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

**Washington, D. C.  20549**

 

**FORM 10-QSB**

 

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

 

**For the quarterly period ended September 30, 2003**

 

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

 

**For the transition period from****             to             **

 

**Commission File No. 1-4766**

 

**GATEWAY ENERGY CORPORATION**

(Exactname of small business issuer as specified in its charter)

 

| **Delaware**                                                     |   | **44-0651207**                            |
|------------------------------------------------------------------|--------|-------------------------------------------|
| (State  or other jurisdiction of  incorporation or organization) |   | (I.R.S.  Employer Identification  Number) |
|                                                             |   |                                      |
| **500  Dallas Street, Suite 2615****Houston,  TX  77002**   |
| (Address  of principal executive offices)                        |
|                                                             |
| **(713) 336-0844**                                               |
| (Issuer’s  telephone number)                                |

 

APPLICABLEONLY TO CORPORATE ISSUERS

 

Asof November 10, 2003, the Issuer had 15,426,317 shares of its common stockoutstanding.

 

TransitionalSmall Business Disclosure Format: Yes  o    No  ý

 

 

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**FORM10-QSB**

 

**Part  I**

 
| **Item  1.** | **Financial Statements**                                                                                                            |   |
|-------------------|-------------------------------------------------------------------------------------------------------------------------------------|--------|
|              |                                                                                                                                |   |
|              | Unaudited Consolidated  Balance Sheetas of September 30, 2003                                                                       |   |
|              |                                                                                                                                |   |
|              | Unaudited  Consolidated Statements of Operationsfor the three months and nine months ended September 30, 2003and September 30, 2002 |   |
|              |                                                                                                                                |   |
|              | Unaudited  Consolidated Statements of Cash Flowsfor the nine months ended September 30, 2003and September 30, 2002                  |   |
|              |                                                                                                                                |   |
|              | Notes to  Unaudited Consolidated Financial Statements                                                                               |   |

 

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**GATEWAY ENERGY CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEET**

**September 30, 2003**

**(Unaudited)**

 
| **ASSETS**                                                                                                   |   |        |      |
|--------------------------------------------------------------------------------------------------------------|--------|-------------|-----------|
| Current Assets                                                                                               |   |        |      |
| Cash and cash equivalents                                                                                    |   | $           | 118,913   |   |
| Certificates of deposit                                                                                      |   | 130,663     |      |
| Trade accounts receivable, net of reserve of  $130,832                                                       |   | 1,556,273   |      |
| Inventories, at average cost                                                                                 |   | 63,644      |      |
| Prepaid expenses and other assets                                                                            |   | 137,560     |      |
| Total current assets                                                                                         |   | 2,007,053   |      |
|                                                                                                         |   |        |      |
| Property and Equipment, at cost                                                                              |   |        |      |
| Gas gathering, processing and transportation                                                                 |   | 10,357,106  |      |
| Office furniture and other equipment                                                                         |   | 810,659     |      |
|                                                                                                         |   | 11,167,765  |      |
| Less accumulated depreciation and amortization                                                               |   | (3,608,652  | )         |
|                                                                                                         |   | 7,559,113   |      |
| Other Assets                                                                                                 |   |        |      |
| Investment in AET license, net of accumulatedamortization  of $114,013                                       |   | 307,037     |      |
| Other                                                                                                        |   | 120,506     |      |
|                                                                                                         |   | 427,543     |      |
|                                                                                                         |   | $           | 9,993,709 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                |   |        |      |
| Current Liabilities                                                                                          |   |        |      |
| Accounts payable                                                                                             |   | $           | 1,361,957 |   |
| Accrued expenses and other liabilities                                                                       |   | 351,702     |      |
| Notes payable                                                                                                |   | 191,365     |      |
| Current maturities of long-term debt                                                                         |   | 862,663     |      |
| Total current liabilities                                                                                    |   | 2,767,687   |      |
|                                                                                                         |   |        |      |
| Noncurrent Liabilities                                                                                       |   |        |      |
| Future asset retirement obligations                                                                          |   | 294,217     |      |
| Reserve for ADAC guarantee                                                                                   |   | 67,500      |      |
| Total noncurrent liabilities                                                                                 |   | 361,717     |      |
|                                                                                                         |   |        |      |
| Long-term Debt, less current maturities                                                                      |   | 2,408,706   |      |
|                                                                                                         |   |        |      |
| 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; 15,426,317 shares issued and outstanding |   | 3,856,577   |      |
| Additional paid-in capital                                                                                   |   | 15,989,102  |      |
| Accumulated deficit                                                                                          |   | (15,390,080 | )         |
|                                                                                                         |   | 4,455,599   |      |
|                                                                                                         |   | $           | 9,993,709 |   |

 

The accompanying notes are an integral part of thisstatement.

