 68,860 |   |
| Other income  (loss), net                              |   | (6,881                                | )         | 190                                  |   | 24,541 |   | 275,864 |   |
|                                                   |   | (75,806                               | )    | 4,530                                |   | (125,929 | )  | 285,318 |   |
| Net income  (loss)                                     |   | $                                     | 115,442   |                                 | $      | (103,922 | ) | $ | (443,183 | ) | $ | (755,172 | ) |
|                                                   |   |                                  |      |                                 |   |   |   |   |   |
|                                                   |   |                                  |      |                                 |   |   |   |   |   |
| Basic and  diluted income (loss) per share             |   | $                                     | 0.01      |                                 | $      | (0.01 | ) | $ | (0.03 | ) | $ | (0.05 | ) |
|                                                   |   |                                  |      |                                 |   |   |   |   |   |
| Weighted average number of common shares  outstanding: |   |                                  |      |                                 |   |   |   |   |   |
| Basic                                                  |   | 15,358,640                            |      | 15,312,172                           |   | 15,331,891 |   | 15,312,195 |   |
| Diluted                                                |   | 15,465,860                            |      | 15,314,472                           |   | 15,427,229 |   | 15,312,195 |   |

 

 

 

The accompanying notesare an integral part of these statements.

 

 

 

** **

**GATEWAY ENERGY CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

** **

** **
|                                                                         |   | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------|--------|-------------------------------------|------------|
|                                                                         |   | **2001**                            | ** ** | **2000** | ** ** |
| **INCREASE (DECREASE) IN CASH AND CASH****EQUIVALENTS**                      |   |                                |       |   |   |
|                                                                         |   |                                |       |   |   |
| Cash flows from operating activities                                         |   |                                |       |   |   |
| Net loss                                                                     |   | $                                   | (443,183   | ) | $ | (755,172 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                                |       |   |   |
| Equity in undistributed earnings of  partnerships                            |   | -                                   |       | (7,763 | ) |
| Depreciation and amortization                                                |   | 524,658                             |       | 514,333 |   |
| Gain on sale of properties                                                   |   | (2,500                              | )          | (170,034 | ) |
| Stock option compensation expense                                            |   | 4,515                               |       | 86,036 |   |
| Non-cash expenses, net                                                       |   | 20,753                              |       | 42,191 |   |
| Net change in cash and cash equivalents,  resulting from changes in:         |   |                                |       |   |   |
| Trade accounts receivable                                                    |   | 642,169                             |       | (613,701 | ) |
| Inventories                                                                  |   | 1,708                               |       | (10,724 | ) |
| Prepaid expenses and other current assets                                    |   | (256,176                            | )          | (76,104 | ) |
| Accounts payable                                                             |   | (1,036,951                          | )          | 611,839 |   |
| Accrued expenses and other liabilities                                       |   | 49,965                              |       | (252,414 | ) |
| Net cash used in operating activities                                        |   | (495,042                            | )          | (631,513 | ) |
|                                                                         |   |                                |       |   |   |
| Cash flows from investing activities                                         |   |                                |       |   |   |
| Capital expenditures                                                         |   | (643,142                            | )          | (209,693 | ) |
| Additional investment in AET license                                         |   | (90,000                             | )          | - |   |
| Proceeds from sale of properties                                             |   | 2,500                               |       | 909,589 |   |
| Decrease in certificates of deposit                                          |   | 20,223                              |       | 282,153 |   |
| Net cash (used in) provided by investing  activities                         |   | (710,419                            | )          | 982,049 |   |
|                                                                         |   |                                |       |   |   |
| Cash flows from financing activities                                         |   |                                |       |   |   |
| Proceeds from borrowings                                                     |   | 1,988,827                           |       | 330,000 |   |
| Payments on borrowings                                                       |   | (864,110                            | )          | (628,119 | ) |
| Retirement of common stock                                                   |   | (630                                | )          | - |   |
| Net cash provided by (used in) financing  activities                         |   | 1,124,087                           |       | (298,119 | ) |
|                                                                         |   |                                |       |   |   |
| Net (decrease) increase in cash and cash  equivalents                        |   | (81,374                             | )          | 52,417 |   |
| Cash and cash equivalents at beginning of  period                            |   | 171,367                             |       | 26,089 |   |
|                                                                         |   |                                |       |   |   |
| Cash and cash equivalents at end of period                                   |   | $                                   | 89,993     |   | $ | 78,506 |   |

 

The accompanyingnotes are an integral part of these statements.

