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

**Washington, D. C. 20549**

 

**Form 10-QSB**

 

| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|-----------------------------------------------------------------------------------------------|

** **

**For thequarterly period ended March 31, 2002**

 

| o | **TRANSITION REPORT 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 incorporation or organization) | (IRS Employer  Identification Number) |

##  

## **500 Dallas Street, Suite 2615**

**Houston,TX  77002**

(Address of principalexecutive offices)

 

**(713)336-0844**

Issuer’s telephone number

 

 

                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  No o

 

APPLICABLE ONLY TOCORPORATE ISSUERS

 

                As of May 7, 2002,the Issuer had 15,354,880 shares of its common stock outstanding.

 

Transitional Small Business Disclosure Format:  Yes  o   No ý

 

 

----

**FORM 10-QSB**

**Part  I**

** **

** **

** **
| **Item  1.** | **Financial  Statements**                                                                                       |   |
|-------------------|-----------------------------------------------------------------------------------------------------------------|--------|
|              |                                                                                                            |
|              | Unaudited Consolidated  Balance Sheet as of March 31, 2002.                                                     |
|              |                                                                                                            |
|              | Unaudited  Consolidated Statements of Operations for the three months ended March 31,  2002 and March 31, 2001. |
|              |                                                                                                            |
|              | Unaudited  Consolidated Statements of Cash Flows for the three months ended March 31,  2002 and March 31, 2001. |
|              |                                                                                                            |
|              | Notes to  Consolidated Financial Statements.                                                                    |

 

2

----

 

**GATEWAY ENERGY CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEET**

**March 31, 2002**

**(Unaudited)**

 
| **ASSETS**                                                                                                   |   |        |      |
|--------------------------------------------------------------------------------------------------------------|--------|-------------|-----------|
| Current Assets                                                                                               |   |        |      |
| Cash and cash equivalents                                                                                    |   | $           | 391,491   |   |
| Certificates of deposit                                                                                      |   | 671,164     |      |
| Trade accounts receivable, net of reserve of  $130,832                                                  |   | 917,920     |      |
| Note receivable                                                                                              |   | 83,869      |      |
| Inventories, at average cost                                                                                 |   | 57,018      |      |
| Prepaid expenses and other assets                                                                            |   | 227,804     |      |
| Total current assets                                                                                         |   | 2,349,266   |      |
|                                                                                                         |   |        |      |
| Property and Equipment, at cost                                                                              |   |        |      |
| Gas gathering, processing and transportation                                                                 |   | 9,654,548   |      |
| Office furniture and other equipment                                                                         |   | 670,904     |      |
|                                                                                                         |   | 10,325,452  |      |
| Less accumulated depreciation and amortization                                                               |   | 4,138,091   |      |
|                                                                                                         |   | 6,187,361   |      |
| Other Assets                                                                                                 |   |        |      |
| Investment in AET license, net of accumulated  amortization  of $70,951                                      |   | 350,100     |      |
| Other                                                                                                        |   | 51,602      |      |
|                                                                                                         |   | 401,702     |      |
|                                                                                                         |   | $           | 8,938,329 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                               |   |        |      |
| Current Liabilities                                                                                          |   |        |      |
| Accounts payable                                                                                             |   | $           | 746,156   |   |
| Accrued expenses and other liabilities                                                                       |   | 83,697      |      |
| Notes payable                                                                                                |   | 517,514     |      |
| Current maturities of long-term debt                                                                         |   | 391,379     |      |
| Total current liabilities                                                                                    |   | 1,738,746   |      |
|                                                                                                         |   |        |      |
| Long-term Debt, less current maturities                                                                      |   | 1,250,631   |      |
|                                                                                                         |   |        |      |
| 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;  15,354,880 shares issued and outstanding |   | 3,838,720   |      |
| Additional paid-in capital                                                                                   |   | 15,979,217  |      |
| Accumulated deficit                                                                                          |   | (13,868,985 | )         |
|                                                                                                         |   | 5,948,952   |      |
|                                                                                                         |   | $           | 8,938,329 |   |