 

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**GATEWAY ENERGY CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                                               |   | **Three  Months Ended  September 30,** |      | **Nine  Months Ended  September 30,** |   |
|------------------------------------------------------------------------------------|--------|----------------------------------------|-----------|---------------------------------------|--------|
|                                                                               |   | **2003**                               |      | **2002**                              |   | **2003** |   | **2002** |   |
| Operating revenues                                                                 |   |                                   |      |                                  |   |   |   |   |   |
| Natural gas  sales                                                                 |   | $                                      | 4,404,378 |                                  | $      | 1,616,298 |   | $ | 9,335,958 |   | $ | 4,050,374 |   |
| Transportation  of natural gas and liquids                                         |   | 139,650                                |      | 141,029                               |   | 380,931 |   | 448,524 |   |
| Treating and  other                                                                |   | 41,486                                 |      | 41,585                                |   | 120,212 |   | 149,733 |   |
|                                                                               |   | 4,585,514                              |      | 1,798,912                             |   | 9,837,101 |   | 4,648,631 |   |
| Operating costs  and expenses                                                      |   |                                   |      |                                  |   |   |   |   |   |
| Cost of natural  gas purchased                                                     |   | 3,808,806                              |      | 1,171,089                             |   | 7,890,339 |   | 2,948,960 |   |
| Operation and  maintenance                                                         |   | 226,407                                |      | 208,326                               |   | 687,085 |   | 648,532 |   |
| Depreciation and  amortization                                                     |   | 158,968                                |      | 133,086                               |   | 435,915 |   | 399,756 |   |
| Accretion                                                                          |   | 102,081                                |      | —                                |   | 102,081 |   | — |   |
| General and  administrative                                                        |   | 360,838                                |      | 451,842                               |   | 1,211,067 |   | 1,433,681 |   |
|                                                                               |   | 4,657,100                              |      | 1,964,343                             |   | 10,326,487 |   | 5,430,929 |   |
| Operating income  (loss)                                                           |   | (71,586                                | )         | (165,431                              | )      | (489,386 | ) | (782,298 | ) |
|                                                                               |   |                                   |      |                                  |   |   |   |   |   |
| Other income  (expense)                                                            |   |                                   |      |                                  |   |   |   |   |   |
| Interest income                                                                    |   | 1,166                                  |      | 10,260                                |   | 13,791 |   | 37,273 |   |
| Interest expense                                                                   |   | (139,228                               | )         | (63,509                               | )      | (279,974 | ) | (170,293 | ) |
| Interest  capitalized                                                              |   | —                                 |      | 18,837                                |   | 24,466 |   | 37,395 |   |
| Other income  (expense), net                                                       |   | (6,554                                 | )         | (121                                  | )      | 8,273 |   | 37,474 |   |
|                                                                               |   | (144,616                               | )         | (34,533                               | )      | (233,444 | ) | (58,151 | ) |
| Loss from  continuing operations before income taxes                               |   | (216,202                               | )         | (199,964                              | )      | (722,830 | ) | (840,449 | ) |
| Provision for  income taxes                                                        |   | —                                 |      | —                                |   | — |   | — |   |
| Loss from  continuing operations                                                   |   | (216,202                               | )         | (199,964                              | )      | (722,830 | ) | (840,449 | ) |
| Discontinued  operations                                                           |   |                                   |      |                                  |   |   |   |   |   |
| Operations of  properties sold                                                     |   | —                                 |      | 6,449                                 |   | — |   | 22,746 |   |
| Gain on sale of  properties                                                        |   | —                                 |      | 63,865                                |   | — |   | 63,865 |   |
|                                                                               |   | —                                 |      | 70,314                                |   | — |   | 86,611 |   |
| Loss before  cumulative effect of change in accounting principle                   |   | (216,202                               | )         | (129,650                              | )      | (722,830 | ) | (753,838 | ) |
| Cumulative  effect of change in accounting for future asset retirement obligations |   | —                                 |      | —                                |   | (105,777 | ) | — |   |
| Net loss                                                                           |   | $                                      | (216,202  | )                                     | $      | (129,650 | ) | $ | (828,607 | ) | $ | (753,838 | ) |
| Basic and diluted loss per share                                                   |   |                                   |      |                                  |   |   |   |   |   |
| Continuing operations                                                              |   | $                                      | (0.01     | )                                     | $      | (0.01 | ) | $ | (0.05 | ) | $ | (0.05 | ) |
| Discontinued operations                                                            |   | —                                 |      | —                                |   | — |   | — |   |
| Cumulative effect of change in accounting principle                                |   | —                                 |      | —                                |   | — |   | — |   |
| Net loss                                                                           |   | $                                      | (0.01     | )                                     | $      | (0.01 | ) | $ | (0.05 | ) | $ | (0.05 | ) |
| Weighted average  number of common shares outstanding:                             |   |                                   |      |                                  |   |   |   |   |   |
| Basic and  diluted                                                                 |   | 15,426,317                             |      | 15,426,318                            |   | 15,426,317 |   | 15,385,234 |   |
| Pro Forma amounts assuming the new  principle is applied retroactively             |   |                                   |      |                                  |   |   |   |   |   |
| Loss from continuing operations                                                    |   | $                                      | (120,674  | )                                     | $      | (206,649 | ) | $ | (640,406 | ) | $ | (860,503 | ) |
| Loss per basic and diluted common share  outstanding                               |   | $                                      | (0.01     | )                                     | $      | (0.01 | ) | $ | (0.04 | ) | $ | (0.06 | ) |
| Net Loss                                                                           |   | $                                      | (120,674  | )                                     | $      | (136,335 | ) | $ | (746,183 | ) | $ | (773,892 | ) |
| Net loss per basic and diluted common share  outstanding                           |   | $                                      | (0.01     | )                                     | $      | (0.01 | ) | $ | (0.05 | ) | $ | (0.05 | ) |

 

Theaccompanying notes are an integral part of these statements.