**GATEWAY ENERGY CORPORATIONAND SUBSIDIARIES**

## **NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

(1)           Principlesof Consolidation and Nature of Business

 

The consolidated financial statements include theaccounts of Gateway Energy Corporation and its wholly owned subsidiarycompanies, Gateway Pipeline Company, Gateway Offshore Pipeline Company, GatewayEnergy Marketing Company, Fort Cobb Fuel Authority, L.L.C. and GatewayProcessing Company, plus a small amount of activity in one joint venture.  Based on its ownership, the Companyproportionally consolidates its joint venture interest.  All significant intercompany transactionshave been eliminated in consolidation.

 

                The accompanying consolidatedfinancial statements have been prepared by the Company, without audit.  In the opinion of management, such financialstatements reflect all adjustments necessary for a fair presentation of thefinancial position and results of operations in accordance with generallyaccepted accounting principles. The financial statements should be read inconjunction with the financial statements and the Notes thereto included in theCompany's Annual Report on Form 10-KSB for the year ended December 31, 2000.

 

The Company owns and operates natural gas gathering,transportation and distribution systems and related facilities in Texas,Oklahoma and Louisiana, and offshore in Texas and federal waters of the Gulf ofMexico.  The Company also operates anatural gas distribution company in Oklahoma.

 

                (2)           Earnings Per Share

 

                Basic earnings per share iscomputed by dividing net earnings or loss by the weighted average number ofcommon shares outstanding during the period. Diluted earnings per share is computed by dividing net earnings or lossby the weighted average number of shares outstanding, after giving effect topotentially dilutive common share equivalents outstanding during the period.  Potentially dilutive common shareequivalents are not included in the computation of diluted earnings per shareif they are anti-dilutive.  For thethree-month and nine-month periods ended September 30, 2001 and 2000, thediluted loss per common share is the same as basic since the effect ofpotentially dilutive common shares arising from outstanding stock options andwarrants was either immaterial or anti-dilutive.

 

                The Company issued 46,512 sharesof common stock to its directors in May 2001 as part of their annualcompensation.

 

(3)           Dry Hole Cost

 

During the firstquarter of the year, Gateway Processing Company participated as a non-operatingworking interest owner in the drilling of a natural gas well on a prospect inthe Sacramento Basin, California.  The wellwas expected to yield high-nitrogen natural gas reserves and employ theCompany’s licensed nitrogen rejection process to meet pipeline qualityspecifications.  The well was determinedto be uneconomic and was abandoned.  Theaccompanying consolidated statement of operations for the nine months endedSeptember 30, 2001 includes an impairment charge against earnings of $89,940reflecting the abandonment of this project.

##  

                (4)           Notes Payable

 

                The Company has anoperating line of credit with a bank that provides for maximum borrowings of$500,000 through June 20, 2003. Interest is payable monthly at 5.3% per year and principal is due ondemand, or if no demand is made, at maturity. The line is collateralized by a $500,000 certificate of deposit.

 

Effective June 1, 2001, Fort Cobb entered into arevolving credit agreement with a bank for borrowings up to $250,000.  Principal outstanding under the revolveraccrues interest at a variable rate, based on the bank’s prime rate index plus1.25%, with a minimum rate of 8%.  Thebalance under the revolver is due upon demand, or if no demand is made, atmaturity at June 1, 2002, and is renewable annually.  Costs of obtaining this debt totaled $4,932 and are being chargedto interest expense ratably over the maturity period of the note.  Fort Cobb will use the proceeds for generalworking capital purposes.  The agreementis collateralized with the assets of Fort Cobb, and the Company has guaranteedthe loan.