##  

## The accompanying notes are anintegral part of this statement.

 

3

----

## **GATEWAY ENERGY CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                   |   | **Three Months  Ended March 31,** |      |
|--------------------------------------------------------|--------|-----------------------------------|-----------|
|                                                   |   | **2002**                          |      | **2001** |   |
| Operating  revenues                                    |   |                              |      |   |   |
| Sales of natural  gas                                  |   | $                                 | 1,464,567 |   | $ | 4,006,105 |   |
| Transportation of natural gas and liquids              |   | 200,236                           |      | 168,109 |   |
| Treating and  other                                    |   | 63,678                            |      | 67,144 |   |
|                                                   |   | 1,728,481                         |      | 4,241,358 |   |
| Operating costs  and expenses                          |   |                              |      |   |   |
| Cost of natural gas purchased                          |   | 1,026,542                         |      | 3,452,899 |   |
| Operation and maintenance                              |   | 251,508                           |      | 281,494 |   |
| Depreciation and amortization                          |   | 181,222                           |      | 172,521 |   |
| Dry hole cost                                          |   | —                            |      | 89,940 |   |
| General and administrative                             |   | 488,426                           |      | 488,366 |   |
|                                                   |   | 1,947,698                         |      | 4,485,220 |   |
| Operating loss                                         |   | (219,217                          | )         | (243,862 | ) |
|                                                   |   |                              |      |   |   |
| Other income  (expense)                                |   |                              |      |   |   |
| Interest income                                        |   | 15,571                            |      | 12,589 |   |
| Interest expense                                       |   | (47,924                           | )         | (32,309 | ) |
| Interest capitalized                                   |   | 3,079                             |      | — |   |
| Other income (expense), net                            |   | 19,360                            |      | 23,506 |   |
|                                                   |   | (9,914)                           |      | 3,786 |   |
|                                                   |   |                              |      |   |   |
| Net loss                                               |   | $                                 | (229,131  | ) | $ | (240,076 | ) |
|                                                   |   |                              |      |   |   |
| Basic and  diluted loss per share                      |   | $                                 | (0.01     | ) | $ | (0.02 | ) |
|                                                   |   |                              |      |   |   |
| Weighted average  number of common shares outstanding: |   |                              |      |   |   |
| Basic                                                  |   | 15,354,880                        |      | 15,312,128 |   |
| Diluted                                                |   | 15,389,755                        |      | 15,408,790 |   |

 

The accompanying notesare an integral part of these statements.

 