 

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**GATEWAY ENERGY CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                                         |   | **Nine Months Ended September 30,** |     |
|----------------------------------------------------------------------------------------------|--------|-------------------------------------|----------|
|                                                                                         |   | **2003**                            |     | **2002** |   |
| **Increase (Decrease) in Cash and Cash  Equivalents**                                   |   |                                |     |   |   |
|                                                                                         |   |                                |     |   |   |
| Cash flows from operating activities                                                         |   |                                |     |   |   |
| Net loss                                                                                     |   | $                                   | (828,607 | ) | $ | (753,838 | ) |
| Adjustments to reconcile net loss to net cash  provided (used) by operating activities:      |   |                                |     |   |   |
| Cumulative effect of change in accounting  principle                                         |   | 105,777                             |     | — |   |
| Depreciation and amortization, including  $75,874 related to discontinued operations in 2002 |   | 435,915                             |     | 475,630 |   |
| Gain on sale of properties                                                                   |   | (5,807                              | )        | (64,784 | ) |
| Stock compensation (income) expense                                                          |   | (15,803                             | )        | 30,000 |   |
| Accretion expense                                                                            |   | 102,081                             |     | — |   |
| Amortization of debt discount and debt issuance  costs                                       |   | 42,389                              |     | 12,715 |   |
| Reserve for ADAC guarantee                                                                   |   | 67,500                              |     | — |   |
| Change in assets and liabilities:                                                            |   |                                |     |   |   |
| Trade accounts receivable                                                                    |   | (614,028                            | )        | 143,254 |   |
| Inventories                                                                                  |   | (14,799                             | )        | 2,763 |   |
| Prepaid expenses and other current assets                                                    |   | 7,976                               |     | (206,357 | ) |
| Accounts payable                                                                             |   | 620,525                             |     | (63,002 | ) |
| Accrued expenses and other liabilities                                                       |   | 221,360                             |     | (2,550 | ) |
| Net cash provided (used) by operating  activities                                            |   | 124,479                             |     | (426,169 | ) |
|                                                                                         |   |                                |     |   |   |
| Cash flows from investing activities                                                         |   |                                |     |   |   |
| Capital expenditures                                                                         |   | (1,944,559                          | )        | (851,038 | ) |
| Proceeds from sale of properties                                                             |   | 14,500                              |     | 840,000 |   |
| Note receivable                                                                              |   | —                              |     | 82,432 |   |
| Decrease in certificate of deposit                                                           |   | 522,932                             |     | 17,569 |   |
| Other                                                                                        |   | 1,915                               |     | — |   |
| Net cash (used) provided by investing  activities                                            |   | (1,405,212                          | )        | 88,963 |   |
|                                                                                         |   |                                |     |   |   |
| Cash flows from financing activities                                                         |   |                                |     |   |   |
| Proceeds from borrowings                                                                     |   | 2,231,401                           |     | 1,434,000 |   |
| Payments on borrowings                                                                       |   | (847,210                            | )        | (1,019,200 | ) |
| Debt issue costs                                                                             |   | (65,433                             | )        | (39,453 | ) |
| Net cash provided by financing activities                                                    |   | 1,318,758                           |     | 375,347 |   |
|                                                                                         |   |                                |     |   |   |
| Net increase in cash and cash equivalents                                                    |   | 38,025                              |     | 38,141 |   |
| Cash and cash equivalents at beginning of  period                                            |   | 80,888                              |     | 141,337 |   |
| Cash and cash equivalents at end of period                                                   |   | $                                   | 118,913  |   | $ | 179,478 |   |
| Supplemental Disclosures of Cash Flow  Information:                                          |   |                                |     |   |   |
| Cash interest (including capitalized interest)                                               |   | $                                   | 176,593  |   | $ | 144,390 |   |
| Non-cash transactions:                                                                       |   |                                |     |   |   |
| Receivable from sale of property                                                             |   | $                                   | —   |   | $ | 85,000 |   |

 

Theaccompanying notes are an integral part of these statements.

 

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**GATEWAY ENERGY CORPORATION ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**(1)****          ****Principles of Consolidationand Nature of Business**

 

The consolidated financialstatements include the accounts of Gateway Energy Corporation and its whollyowned subsidiary companies, Gateway Pipeline Company, Gateway Offshore PipelineCompany, Gateway Energy Marketing Company, Fort Cobb Fuel Authority, L.L.C. andGateway Processing Company.  Allsignificant intercompany transactions have been eliminated in consolidation.

 

The accompanying consolidated financialstatements 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 accountingprinciples generally accepted in the United States of America. The financialstatements should be read in conjunction with the financial statements and thenotes thereto included in the Company’s Annual Report on Form 10-KSB for theyear ended December 31, 2002.