 

(5)           Long-term Debt

 

                Long-term debt as of September 30, 2001 consists ofthe following:

 
| Term note                |   | $         | 742,043   |   |
|--------------------------|--------|-----------|-----------|--------|
| Subordinated notes       |   | 636,111   |      |
|                     |   | 1,378,154 |      |
| Less current  maturities |   | 281,620   |      |
|                     |   | $         | 1,096,534 |   |

 

                Effective June 1,2001, Fort Cobb borrowed $750,000 from a bank. Principal outstanding under the note accrues interest at a variablerate, based on the bank’s prime rate index plus 1.25%, with a minimum rate of8%.  The note requires monthly paymentsranging from $7,500 to $13,008, with the balance under the note due June 1,2008.  Costs of obtaining this debttotaled $14,795 and are being charged to interest expense ratably over thematurity period of the note.  Fort Cobbused the proceeds to refinance its borrowings from the Company, and the Companywill use the proceeds for general corporate purposes.  Future maturities under the loan are as follows:

 
| 2001       |   | $       | 30,000 |   |
|------------|--------|---------|--------|--------|
| 2002       |   | 97,407  |   |
| 2003       |   | 105,492 |   |
| 2004       |   | 114,248 |   |
| 2005       |   | 123,730 |   |
| Thereafter |   | 279,123 |   |
|            |        |         |        |        |  |

##  

(6)           Commitmentsand Contingencies

 

                                On June 18,2001, the Company announced that Gateway Processing Company entered into along-term agreement with a producer to purchase non-pipeline quality naturalgas near Madisonville, Texas. Concurrently, Gateway Processing entered into an agreement with HanoverCompression Limited Partnership, an affiliate of The Hanover Company, underwhich Hanover will treat the gas to remove impurities from the gas to enablethe gas to meet pipeline quality sales specifications.

 

                Of significance toGateway, Hanover will employ the state-of-the-art, patented, absorption basedtechnology developed by Advanced Extraction Technologies, Inc. (“AET”), forwhich Gateway has the exclusive U.S. license, to remove the nitrogen from thegas.

 

                Hanover'sfacilities, designed initially to treat 18,000 Mcf per day, and the eight-inchpipeline to be installed by Gateway Pipeline Company to transport the treatedresidue gas are expected to be on stream during the first quarter of nextyear.  The Company expects its capitalcommitment in this project to be approximately $1.3 million.

 

                The Company’scontingent obligation under a note agreement entered into in conjunction withits acquisition of a pipeline system has been settled.  The required asset performance goals wereachieved and the Company paid $601,333, including $78,333 of interest, duringthe nine months ended September 30, 2001. Accordingly, the carrying value of the pipeline system was increased$523,000 in the accompanying balance sheet.

 

(7)           New Accounting Pronouncements

 

In June 2001, theFinancial Accounting Standards Board (“FASB”) issued Statement on FinancialAccounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”,which eliminates amortization of goodwill and requires that goodwill and otherintangible assets be presented at “fair value” and be periodically assessed forimpairment.  This statement is effectivefor fiscal years beginning after December 15, 2001 and the Company willimplement it for the year ending December 31, 2002.  The impact of adopting this statement on the consolidatedfinancial position or results of operations is not expected to be material.

 

In June 2001, the FASB issued SFAS No. 143,“Accounting for Asset Retirement Obligations”, which requires that the fairvalue of the liability for asset retirement costs be recognized in an entity’sbalance sheet, as both a liability and an increase in the carrying values ofsuch assets, in the periods in which such liabilities can be reasonablyestimated.  It also requires allocationof such asset retirement cost to expense over its useful life.  This statement is effective for fiscal yearsbeginning after June 15, 2002 and the Company will implement it for the yearending December 31, 2003.  The Companyhas not yet determined the impact of this statement on its consolidated financialposition or results of operations.

 

##  

In August 2001, the FASB issued SFAS No. 144,“Accounting for the Impairment or Disposal of Long-lived Assets”, which setsnew standards for periodically assessing long-lived assets to determine if thecarrying costs are recoverable from estimated future cash flows.  This statement is effective for fiscal yearsbeginning after December 15, 2001 and the Company will implement it for theyear ending December 31, 2002.  Theimpact of adopting this statement on the consolidated financial position orresults of operations is not expected to be material.