4

----

** **

**GATEWAY ENERGY CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

** **
|                                                                         |   | **Three Months Ended March 31,** |     |
|------------------------------------------------------------------------------|--------|----------------------------------|----------|
|                                                                         |   | **2002**                         |     | **2001** |   |
| **INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS**                        |   |                             |     |   |   |
|                                                                         |   |                             |     |   |   |
| Cash flows from operating activities                                         |   |                             |     |   |   |
| Net loss                                                                     |   | $                                | (229,131 | ) | $ | (240,076 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities: |   |                             |     |   |   |
| Depreciation and amortization                                                |   | 181,222                          |     | 172,521 |   |
| Gain on sale of properties                                                   |   | (919                             | )        | (2,500 | ) |
| Other noncash expenses, net                                                  |   | 4,318                            |     | 45,942 |   |
| Change in assets and liabilities:                                            |   |                             |     |   |   |
| Trade accounts receivable                                                    |   | 7,673                            |     | 441,219 |   |
| Inventories                                                                  |   | (671                             | )        | 968 |   |
| Prepaid expenses and other current assets                                    |   | (102,056                         | )        | (67,181 | ) |
| Accounts payable                                                             |   | 55,465                           |     | (633,714 | ) |
| Accrued expenses and other liabilities                                       |   | (43,027                          | )        | 42,033 |   |
| Net cash used in operating activities                                        |   | (127,126                         | )        | (240,788 | ) |
|                                                                         |   |                             |     |   |   |
| Cash flows from investing activities                                         |   |                             |     |   |   |
| Capital expenditures                                                         |   | (191,795                         | )        | (47,701 | ) |
| Proceeds from sale of properties                                             |   | 1,000                            |     | 2,500 |   |
| Note receivable                                                              |   | 26,991                           |     | — |   |
| Decrease in certificate of deposit                                           |   | —                           |     | 20,223 |   |
| Net cash used in investing activities                                        |   | (163,804                         | )        | (24,978 | ) |
|                                                                         |   |                             |     |   |   |
| Cash flows from financing activities                                         |   |                             |     |   |   |
| Proceeds from borrowings                                                     |   | 828,000                          |     | 455,100 |   |
| Payments on borrowings                                                       |   | (286,916                         | )        | (234,328 | ) |
| Net cash provided by financing activities                                    |   | 541,084                          |     | 220,772 |   |
|                                                                         |   |                             |     |   |   |
| Net increase (decrease) in cash and cash equivalents                         |   | 250,154                          |     | (44,994 | ) |
| Cash and cash equivalents at beginning of period                             |   | 141,337                          |     | 171,367 |   |
|                                                                         |   |                             |     |   |   |
| Cash and cash equivalents at end of period                                   |   | $                                | 391,491  |   | $ | 126,373 |   |
|                                                                         |   |                             |     |   |   |
| Supplemental Disclosures of Cash Flow Information:                           |   |                             |     |   |   |
| Cash paid for interest (net of capitalized interest in 2002)                 |   | $                                | 40,187   |   | $ | 27,305 |   |

 

The accompanyingnotes are an integral part of these statements.

 

5

----

**GATEWAY ENERGY CORPORATION AND SUBSIDIARIES**

## **NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**(1)           Principles of Consolidation andNature 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 Company proportionallyconsolidates its joint venture interest. All significant intercompany transactions have been eliminated inconsolidation.

 

The accompanying consolidated financial statementshave been prepared by the Company, without audit.  In the opinion of management, such financial statements reflectall adjustments necessary for a fair presentation of the financial position andresults of operations in accordance with generally accepted accountingprinciples. The financial statements should be read in conjunction with thefinancial statements and the notes thereto included in the Company’s AnnualReport on Form 10-KSB for the year ended December 31, 2001.

 

The Company owns and operates natural gas gathering,transportation and distribution systems and related facilities in Texas,Oklahoma and Louisiana, and offshore in Texas state and federal waters of theGulf of Mexico.

 

**(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 months ended March 31, 2002 and 2001, the diluted loss per common shareis the same as basic since the effect of potentially dilutive common sharesarising from outstanding stock options and warrants was anti-dilutive.

 

**(3)           Recent Accounting Pronouncements**

 

In June 2001, theFinancial Accounting Standards Board (“FASB”) issued Statement on Financial AccountingStandards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, whicheliminates amortization of goodwill and requires that goodwill and otherintangible assets be presented at “fair value” and be periodically assessed forimpairment.  The Company adopted thisstatement effective January 1, 2002. The impact of adopting this statement on the consolidated financialposition or results of operations was not material.

 

In August 2001, the FASBissued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-livedAssets”, which sets new standards for periodically assessing long-lived assetsto determine if the carrying costs are recoverable from estimated future cashflows.  The Company adopted this statementeffective January 1, 2002.  The impactof adopting this statement on the consolidated financial position or results ofoperations was not material.

 

6

----

 

**(4)           Dry Hole Cost**

 

During the three monthsended March 31, 2001, Gateway Processing Company participated as anon-operating working interest owner in the drilling of a natural gas well on aprospect in the Sacramento Basin, California. The well was expected to yield high-nitrogen natural gas reserves andemploy the Company’s licensed nitrogen rejection process to meet pipelinespecifications.  The well was determinedto be uneconomic and was abandoned.  Theaccompanying consolidated statement of operations for the three months endedMarch 31, 2001 includes an impairment charge against earnings of $89,940reflecting the abandonment of this project.