 

The Company owns andoperates natural gas gathering, transportation and distribution systems andrelated facilities in Texas and Oklahoma, and offshore in Texas and federalwaters of the Gulf of Mexico. The Company also pursues projects that employ itsnitrogen rejection technology, and is actively evaluating several suchprojects.  These projects are located ingeographic areas with well known concentrations of high nitrogen natural gasreserves.  The Company has atechnological advantage in this niche, due to its exclusive U.S. license forthe 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.

 

**(2)**           Summary of Significant Accounting Policies

 

A summary of the significantaccounting policies consistently applied in the preparation of the accompanyingconsolidated financial statements follows. Certain reclassifications have been made to the prior period statementsto be consistent with the current presentation.

 

***Revenue Recognition Policy***

 

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 or liquidhydrocarbons.

 

*Property and 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.

 

For the nine months endedSeptember 30, 2003 and 2002, depreciation expense was $409,732 and $453,631respectively.

 

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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.  Theamount of impairment is measured by comparing the fair value of the asset toits carrying amount.

 

The Company provides for the future asset retirementobligations related to the Shipwreck offshore production platform because,eventually, law or regulation will require its abandonment.  The present value of the estimated futureasset retirement obligation, as of the date of acquisition, was capitalized to gas gathering, processing and transportationequipment.  The present value of theestimated future asset retirement obligation, as of the balance sheet date, ispresented as a noncurrent liability. Until the platform is ultimately sold or retired, the Company willrecognize (i) depreciation expense on the additional capitalized costs; (ii)accretion expense as the present value of the future asset retirementobligation increases with the passage of time, and; (iii) the impact, if any,of changes in estimates of the liability. The following table sets forth a reconciliation of the beginning andending aggregate carrying amount of asset retirement obligations for the ninemonths ended September 30, 2003:

 
| Beginning balance                  |   | $      | 202,007 |   |
|------------------------------------|--------|--------|---------|--------|
| Accretion                          |   | 10,854 |    |
| Revisions in  estimated cash flows |   | 81,356 |    |
| Ending balance                     |   | $      | 294,217 |   |

 

The pro forma amounts onthe income statement show the effects of retroactive application of thestatement on loss from continuing operations and net loss as if the newaccounting principle was already in effect prior to the periods presented.

 

***Other Assets***

 

The Company’s primary otherasset, its license for a patented process to remove nitrogen from streams ofnatural gas, is being amortized to expense over the life of the underlyingpatents.  The latest of these patentsexpires in 2014.

 

*Cash Equivalents andSupplemental Disclosure of Noncash Investing and Financing Activities*

 

For purposes of theconsolidated statements of cash flows, the Company considers all highly liquiddebt instruments purchased with original maturities of three months or less tobe cash equivalents.

 

The Company recognizedfuture asset retirement obligations related to prior periods totaling $202,007pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 143,discussed below.  A portion of suchcosts—$96,230 (net of accumulated depreciation of $15,883)—was capitalized togas gathering, processing and transportation assets to be depreciated over theremaining useful life of the assets. The remainder of these prior year costs was expensed as the cumulative(noncash) effect of change in accounting principle.

 

*Income Taxes*

 

The Company has no currentprovision for income taxes because it had net losses in the periods presented,and the related tax benefits may not be realized in future periods and aretherefore fully reserved in the accompanying financial statements.  Deferred tax assets and liabilities arerecognized for the expected future tax consequences of events that have beenincluded in the financial statements or income tax returns. Under this method,deferred tax assets and liabilities are determined based on the differencebetween the financial and tax bases of assets and liabilities as measured usingthe enacted tax rates expected to apply when these differences reverse.Deferred tax assets are reduced by a valuation

 

7

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allowance when it is likely that they willnot be realized.  The deferred taxprovision is the result of changes in deferred tax assets and liabilities.

 

*Stock-Based Compensation*

 

The Company accounts for itsstock-based employee compensation plan under the recognition and measurementprinciples of Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees”, and related Interpretations.  No stock-based employee compensation cost(except for the compensation expense related to certain repriced options) isreflected in net loss, as all options granted under the plans had an exerciseprice equal to the market value of the underlying common stock at the date ofgrant.

 

During May 2003 the companygranted 79,998 common stock options to its nonemployee directors as part oftheir annual compensation for service to the Company.  Of the total options granted, 50,000 were granted from the 1998Outside Directors Stock Option Plan (a non-approved plan) and 29,998 were grantedfrom the 1998 Stock Option Plan.