 

**(8)           Segment Disclosures**

 

                Summarized financial information of the Company’sreportable segments, and a reconciliation of operating margin to consolidatednet income (loss), for the three months and nine months ended September 30,2001 and 2000 are presented below. Operating margin is defined by the Company as total revenues less costof natural gas purchased less operation and maintenance expenses:

 

 
|                                     |   | **Three  Months Ended** |       | **Nine Months Ended** |       |
|------------------------------------------|--------|-------------------------|------------|-----------------------|------------|
|                                     |   | **September 30,**       |       | **September 30,**     |       | **September 30,** |   | **September 30,** |   |
|                                     |   | **2001**                |       | **2000**              |       | **2001** |   | **2000** |   |
|                                     |   |                    | ** ** |                  | ** ** |   | ** ** |   | ** ** |
| **Onshore  Operations**                  |   |                    |       |                  |       |   |   |   |   |
| Revenues                                 |   | $                       | 1,427,694  |                  | $          | 1,936,485 |   | $ | 6,810,216 |   | $ | 4,708,319 |   |
| Operating margin                         |   | 214,673                 |       | 335,069               |       | 764,092 |   | 726,812 |   |
| Total assets                             |   | 3,844,254               |       | 4,000,579             |       | 3,844,254 |   | 4,000,579 |   |
|                                     |   |                    |       |                  |       |   |   |   |   |
| **Offshore  Operations**                 |   |                    |       |                  |       |   |   |   |   |
| Revenues                                 |   | 330,379                 |       | 67,157                |       | 902,316 |   | 179,713 |   |
| Operating margin                         |   | 211,499                 |       | (6,927                | )          | 519,360 |   | (76,090 | ) |
| Total assets                             |   | 1,926,900               |       | 1,819,342             |       | 1,926,900 |   | 1,819,342 |   |
|                                     |   |                    |       |                  |       |   |   |   |   |
| **Fort  Cobb Operations**                |   |                    |       |                  |       |   |   |   |   |
| Revenues                                 |   | 1,043,499               |       | 1,222,247             |       | 2,127,549 |   | 1,672,880 |   |
| Operating margin                         |   | 347,982                 |       | 255,078               |       | 410,751 |   | 214,241 |   |
| Total assets                             |   | 2,569,514               |       | 2,931,842             |       | 2,569,514 |   | 2,931,842 |   |
|                                     |   |                    |       |                  |       |   |   |   |   |
| **Corporate**                            |   |                    |       |                  |       |   |   |   |   |
| Total assets                             |   | 968,888                 |       | 919,133               |       | 968,888 |   | 919,133 |   |
|                                     |   |                    |       |                  |       |   |   |   |   |
| **Total**                                |   |                    |       |                  |       |   |   |   |   |
| Revenues                                 |   | 2,801,572               |       | 3,225,889             |       | 9,840,081 |   | 6,560,912 |   |
| Operating margin                         |   | 774,154                 |       | 583,220               |       | 1,694,203 |   | 864,963 |   |
| Total assets                             |   | 9,309,556               |       | 9,670,896             |       | 9,309,556 |   | 9,670,896 |   |
|                                     |   |                    |       |                  |       |   |   |   |   |
| **Reconciliation  to net income (loss)** |   |                    |       |                  |       |   |   |   |   |
| Operating margin                         |   | 774,154                 |       | 583,220               |       | 1,694,203 |   | 864,963 |   |
| Depreciation and  amortization           |   | 179,896                 |       | 171,796               |       | 524,658 |   | 514,333 |   |
| Dry hole cost                            |   | -                       |       | -                     |       | 89,940 |   | - |   |
| General &  administrative            |   | 403,010                 |       | 519,876               |       | 1,396,859 |   | 1,391,120 |   |
| Other income  (loss)                     |   | (75,806                 | )          | 4,530                 |       | (125,929 | ) | 285,318 |   |
| Net income  (loss)                       |   | 115,442                 |       | (103,922              | )          | (443,183 | ) | (755,172 | ) |
|                                          |        |                         |            |                       |            |  |  |  |  |  |  |  |  |

 

 

(9)           Supplemental Disclosures of Cash FlowInformation

** **

**                Cash paid for interest was$122,737 and $81,841 during the nine months ended September 30, 2001 and 2000.**

**Item 2.    Management's Discussion and Analysis of Financial Conditionand**

**                                  Resultsof Operations.**

 

**               **The following management's discussion andanalysis contains trend analysis and other forward-looking statements withinthe meaning of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended.  Actual results could differ materially fromthose projected in the forward-looking statements throughout this document as aresult of the risk factors set forth below in the section entitled *FactorsAffecting Future Results* and elsewhere in this document.