 

**(5)****                                ****Debt**

 

*Notes Payable*

 

The Company’soperating line of credit agreement provides for maximum available borrowings of$500,000 through June 2003.  Interest ispayable monthly at 5.3% per annum and principal is due on demand, or if nodemand is made, at maturity.  The lineis collateralized by a $500,000 certificate of deposit.  The Company had $7,486 of available borrowingsunder the agreement as of March 31, 2002.

 

The Company’s revolving credit agreement with a bankprovides for maximum available borrowings of $250,000 through June 1,2002.  Principal outstanding under theagreement accrues interest at a variable rate, based on the bank’s prime rateindex plus 11⁄4%, with a minimum rate of 8%. The balance under the agreement is due upon demand, or if no demand ismade, at maturity and is renewable annually. Costs of obtaining this debt totaled $4,932 and are being charged tointerest expense ratably over the maturity period of the note.  Fort Cobb will use the proceeds from time totime for general working capital purposes. The agreement, along with the Fort Cobb term note, is collateralizedwith the assets of Fort Cobb and guaranteed by the Company.  The Company had $225,000 of availableborrowings under the agreement as of March 31, 2002.

 

*Long-termDebt*

 

                Long-term debt at March 31, 2002 consists of thefollowing:

 
| Subordinated  notes            |   | $         | 415,619   |   |
|--------------------------------|--------|-----------|-----------|--------|
| Term note — Fort  Cobb    |   | 726,391   |      |
| Term note —  Madisonville |   | 500,000   |      |
|                           |   | 1,642,010 |      |
| Less current maturities        |   | 391,379   |      |
|                           |   | $         | 1,250,631 |   |

 

Effective February 21,2002, Gateway Pipeline Company and Gateway Processing Company (the “Borrowers”)entered into a term credit agreement with a bank.   Under the agreement, the Borrowers may borrow through July 31,2002 up to $1.5 million in one or more advances.  Principal outstanding

 

7

----

 

under the noteaccrues interest at a fixed rate of 71⁄4% and the note matures January 31,2005.  The first six monthly note paymentsrepresent interest only, and thereafter the note requires monthly payments ofprincipal and interest ranging from $9,063 to $54,819 if the maximum availableunder the agreement is borrowed.  Ifless than the maximum amount is borrowed, the monthly payments areproportionately reduced.  Costs ofsecuring this debt are expected to total approximately $26,000 and are beingcharged to interest expense ratably over the maturity period of the note. TheBorrowers will use the proceeds to finance the construction of gathering andsales pipelines servicing the Madisonville Plant.  The agreement is collateralized with the Company’s economicinterest in the Madisonville plant and system and the Waxahachie distributionsystem, and the Company has guaranteed the loan and pledged the common stock ofthe Borrowers.  The Company had $1.0million of available borrowings under the agreement as of March 31, 2002.  The project is expected to be on streammid-year 2002.

 

*Lettersof Credit*

 

As of March 31, 2002, theCompany had outstanding letters of credit totaling $525,000.

 

**(6)          **Commitments and Contingencies

 

On June 18, 2001, theCompany announced that Gateway Processing Company entered into a long-termagreement with a producer to purchase non-pipeline quality natural gas nearMadisonville, Texas.  Concurrently,Gateway Processing entered into an agreement with Hanover Compression LimitedPartnership (“Hanover”), an affiliate of The Hanover Company, under whichHanover will treat the gas to remove impurities from the gas to enable the gasto meet pipeline sales quality specifications.

 

                Of significance toGateway, Hanover will employ the state-of-the-art, patented, absorption basedtechnology developed by AET, for which Gateway has the exclusive U.S. license,to remove the nitrogen from the gas.