 

For pro forma purposes, theestimated value of the Company’s stock-based awards to employees is amortizedover the options’ vesting period.  Thefollowing table illustrates the effect on net loss and net loss per share ifthe Company had applied the fair value recognition provisions of SFAS No. 123,“Accounting for Stock-Based Compensation”, to its stock-based employeecompensation for the three months and nine months ended September 30, 2003 and2002:

 
|                                                                                                                                         |   | **Three Months  Ended September 30,** |       | **Nine Months  Ended September 30,** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
|                                                                                                                                         |   | **2003**                              |       | **2002**                             |       | **2003** |   | **2002** |   |
|                                                                                                                                         |   |                                  | ** ** |                                 | ** ** |   | ** ** |   | ** ** |
| Net loss – as reported                                                                                                                  |   | $                                     | (216,202   | )                                    | $          | (129,650 | ) | $ | (828,607 | ) | $ | (753,838 | ) |
| Deduct stock option compensation income recognized  on repriced options                                                                      |   | (13,545                               | )          | —                               |       | (15,803 | ) | — |   |
| Deduct total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |   | (6,817                                | )          | (4,773                               | )          | (15,811 | ) | (14,559 | ) |
| Net loss – pro forma                                                                                                                    |   | $                                     | (236,564   | )                                    | $          | (134,423 | ) | $ | (860,221 | ) | $ | (739,279 | ) |
|                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Basic and diluted net loss per share – as reported                                                                                      |   | $                                     | (0.01      | )                                    | $          | (0.01 | ) | $ | (0.05 | ) | $ | (0.05 | ) |
| Basic and diluted net loss per share – pro forma                                                                                        |   | $                                     | (0.02      | )                                    | $          | (0.01 | ) | $ | (0.06 | ) | $ | (0.05 | ) |

 

*Earnings Per Share*

 

Basicearnings per share is computed by dividing net earnings or loss by the weightedaverage number of common shares outstanding during the period.  Diluted earnings per share is computed bydividing net earnings or loss by the weighted average number of sharesoutstanding, after giving effect to potentially dilutive common shareequivalents outstanding during the period. Potentially dilutive common share equivalents are not included in thecomputation of diluted earnings per share if they are anti-dilutive.  Diluted loss per common share is the same asbasic for all periods presented because the effect of potentially dilutivecommon shares arising from outstanding stock options and warrants wasanti-dilutive.  For the three monthsended September 30, 2003 and 2002, the potentially dilutive common

 

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shares were 67,612 and 0, respectively.  For the nine months ended September 30, 2003and 2002, the potentially dilutive common shares were 36,624 and 13,283,respectively.

 

*AccountingPronouncements*

 

In June 2001, the FASB issued SFAS No. 143, “Accounting for AssetRetirement Obligations”, which requires that the fair value of the liabilityfor asset retirement costs be recognized in an entity’s balance sheet, as botha liability and an increase in the carrying values of such assets, in theperiods in which such liabilities can be reasonably estimated.  It also requires allocation of such assetretirement cost to expense over its useful life.  The Company has adopted this statement, which is effective forfiscal years beginning after June 15, 2002. The cumulative effect of adopting this statement was to increase netloss for the nine months ended September 30, 2003 by $105,777, or less than$0.01 per common share.  The applicationof this statement is further described above under the caption *Property and Equipment*.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities andEquity”.  SFAS No. 150 establishesstandards for how an issuer classifies and measures certain freestandinginstruments with characteristics of both liabilities and equity.  SFAS No. 150 requires that an issuerclassify a financial instrument that is within its scope as a liability (or assetin some circumstances).  The Company adoptedSFAS No. 150 effective July 1, 2003. The adoption of this statement did not have a material effect on theCompany’s financial position, results of operations or cash flows.

 

*Use of Estimates*

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and the disclosureof contingent assets and liabilities at the date of the financial statementsand the reported amounts of revenues and expenses during the reportingperiod.  Actual results could differfrom those estimates.

 

**(3)**           Acquisitions and Divestitures

 

TheCompany made total capital expenditures of $1,944,559 in the nine months endedSeptember 30, 2003, primarily to construct the pipelines servicing theMadisonville Plant—a four-inch gathering line, a three-inch injection line andthe ten-inch pipeline to transport the pipeline quality gas (the “PipelineFacilities”).  As of September 30, 2003,the Pipeline Facilities were constructed and operational and the MadisonvillePlant was completing its start-up phase. See discussion of the Madisonville Plant in Note 5 and the projectfinancing in Note 4 to the consolidated financial statements.

 

TheCompany sold from its onshore segment 14 non-core natural gas gathering systemslocated in Texas, Oklahoma and Louisiana, effective August 1, 2002.  Cash of $839,000 was received at closing inthe third quarter of 2002, and a contingent payment of $20,806 was receivedNovember 12, 2003 based on the subsequent performance of the assets.  Additionally, effective September 30, 2002,the Company sold its interest in an onshore joint venture that owned a southTexas natural gas gathering system for $85,000 cash.  A net gain of $63,865 was recognized in the 2002 financialstatements in connection with these sales, and the contingent payment will berecognized as gain on sale in the fourth quarter.  A portion of the aggregate proceeds from the sales was used bythe Company to finance construction of the Pipeline Facilities.  The operations of the assets sold have beenpresented in the consolidated statement of operations as discontinued operationsfor the three months and nine months ended September 30, 2002.

 

9

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**(4)****          ****Debt**

 

*Notes Payable*

 

TheCompany’s operating line of credit agreement provided for maximum availableborrowings of $500,000 through June 2003. Interest was payable monthly at 5.3% per annum and principal was due ondemand, or if no demand was made, at maturity. The Company liquidated the $500,000 certificate of deposit which servedas collateral for the line and repaid the line of credit during June 2003.