 

**Results of Operations**

 

***General***

 

The Company evaluates each of its activities based onthe operating margin it produces.  TheCompany defines operating margin as revenues, less the cost of purchased gasand operating and maintenance expenses. Management reviews and evaluates the operations of three main segments –Onshore operations, Offshore operations and Fort Cobb operations.  The Company continues to actively pursueopportunities in all three segments.

 

# **Three Months Ended September 30, 2001Compared to September 30, 2000**

 

# *Total Operations*

 

The following table sets forth information for thethree months ended September 30, 2001 and 2000:

 
|                           |   | **2001** | ** ** | **2000** | ** ** |
|--------------------------------|--------|----------|------------|----------|------------|
| Revenues                       |   | $        | 2,801,572  |     | $          | 3,225,889 |   |
| Operating  margins             |   | 774,154  |       | 583,220  |       |
| Depreciation and  amortization |   | 179,896  |       | 171,796  |       |
|                                |        |          |            |          |            |  |  |

 

Operating marginsfor the three months ended September 30, 2001 increased by $191,000 compared tothe same period of the prior year.  Theincreases in Offshore operating margins of $218,000 and Fort Cobb operating marginsof $93,000 were partially offset by a decline in Onshore operating margins of$120,000.  These segments are discussedindividually below in greater detail.

 

# *Onshore Operations*

 

The following table sets forth information for thethree months ended September 30, 2001 and 2000:

 
|                           |   | **2001** | ** ** | **2000** | ** ** |
|--------------------------------|--------|----------|------------|----------|------------|
| Revenues                       |   | $        | 1,427,694  |     | $          | 1,936,485 |   |
| Operating  margins             |   | 214,673  |       | 335,069  |       |
| Depreciation and  amortization |   | 95,293   |       | 95,123   |       |
|                                |        |          |            |          |            |  |  |

 

Operating margins for Onshore operations decreased inthe third quarter by $120,000 from the same period of the prior year.  The decrease was due to reductions inthroughput volumes on several systems with relatively higher margins, partiallyoffset by additional volumes on several systems with relatively lower margins.

 

# *Offshore Operations*

 

The following table sets forth information for thethree months ended September 30, 2001 and 2000:

 
|                           |   | **2001** | ** ** | **2000** | ** ** |
|--------------------------------|--------|----------|------------|----------|------------|
| Revenues                       |   | $        | 330,379    |     | $          | 67,157 |   |
| Operating  margins             |   | 211,499  |       | (6,927   | )          |
| Depreciation and  amortization |   | 35,114   |       | 35,198   |       |
|                                |        |          |            |          |            |  |  |

 

Operating margins for Offshore operations increased inthe third quarter by $218,000 over the same period of the prior year.  The increase was primarily due to theadditional natural gas and liquids volumes transported for producers in thearea of Galveston Blocks 144L, 190L and 213L, and High Island Block 98L.

 

# *Fort Cobb Operations*

 

The following table sets forth information for thethree months ended September 30, 2001 and 2000:

 
|                           |   | **2001** | ** ** | **2000** | ** ** |
|--------------------------------|--------|----------|------------|----------|------------|
| Revenues                       |   | $        | 1,043,499  |     | $          | 1,222,247 |   |
| Operating  margins             |   | 347,982  |       | 255,078  |       |
| Depreciation and  amortization |   | 49,489   |       | 41,475   |       |
|                                |        |          |            |          |            |  |  |

 

Operating margins for Fort Cobb operations increasedin the third quarter by $93,000 from the same period of the prior year dueprimarily to the impact of the utility’s new rates which became effective inDecember 2000, partially offset by lower sales volumes.

 

# *Operations Support*

 

The following table sets forth information for thethree months ended September 30, 2001 and 2000:

 
|                               |   | **2001** | ** ** | **2000** | ** ** |
|------------------------------------|--------|----------|------------|----------|------------|
| General and  administrative        |   | $        | 403,010    |     | $          | 519,876 |   |
| Interest income                    |   | 10,959   |       | 11,708   |       |
| Interest expense                   |   | (79,884  | )          | (34,158  | )          |
| Equity in  earnings of partnership |   | -        |       | 26,790   |       |
| Other income  (expense), net       |   | (6,881   | )          | 190      |       |
|                                    |        |          |            |          |            |  |  |

 

General and administrative expenses for the quarterare 22% lower than for the same period of last year, due primarily to thenon-cash impact of the revaluation of employee stock options that were repricedin 1999, partially offset by higher employee costs and legal expenses.  Under the Financial Accounting StandardsBoard Interpretation 44, *Interpretation of APB Opinion 25*, theCompany is required to account for these options under variable awardaccounting, due to the change in the option exercise price.  Variable award accounting requiresrecognition of compensation expense (or income) under certain circumstances whenthe market price of the Company’s stock exceeds the exercise price of the stockoption.