 

                Hanover’sfacilities (the “Madisonville Plant”), designed initially to treat 18,000 Mcfper day, and the ten-inch pipeline to be installed by Gateway Pipeline Companyto transport the treated residue gas are expected to be on stream during themiddle of 2002.  The Company expects itscapital commitment in this project to be approximately $2.0 million,approximately $500,000 more than it has currently available under the term loanfor the project.  The estimated totalcosts are greater due mainly to an increase in the diameter of the salespipeline and an increase in the length of the sales pipeline.  The additional capital required is expectedto come from a combination of internally generated funds and additional bankborrowings.  As of May 7, 2002 theCompany had spent approximately $500,000 for the purchase of rights of way andengineering and design services.  SeeNote (5) for a description of the Company’s financing related to this project.

 

The Company andits subsidiaries are parties to litigation and claims arising in the normalcourse of business.  Management, afterconsultation with legal counsel, believes that the liabilities, if any, arisingfrom such litigation and claims, will not be material to the consolidatedfinancial statements.

 

8

----

** **

**(7)****                                ****Segment Disclosures**

 

|                           |   | **Three  Months Ended March 31,** |       |
|--------------------------------|--------|-----------------------------------|------------|
|                           |   | **2002**                          |       | **2001** |   |
| **Onshore  Operations**        |   |                              |       |   |   |
| Revenues                       |   | $                                 | 1,000,164  |   | $ | 3,213,426 |   |
| Operating margin               |   | 136,113                           |       | 345,853 |   |
| Depreciation and  amortization |   | 96,241                            |       | 88,024 |   |
| Total assets                   |   | 4,803,228                         |       | 4,372,460 |   |
|                           |   |                              |       |   |   |
| **Offshore Operations**        |   |                              |       |   |   |
| Revenues                       |   | 202,033                           |       | 172,578 |   |
| Operating margin               |   | 136,446                           |       | 47,827 |   |
| Depreciation and  amortization |   | 35,413                            |       | 35,115 |   |
| Total assets                   |   | 1,728,250                         |       | 1,864,882 |   |
|                           |   |                              |       |   |   |
| **Fort Cobb Operations**       |   |                              |       |   |   |
| Revenues                       |   | 526,284                           |       | 855,354 |   |
| Operating margin               |   | 177,872                           |       | 113,285 |   |
| Depreciation and  amortization |   | 49,568                            |       | 49,382 |   |
| Total assets                   |   | 2,406,851                         |       | 2,748,591 |   |
|                           |   |                              |       |   |   |
| **Total**                      |   |                              |       |   |   |
| Revenues                       |   | 1,728,481                         |       | 4,241,358 |   |
| Operating margin               |   | 450,431                           |       | 506,965 |   |
| Depreciation and  amortization |   | 181,222                           |       | 172,521 |   |
| Total assets                   |   | 8,938,329                         |       | 8,985,933 |   |
|                           |   |                              |       |   |   |
| **Reconciliation to net loss** |   |                              | ** ** |   | ** ** |
| Operating margin               |   | $                                 | 450,431    |   | $ | 506,965 |   |
| Depreciation and  amortization |   | 181,222                           |       | 172,521 |   |
| Dry hole cost                  |   | —                            |       | 89,940 |   |
| General &  administrative  |   | 488,426                           |       | 488,366 |   |
| Other income  (loss)           |   | (9,914                            | )          | 3,786 |   |
| Net loss                       |   | $                                 | (229,131   | ) | $ | (240,076 | ) |

 

 

**Item 2.   Management’s Discussion andAnalysis of Financial Condition and Results of 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.

 

9

----

 

**CriticalAccounting Policies**

 

The Company’s consolidated financial statements areimpacted by the accounting policies used and the estimates and assumptions madeby management during their preparation. The following is a discussion of the Company’s most significantaccounting policies pertaining to property and equipment, license agreement,related depreciation and amortization and revenue recognition as well as theuse of estimates.  Additionalinformation about the Company’s significant accounting policies can be found inNote 2 to the consolidated financial statements for the year ended December 31,2001 included in the Company’s Annual Report on Form 10-KSB as filed with theSecurities and Exchange Commission.