 

The Company’s revolvingcredit agreement provides for maximum available borrowings of up to $250,000through May 22, 2004.  Principaloutstanding under the agreement accrues interest at a variable rate, based onthe bank’s prime rate index plus 1.25%, with a minimum rate of 8%.  The balance under the agreement is due upondemand, or if no demand is made, at maturity, and is renewable annually.  Costs of obtaining this debt are beingcharged to interest expense ratably over the maturity period of the note.  Fort Cobb uses the proceeds from time totime for general working capital purposes. The agreement, along with the Fort Cobb Term Note discussed below, iscollateralized with the assets of Fort Cobb and guaranteed by the Company.  The Company had $58,635 of available borrowingsunder the agreement as of September 30, 2003.

 

*Long-term Debt*

 

Long-termdebt at September 30, 2003 consisted of the following:

 
| Subordinated notes                  |   | $         | 222,797   |   |
|-------------------------------------|--------|-----------|-----------|--------|
| Term note – Fort Cobb          |   | 597,078   |      |
| Term note – Madisonville       |   | 1,500,000 |      |
| Balloon note – Madisonville    |   | 900,000   |      |
| Term note – Fort Cobb vehicles |   | 51,494    |      |
|                                |   | 3,271,369 |      |
| Less current maturities             |   | 862,663   |      |
|                                |   | $         | 2,408,706 |   |

 

*SubordinatedNotes*

 

Inconnection with the Recapitalization that was effective March 1, 1997, theCompany issued subordinated promissory notes with a face amount of$1,171,700.  The stated interest rate is10% payable quarterly with equal annual principal payments beginning on March1, 2000 and continuing through March 1, 2004. The Company calculated the fair market value of the notes to be $978,000at March 1, 1997 and recorded the difference between fair value and the faceamount as discount on subordinated notes. The discount is being amortized to interest expense using the interestmethod over the term of the subordinated notes.  Such charge to interest expense was $20,753 for the nine monthsended September 30, 2003 and 2002.  As aresult, the effective interest rate of the subordinated notes is 15%.

 

***TermNote – Fort Cobb***

** **

EffectiveJune 1, 2001, Fort Cobb borrowed $750,000 from a bank.  Principal outstanding under the note accruesinterest at a variable rate, based on the bank’s prime rate index plus 11⁄4%,with a minimum rate of 8%.  The interestrate at September 30, 2003 was 8%.  Thenote requires monthly payments of approximately $13,000, with the balance underthe note due June 1, 2008.  Costs ofobtaining this debt 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 Companyused the proceeds for general corporate purposes.

 

10

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***TermNote – Madisonville***

** **

Effective February 21, 2002,Gateway Pipeline Company and Gateway Processing Company (the “Borrowers”) enteredinto a term credit agreement with a bank. During July 2003 the agreement was amended, effective March 31, 2003, toextend the interest only period to September 30, 2003.  All other terms and conditions of theagreement, including the maturity date, remained the same.  Under the agreement, as amended effectiveMarch 31, 2003, the Borrowers borrowed $1.5 million in multiple advances.  The monthly note payments through September30, 2003 represent interest only at a fixed rate of 71⁄4%.  Thereafter the note requires 26 monthlypayments of principal and interest of $54,818.54, with a final payment ofunpaid principal, and accrued but unpaid interest due at the December 31, 2005maturity date.  Costs of securing this debtare being charged to interest expense ratably over the maturity period of thenote.  The Borrowers used the proceedsto finance the construction of the Pipeline Facilities.  The agreement is collateralized with theCompany’s economic interest in the Madisonville project and the Waxahachie pipelinesystem, and the Company has guaranteed the loan and pledged the common stock ofthe Borrowers.  The agreement containscross collateral and cross default provisions linking it to the Balloon Note,described below.

 

*BalloonNote – Madisonville*

 

Effective March 31, 2003,the Company entered into a balloon credit agreement (the “Balloon Note”).  Under the Balloon Note agreement, theBorrowers borrowed $900,000 in multiple advances.  Principal outstanding under the Balloon Note accrues interest ata fixed rate of 71⁄4% and the note will mature after thirty-six months.  The monthly note payments represent interestonly on the total balance outstanding.  Costs of securing this debt are being charged to interest expenseratably over the maturity period of the note. The Borrowers used the proceeds to finance the remaining constructioncosts of the Pipeline Facilities, and to fund the principal and interestpayments which were due under the Company’s subordinated note agreements onMarch 1, 2003.

 

The Balloon Note iscollateralized with letters of credit obtained through Allen DrillingAcquisition Company, a Nebraska corporation (“ADAC”).  Charles A. Holtgraves, a director of the Company, is Presidentand a director of ADAC, and Larry J. Horbach, a director of the Company, isSecretary and a director of ADAC.  Mr.Holtgraves owns directly no shares of ADAC common stock, and owns 14.65% of anentity that owns 55.56% of the ADAC senior preferred stock.  Such preferred stock has a stated dividendrate equal to two-thirds (66-2/3%) of any Madisonville payments received byADAC pursuant to the Agreement discussed below.  Mr. Horbach owns no ADAC common or preferred stock.