 

Interestincome varies directly with the balance on deposit in the Company’scertificates of deposit and short-term money market accounts.

 

Interest expense for the three months ended September30, 2001 includes $35,000 of interest related to the settlement of thecontingent obligation under a note agreement entered into to acquire a pipelinesystem.  Otherwise, it fluctuates directlywith the amount of outstanding long-term debt and the amount of borrowingsunder the Company’s operating bank lines of credit.

 

Equity in earnings of partnership for the prior yearrelates to a partnership that was sold effective October 31, 2000.

#  

# **Nine Months Ended September 30, 2001Compared to September 30, 2000**

 

# *Total Operations*

 

The following table sets forth information for thenine months ended September 30, 2001 and 2000:

 
|                           |   | **2001**  | ** ** | **2000** | ** ** |
|--------------------------------|--------|-----------|------------|----------|------------|
| Revenues                       |   | $         | 9,840,081  |     | $          | 6,560,912 |   |
| Operating  margins             |   | 1,694,203 |       | 864,963  |       |
| Depreciation and  amortization |   | 524,658   |       | 514,333  |       |
|                                |        |           |            |          |            |  |  |

 

Operating margins for the nine months ended September30, 2001 increased by $829,000 compared to the same period of the prioryear.  Offshore, Fort Cobb and OnshoreOperations operating margins increased $595,000, $197,000 and $37,000,respectively. These segments are discussed individually below in greaterdetail.

#  

# *Onshore Operations*

 

The following table sets forth information for thenine months ended September 30, 2001 and 2000:

 
|                           |   | **2001** | ** ** | **2000** | ** ** |
|--------------------------------|--------|----------|------------|----------|------------|
| Revenues                       |   | $        | 6,810,216  |     | $          | 4,708,319 |   |
| Operating  margins             |   | 764,092  |       | 726,812  |       |
| Depreciation and  amortization |   | 271,788  |       | 287,864  |       |
|                                |        |          |            |          |            |  |  |

 

Operating margins for Onshore Operations increased$37,000 in the nine months ended September 30, 2001 from the same period of theprior year.  The increase was due toincreased throughput volumes on several of the Company’s onshore systems.

 

# *Offshore Operations*

 

The following table sets forth information for thenine months ended September 30, 2001 and 2000:

 
|                           |   | **2001** | ** ** | **2000** | ** ** |
|--------------------------------|--------|----------|------------|----------|------------|
| Revenues                       |   | $        | 902,316    |     | $          | 179,713 |   |
| Operating  margins             |   | 519,360  |       | (76,090  | )          |
| Depreciation and  amortization |   | 104,551  |       | 101,298  |       |
|                                |        |          |            |          |            |  |  |

 

Operating margins for Offshore Operations increased$595,000 in the nine months ended September 30, 2001 from the same period ofthe prior year.  The increase wasprimarily due to the additional natural gas and liquids volumes transported forproducers in the area of Galveston Blocks 144L, 190L and 213L, and High IslandBlock 98L.

 

# *Fort Cobb Operations*

 

The following table sets forth information for thenine months ended September 30, 2001 and 2000:

 
|                           |   | **2001** | ** ** | **2000** | ** ** |
|--------------------------------|--------|----------|------------|----------|------------|
| Revenues                       |   | $        | 2,127,549  |     | $          | 1,672,880 |   |
| Operating  margins             |   | 410,751  |       | 214,241  |       |
| Depreciation and  amortization |   | 148,319  |       | 125,171  |       |
|                                |        |          |            |          |            |  |  |

 

Operating marginsfor Fort Cobb Operations increased by $197,000 in the nine months endedSeptember 30, 2001 from the same period of the prior year due primarily to theimpact of the utility’s new rates which became effective in December 2000,partially offset by lower sales volumes.