 

*Propertyand Equipment*

 

Property and equipment isstated at cost, plus capitalized interest costs on major pipeline projectsduring their construction period. Additions and improvements that add to the productive capacity or extendthe useful life of an asset are capitalized. Expenditures for maintenance and repairs are charged to expense asincurred.  Depreciation is providedusing the straight-line method over estimated useful lives ranging from 6 to 30years for pipeline systems, gas plant and processing equipment, and from 2 to10 years for office furniture and other equipment.  Upon disposition or retirement of pipeline components or gasplant components, any gain or loss is charged or credited to accumulateddepreciation.  When entire pipelinesystems, gas plants or other property and equipment are retired or sold, anyresulting gain or loss is credited to or charged against operations.

 

Impairment losses arerecognized for long-lived assets used in operations when indicators ofimpairment are present and the undiscounted cash flows are not sufficient torecover the assets’ carrying value. The amount of impairment is measured bycomparing the fair value of the asset to its carrying amount.

 

*LicenseAgreement*

 

The Company has a licenseagreement for a patented process to remove nitrogen from streams of naturalgas.  The license agreement is beingamortized over the average 17-year life of the underlying patents.

 

*RevenueRecognition*

 

The Company’s sales revenuesare generated under back-to-back purchase and sales contracts.  Sales revenues are recognized at theredelivery point, which is the point at which title to the gas transfers.  The Company’s transportation revenues aregenerated under contracts which have a stated fee per unit of production (Mcf,MMBtu, or Bbl) gathered or transported. Transportation revenues are recognized at the redelivery point, which isthe point at which another party takes physical custody of the gas.

 

*Useof Estimates*

 

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amount of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period.  Actualresults could differ from those estimates.

 

 

10

----

 

Key estimates used by management in this reportinclude:

 

Allowance fordoubtful accounts.  The Companyestimates its allowance for doubtful accounts based on analysis of historicalcollection activity.  Factors that mayaffect this estimate include changes in the financial position of a major customeror significant changes in the prices of oil or natural gas.

 

Depreciation andamortization.  The Company depreciatesits property and equipment as well as the license agreement over theirremaining estimated useful lives.  TheCompany’s estimates of these remaining useful lives may be affected by suchfactors as changing market conditions, technological advances in the industryor changes in regulations governing the industry.

 

*RecentAccounting 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.  The Company adopted thisstatement effective January 1, 2002. The impact of adopting this statement on the consolidated financialposition or results of operations was not material.

 

In August 2001, the FASBissued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-livedAssets”, which sets new standards for periodically assessing long-lived assetsto determine if the carrying costs are recoverable from estimated future cashflows.  The Company adopted thisstatement effective January 1, 2002. The impact of adopting this statement on the consolidated financialposition or results of operations was not material.

 

**Results of Operations**

 

***General***

 

The Henry Hub closing index price for natural gas duringthe three months ended March 31, 2002 averaged $2.34 per MMBtu, approximatelyone-third the average 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 ofpurchased gas, declined proportionately from prior year levels.  Because the Company buys and sells gas under“back-to-back” purchase and sale contracts designed to minimize commodity pricerisk, the Company’s net operating margin is relatively insensitive tofluctuations in the market price of gas. Accordingly, the Company evaluates each of its activities based on theoperating 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 mainsegments—Onshore operations, Offshore operations and Fort Cobb operations.