 

Under the terms of theagreement with ADAC, dated March 6, 2003 (the “Agreement”), ADAC agreed to providesecurity acceptable to the Company’s primary bank to allow the Company toborrow the proceeds of the Balloon Note. In exchange, ADAC will receive, during the term of the Balloon Note,one-half (50%) of the price upside portion only, if any, of the monthly fee tobe received by the Company pursuant to the Madisonville projectagreements.  Under the Agreement, ADACwill have the option to either: (i) receive at the end of the term of theBalloon Note a lump-sum payment, which when added to the payments received, ifany, for the price upside portion, will result in a 15% pre-tax internal rateof return on the $900,000, or (ii) pay off the Balloon Note on or before theend of the Balloon Note term in exchange for a one-third (33-1/3%) ownershipinterest in the Pipeline Facilities from that date forward.  The Company is obligated to pay the periodicinterest payments to the bank during the three-year term of the BalloonNote.  Further, the Company grantedliens, subordinate to the Company’s bank liens, on the Company’s economicinterest in the Madisonville project, its Waxahachie pipeline system, and itsFort

 

11

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Cobb subsidiary.  The agreement contains cross collateral and cross defaultprovisions linking it to the Madisonville Term Note, described above.

 

The Company believes that itis likely that ADAC will elect to pay off the Balloon Note in exchange for anownership interest in the Pipeline Facilities; however, it is beyond theCompany’s control.  Therefore, theminimum return guaranteed to ADAC by the Company is being accrued ratably overthe three-year term of the Balloon Note, and reduced by periodic price upsidepayments, if any, paid to ADAC.  Suchaccruals increased interest expense in the accompanying financial statements by$67,500 for the three months and nine months ended September 30 2003.  If ADAC elects to pay off the Balloon Noteat maturity or before, the reserve for the ADAC guarantee will be credited toincome.

 

*Term Note– Fort Cobb Vehicles*

 

Effective March 2003, FortCobb borrowed $57,900 from a bank to buy three replacement servicevehicles.  The note requires monthlyprincipal and interest payments of $1,386.50, reflecting interest at 6.99%, andmatures on March 25, 2007.

 

*Letters ofCredit*

 

As of September 30, 2003,the Company had outstanding letters of credit totaling $675,000.

 

**(5)****          ****Commitments and Contingencies**

 

In June 2001 the Companyannounced that Gateway Processing Company entered into a long-term agreementwith a producer to purchase non-pipeline quality natural gas near Madisonville,Texas.  Concurrently, Gateway Processingentered into an agreement with Hanover Compression Limited Partnership(“Hanover”), an affiliate of The Hanover Company, under which Hanover willtreat the gas to remove impurities from the gas to enable the gas to meetpipeline sales quality specifications.

 

Ofsignificance to Gateway, Hanover chose to employ the state-of-the-art,patented, absorption based technology developed by Advanced Extraction Technologies,Inc., for which Gateway has the exclusive U.S. license, to remove the nitrogenfrom the gas.

 

Hanover’sfacilities (the “Madisonville Plant”), designed initially to treat 18,000 Mcfper day, and the related Pipeline Facilities are now in production and arecompleting the start-up phase. Typically during this phase various process bottlenecks and mechanicalproblems are encountered, analyzed and repaired.  See Note 4 for a description of the Company’s financing relatedto this project.  In connection withsecuring the Balloon Note, the Company is obligated at ADAC’s option to either:(i) pay at the end of the term of the Balloon Note a lump-sum, which when addedto the payments made, if any, for the price upside portion, will result in ADACreceiving a 15% pre-tax internal rate of return on the $900,000, or (ii) conveyto ADAC a one-third (33-1/3%) ownership interest in the Pipeline Facilities inexchange for ADAC paying off the Balloon Note on or before the end of theBalloon Note term.  The Company isobligated to pay the periodic interest payments to the bank during thethree-year term of the Balloon Note.

 

The Company believes that itis likely that ADAC will elect to pay off the Balloon Note in exchange for anownership interest in the Pipeline Facilities; however, it is beyond theCompany’s control.  Therefore, theminimum return guaranteed to ADAC by the Company is being accrued ratably overthe three-year term of the Balloon Note, and reduced by periodic price upsidepayments, if any, paid to ADAC.  If ADACelects to pay off the Balloon Note at maturity or before, the reserve for theADAC guarantee will be credited to income.

 

12

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TheCompany and its subsidiaries are parties to litigation and claims arising inthe normal course of business. Management, after consultation with legal counsel, believes that theliabilities, if any, arising from such litigation and claims, will not bematerial to the consolidated financial statements.