 

# *Operations Support*

 

The following table sets forth information for thenine months ended September 30, 2001 and 2000:

 
|                               |   | **2001** | ** ** | **2000** | ** ** |
|------------------------------------|--------|----------|------------|----------|------------|
| General and  administrative        |   | $        | 1,396,859  |     | $          | 1,391,120 |   |
| Interest income                    |   | 34,930   |       | 41,776   |       |
| Interest expense                   |   | (185,400 | )          | (101,182 | )          |
| Equity in  earnings of partnership |   | -        |       | 68,860   |       |
| Other income,  net                 |   | 24,541   |       | 275,864  |       |
|                                    |        |          |            |          |            |  |  |

 

General and administrative expenses for the ninemonths ended September 30, 2001 were virtually unchanged compared to the sameperiod of the prior year.  A decreasedue primarily to the non-cash impact of the revaluation of employee stockoptions that were repriced in 1999 was virtually offset by higher legal andoffice expenses.  Under the FinancialAccounting Standards Board Interpretation 44, *Interpretation of APB Opinion 25*,the Company is required to account for these options under variable awardaccounting, due to the change in the option exercise price.  Variable award accounting requiresrecognition of compensation expense (or income) under certain circumstanceswhen the market price of the Company’s stock exceeds the exercise price of thestock option.

 

                Interest incomevaries directly with the balance on deposit in the Company’s certificates ofdeposit and short-term money market accounts.

 

Interest expense for the three months ended September30, 2001 includes $78,000 of interest related to the settlement of thecontingent obligation under a note agreement entered into to acquire a pipelinesystem.  Otherwise, it fluctuates directlywith the amount of outstanding long-term debt and the amount of borrowingsunder the Company’s operating bank lines of credit.

 

Equity in earnings of partnership for the prior yearrelates to a partnership that was sold effective October 31, 2000.

 

                Other income forthe nine months ended September 30, 2000 includes gain on the sales of Catarinaand Zwolle systems and an adjustment to legal fees recognized in prior periods.

 

## **Liquidityand Capital Resources**

 

Net cash used in operating activities totaled $495,000for the nine months ended September 30, 2001, compared to $632,000 used inoperating activities for the same period last year.  The change was due to the increase in operating margins betweenthe two periods which is discussed by segment in the preceding section,partially offset by changes in current asset and liability accounts of $258,000and lower other income.

 

                The Company hadcash and cash equivalents and certificates of deposit totaling $761,000 atSeptember 30, 2001.  During the ninemonths ended September 30, 2001, the Company paid $601,000, including $78,000of interest, to settle the contingent liability related to its acquisition of apipeline system, and $90,000 to maintain the exclusive nature of its licensefor nitrogen rejection technology from AET, the owner of the patents.  During the prior period the Company received$910,000 in proceeds for the January 2000 sales of its interests in theCatarina and Zwolle systems.

 

The Company’s operating line of credit agreement witha bank provides for maximum borrowings of $500,000, through June 20, 2003, andis collateralized with a certificate of deposit for the same amount.  The available borrowing capacity as ofSeptember 30, 2001 was $18,000.  EffectiveJune 1, 2001, Fort Cobb borrowed $750,000 from a bank to refinance borrowings.  Principal outstanding under the term loanaccrues interest at a variable rate, based on the bank’s prime rate index plus1.25%, with a minimum rate of 8%.  Thebalance under the term loan is due June 1, 2008.  Fort Cobb also entered into a revolving credit agreement with abank for borrowings up to $250,000.  AtSeptember 30, 2001, there was $115,000 available under the agreement.  The balance under the revolving credit agreementis due upon demand, or if no demand is made, at maturity at June 1, 2002, andis renewable annually.  The term loanand the revolving credit agreement are collateralized with the assets of FortCobb, and the Company has guaranteed the loans.

 

As discussed in Note 6 tothe financial statements, Gateway Processing Company entered into long-termagreements with a producer and with Hanover Compression Limited Partnership, anaffiliate of The Hanover Company, under which the Company expects to investapproximately $1.3 million.  The fundsfor this commitment are expected to come from outside financing.

 

At September 30, 2001, the Company’s long-term debt tototal capitalization was approximately 14%, which should allow opportunity forthe Company to utilize conventional long-term financing to fund acquisitions orconstruction projects.

 

                Absent significantacquisitions or development projects, the Company will continue to fund itsoperations through internally generated funds and available cash and thecertificates of deposit.  The Companybelieves its cash flows from operations and available cash and certificates ofdeposit will be sufficient to fund its ongoing operations for the foreseeablefuture.  Any significant propertyacquisitions or development projects will require outside project financing.