 

11

----

# **Three Months Ended March 31, 2002Compared to Three Months Ended March 31, 2001**

#  

# *Total Operations*

|             |   | **Three  Months Ended March 31,** |      |
|------------------|--------|-----------------------------------|-----------|
|             |   | **2002**                          |      | **2001** |   |
| Revenues         |   | $                                 | 1,728,481 |   | $ | 4,241,358 |   |
| Operating margin |   | 450,431                           |      | 506,965 |   |
| Depreciation     |   | 181,222                           |      | 172,521 |   |
|                  |        |                                   |           |  |  |  |  |

 

Operating margins for the three months ended March 31,2002 decreased $56,000 compared to the same period of the prior year.  A decline in Onshore operating margins of$210,000 was partially offset by increases in Offshore and Fort Cobb operatingmargins of $89,000 and $65,000.  Thesesegments are discussed individually below in greater detail.

 

# *Onshore Operations*

|             |   | **Three  Months Ended March 31,** |      |
|------------------|--------|-----------------------------------|-----------|
|             |   | **2002**                          |      | **2001** |   |
| Revenues         |   | $                                 | 1,000,164 |   | $ | 3,213,426 |   |
| Operating margin |   | 136,113                           |      | 345,853 |   |
| Depreciation     |   | 96,241                            |      | 88,024 |   |
|                  |        |                                   |           |  |  |  |  |

 

Operating margins for onshore operations decreased inthe first quarter by $210,000 from the same period of the prior year.  The decrease was mainly due to changes ingas transportation terms imposed by a major natural gas pipeline.  The Company is addressing the changes byconstructing new facilities to allow access to another pipeline and additionalsupply sources.  In addition, several ofthe Company’s pipeline segments experienced lower throughput volumes asproducers reacted to falling gas market prices.

 

# *Offshore Operations*

|             |   | **Three  Months Ended March 31,** |    |
|------------------|--------|-----------------------------------|---------|
|             |   | **2002**                          |    | **2001** |   |
| Revenues         |   | $                                 | 202,033 |   | $ | 172,578 |   |
| Operating margin |   | 136,446                           |    | 47,827 |   |
| Depreciation     |   | 35,413                            |    | 35,115 |   |
|                  |        |                                   |         |  |  |  |  |

 

Operating margins for offshore operations increased inthe first quarter by $89,000 over the same period of the prior year, and aredirectly related to greater throughput volumes.  The Company anticipates an increase in monthly gathering andtransporting volumes before the end of 2002.

 

# *Fort Cobb Operations*

|             |   | **Three  Months Ended March 31,** |    |
|------------------|--------|-----------------------------------|---------|
|             |   | **2002**                          |    | **2001** |   |
| Revenues         |   | $                                 | 526,284 |   | $ | 855,354 |   |
| Operating margin |   | 177,872                           |    | 113,285 |   |
| Depreciation     |   | 49,568                            |    | 49,382 |   |
|                  |        |                                   |         |  |  |  |  |

 

Operating margins for Fort Cobb operations increasedin the first quarter by $65,000 over the same period of the prior year withouta significant change in sales volumes. The prior quarter cost of purchased gas included line leaks valued at anaverage purchase cost of approximately $9.00 per MMBtu.

 

12

----

 

# *Operations Support*

|                         |   | **Three  Months Ended March 31,** |    |
|------------------------------|--------|-----------------------------------|---------|
|                         |   | **2002**                          |    | **2001** |   |
| General and  administrative  |   | $                                 | 488,426 |   | $ | 488,366 |   |
| Interest income              |   | 15,571                            |    | 12,589 |   |
| Interest expense             |   | (47,924                           | )       | (32,309 | ) |
| Interest  capitalized        |   | 3,079                             |    | — |   |
| Other income  (expense), net |   | 19,360                            |    | 23,506 |   |
|                              |        |                                   |         |  |  |  |  |

 

                General andadministrative expenses for the quarter are flat compared to the same period oflast year.

 

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

 

Interest expense fluctuates directly with the amountof outstanding long-term debt and the amount of borrowings under the Company’sbank operating lines of credit. Interest expense of $3,079 incurred on the debt to finance theMadisonville project during the construction period was capitalized.

 

## **Liquidityand Capital Resources**

 

                Net cash used byoperating activities totaled $127,000 for the three months ended March 31,2002, compared to $241,000 used by operating activities for the same periodlast year.  The change between theperiods was mainly due to changes in current asset and liability accountstotaling $134,000, partially offset by the decrease in operating marginsbetween the two periods which is discussed by segment in the preceding section.

 

                The Company hascash and cash equivalents and certificates of deposit totaling $1,062,655 atMarch 31, 2002.  The Company’s operatingline of credit agreement with a bank provides for maximum borrowings of$500,000, through June 2003, and is collateralized with a certificate ofdeposit for the same amount.  TheCompany’s revolving credit agreement provides for maximum borrowings of$250,000 through June 1, 2002.  TheCompany had available borrowings of $7,486 and $225,000 as of March 31, 2002under the two agreements.  Additionally,the Company’s Madisonville term note provides for maximum borrowings of $1.5million, and the Company had $1.0 million available under that agreement as ofMarch 31, 2002.

 

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

 

**Factors Affecting Future Results**

 

                One of the principal objectivesof the Company is to enhance stockholder value through the execution of certainstrategies. These strategies 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 ourservices, and; (iv) acquiring or constructing properties in one or more newcore areas.

 

13

----

 

                The Company must provideservices to its customers, primarily producers, at a competitive price.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 additionalproperties to increase operating margin, enabling fixed overhead costs to bespread over a larger asset base. The Company believes its experienced personnelwill allow the Company to access capital and find properties which can provideattractive returns. However, there can be no assurance that the Company will besuccessful in this endeavor.

 

                The Company’s ability togenerate long-term value for the common stockholder is dependent in part uponthe successful acquisition of additional assets which compliment the Company’score business at costs which provide for reasonable returns. There are manycompanies participating in the midstream segment of the natural gas industry,many with resources greater than the Company. Greater competition for profitableoperations can increase prices and make it more difficult to acquire assets atreasonable multiples of cash flow.

 

                The Company believes that itwill be able to compete in this environment and will be able to find attractiveinvestments which compliment its existing properties; however, it is notpossible to predict competition or the effect this will have on the Company’soperations.

 

The Company intends topursue projects that employ its nitrogen rejection technology, and is activelyevaluating several such projects.  Theseprojects are located in geographic areas with well known concentrations of highnitrogen natural gas reserves.  TheCompany has a technological advantage in this niche, due to its exclusive U.S.license for the nitrogen rejection process. Additionally, a substantial portion of the natural gas reserves in thelower 48 states contains nitrogen, either alone or in conjunction with othercontaminants, in excess of the maximum percentage by volume acceptable to mostpipeline companies.   Successfulcompletion of these projects will depend upon the ability of the Company tomarket the technology to the producer community, and to obtain financing onterms satisfactory to the Company for construction of nitrogen rejection plantsand/or acquisition of working interests in the high nitrogen properties.

 

                The Company’s operations arealso significantly affected by factors which are outside the control of theCompany. Gas gathering and processing is dependent on throughput volume.Throughput on the Company’s systems is dependent on natural gas productionwhich is significantly affected by natural gas prices as prices affect thewillingness of producers to invest the required capital to obtain geologicaland geophysical information, to drill development or exploratory wells, and torework or maximize production on existing wells. Natural gas prices arecurrently at levels which should provide adequate incentive to producers;however, there is no assurance that such prices will remain at current levels,and that producers will continue to react positively to the current prices.

 

                The Company’s revenues,particularly in its retail operations, are also affected by weather. Much ofthe retail demand is for crop irrigation and drying.  Above normal precipitation in the growing season and hot, dryweather in the fall can significantly reduce demand for natural gas.

 

 

14

----

 

###### **Part II**

 
| **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:            |
|         |                                                     | None                 |
|         |                                                     |                 |
|         | b)                                                       | Reports on Form 8-K: |
|         |                                                     | None                 |
|              |                                                          |                      |  |

 

 

15

----

 

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 |
|                                   |

 
| May 15, 2002 |
|--------------|
| (Date)       |

 

16

----