 

**FactorsAffecting Future Results**

 

                The Company’s strategies forenhancing stockholder value include, among other things: (i) focusing ongathering, transporting, distributing and treating natural gas; (ii) expandingthe Company’s asset base in core geographic areas; (iii) participating in thedevelopment of sub-quality natural gas reserves to create demand for theCompany’s services, and; (iv) acquiring or constructing properties in one ormore new core areas.

 

The Company must provideservices to its customers, primarily producers, at competitive prices.Therefore, in order to be successful the Company must contain its costs in linewith industry competitors. The Company's access to reasonably priced long-termcapital will have a significant effect on its ability to acquire additional propertiesto increase operating margins sufficiently to cover its fixed overhead costs.The Company believes that its low debt, available cash reserves and experiencedoperating management will allow the Company to access capital and findproperties which can provide attractive returns. However, there can be noassurance that the Company will be successful in this endeavor.

 

The Company’s ability togenerate long-term value for the common stockholder is dependent upon theenhancement of its core assets and the successful acquisition or development ofadditional midstream assets. There are many companies participating in themidstream segment of the natural gas industry, many with resources greater thanthe Company. Greater competition for profitable operations can increase pricesand make it more difficult to acquire assets at reasonable multiples of cashflow.  The Company believes that it willbe able to compete in this environment and will be able to find attractive investmentswhich compliment its existing properties; however, it is not possible topredict competition or the effect this will have on the Company's operations.

 

                The Company's operations arealso significantly affected by factors which are outside the control of theCompany. Gas gathering and treating is dependent on throughput volume.Throughput on the Company's systems is significantly dependent on natural gasproduction which is affected by natural gas prices as prices affect thewillingness of producers to invest the required capital to obtain geologicaland geophysical information, drill development or exploratory wells, and torework or maximize production on existing wells. Natural gas prices are atlevels which should provide adequate incentive to producers; however, there isno assurance that such prices will remain at current levels, and that producerswill continue to react positively to the current prices.

 

                The Company's revenues,particularly from its distribution operations, are also affected by weather.Much of the distribution demand is for crop irrigation and drying. Heavyprecipitation in the spring and summer growing season and hot, dry weather inthe fall can significantly reduce demand for natural gas in the Company’sdistribution service areas.

 

**PartII**

 
| **Item  1.** |   | **Legal  Proceedings**                                   |
|--------------|--------|----------------------------------------------------------|
| None         |
|         |   |                                                     |
| **Item  2.** |   | **Changes  in Securities**                               |
|         |   | None                                                     |
|         |   |                                                     |
| **Item  3.** |   | **Defaults  Upon Senior Securities**                     |
|         |   | None                                                     |
|         |   |                                                     |
| **Item  4.** |   | **Submission  of Matters to a Vote of Security Holders** |
|         |   | None                                                     |
|         |   |                                                     |
| **Item  5.** |   | **Other  Information**                                   |
|         |   | None                                                     |
|         |   |                                                     |
| **Item  6.** |   | **Exhibits  and Reports on Form 8-K.**                   |
|         |   | a)                                                       | Exhibits: |   |
|         |   |                                                     | 10(b)(3) | Employment Agreement with Michael T. Fadden. |
|         |   |                                                     | 10(b)(4) | Employment Agreement with Scott D. Heflin. |
|         |   |                                                     | 11 | Statement Regarding Computation of Per Share  Earnings |
|         |   |                                                     |
|         |   | b)                                                       | Reports on Form 8-K: |
|         |   |                                                     | August 16, 2001 – Changes in Registrant’s Certifying  Accountant |
|         |   |                                                     |   |   |   |   |
|              |        |                                                          |  |  |  |  |  |

 

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15 (d)of the Securities Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
|              |   | GATEWAY ENERGY CORPORATION            |
|-------------------|--------|---------------------------------------|
|              |   |                                  |
|              |   | /s/ Michael T. Fadden                 |
|              |   | President and Chief Executive Officer |
|              |   |                                  |
|              |   |                                  |
|              |   | /s/ Scott D. Heflin                   |
|              |   | Chief Financial Officer and Treasurer |
| November 14, 2001 |   |                                  |
| (Date)            |   |                                  |