 

13

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**(6)****          ****Segment Disclosures**

 

Allof the Company’s operations are in the domestic U.S. and the Gulf of Mexico inTexas and federal waters.  The Company’smanagement reviews and evaluates the operations separately of three mainsegments—Onshore Operations, Offshore Operations and Fort Cobb Operations.  Each segment is an aggregation of operationssubject to similar economic and regulatory conditions such that they are likelyto have similar long-term prospects for financial performance.  Onshore Operations include natural gasgathering, transportation and distribution activities in Texas andOklahoma.  Offshore Operations includenatural gas gathering and transportation activities in the Gulf of Mexico inTexas and federal waters.  Fort CobbOperations are comprised of a local natural gas distribution company inOklahoma.  This segment supplies naturalgas to approximately 2,350 customers, principally for irrigation and cropdrying fuel for farming cooperatives, and residential fuel.

 

During2002 the Company sold 14 of its onshore pipeline systems and its interest in ajoint venture that owned a south Texas natural gas gathering system (the “SoldProperties”), and the operating results of those properties are presented inthe accompanying statement of operations for the three months and nine monthsended September 30, 2002 as discontinued operations.  The figures for those periods presented below have been restatedto remove the operating results of the Sold Properties.

 

Theaccounting policies of the reportable segments are the same as those describedin Note 2 to the Consolidated Financial Statements.  The Company evaluates the segments based on operating margin,defined as revenues less cost of purchased gas and operating and maintenanceexpenses.  Such amounts are beforegeneral and administrative expense, depreciation, interest income or expense orincome taxes.  Inter-segment sales of$428,025 and $275,574 were eliminated during consolidation for the three monthsended September 30, 2003 and 2002. Inter-segment sales of $1,065,639 and $582,714 were eliminated duringconsolidation for the nine months ended September 30, 2003 and 2002.

 

Summarizedfinancial information of the Company’s reportable segments, and areconciliation of operating margin to consolidated net loss, is presentedbelow:

 
|                                                |   | **Three  Months Ended  September 30,** |       | **Nine  Months Ended  September 30,** |       |
|-----------------------------------------------------|--------|----------------------------------------|------------|---------------------------------------|------------|
|                                                |   | **2003**                               |       | **2002**                              |       | **2003** |   | **2002** |   |
| **Onshore Operations**                              |   |                                   |       |                                  |       |   |   |   |   |
| Revenues                                            |   | $                                      | 3,785,144  |                                  | $          | 1,077,020 |   | $ | 7,732,972 |   | $ | 2,802,724 |   |
| Operating margin                                    |   | 301,807                                |       | 148,751                               |       | 663,877 |   | 349,990 |   |
| Depreciation and amortization                       |   | 69,927                                 |       | 49,375                                |       | 178,025 |   | 146,385 |   |
| Total assets                                        |   | 5,996,246                              |       | 4,211,291                             |       | 5,996,246 |   | 4,211,291 |   |
|                                                |   |                                   |       |                                  |       |   |   |   |   |
| **Offshore Operations**                             |   |                                   |       |                                  |       |   |   |   |   |
| Revenues                                            |   | 170,182                                |       | 182,612                               |       | 478,253 |   | 590,777 |   |
| Operating margin                                    |   | 109,675                                |       | 125,609                               |       | 287,698 |   | 405,566 |   |
| Depreciation and amortization                       |   | 40,540                                 |       | 35,413                                |       | 112,390 |   | 106,239 |   |
| Total assets                                        |   | 1,721,543                              |       | 1,783,980                             |       | 1,721,543 |   | 1,783,980 |   |
|                                                |   |                                   |       |                                  |       |   |   |   |   |
| **Fort Cobb Operations**                            |   |                                   |       |                                  |       |   |   |   |   |
| Revenues                                            |   | 630,188                                |       | 539,280                               |       | 1,625,876 |   | 1,255,130 |   |
| Operating margin                                    |   | 138,819                                |       | 145,137                               |       | 308,102 |   | 295,583 |   |
| Depreciation and amortization                       |   | 48,501                                 |       | 48,298                                |       | 145,500 |   | 147,132 |   |
| Total assets                                        |   | 2,275,920                              |       | 2,255,653                             |       | 2,275,920 |   | 2,255,653 |   |
|                                                |   |                                   |       |                                  |       |   |   |   |   |
| **Total**                                           |   |                                   |       |                                  |       |   |   |   |   |
| Revenues                                            |   | 4,585,514                              |       | 1,798,912                             |       | 9,837,101 |   | 4,648,631 |   |
| Operating margin                                    |   | 550,301                                |       | 419,497                               |       | 1,259,677 |   | 1,051,139 |   |
| Depreciation and amortization                       |   | 158,968                                |       | 133,086                               |       | 435,915 |   | 399,756 |   |
| Total assets                                        |   | 9,993,709                              |       | 8,250,924                             |       | 9,993,709 |   | 8,250,924 |   |
|                                                |   |                                   |       |                                  |       |   |   |   |   |
| **Reconciliation to net loss**                      |   |                                   | ** ** |                                  | ** ** |   | ** ** |   | ** ** |
| Operating margin                                    |   | $                                      | 550,301    |                                  | $          | 419,497 |   | $ | 1,259,677 |   | $ | 1,051,139 |   |
| Depreciation and amortization                       |   | (158,968                               | )          | (133,086                              | )          | (435,915 | ) | (399,756 | ) |
| Accretion                                           |   | (102,081                               | )          | —                                |       | (102,081 | ) | — |   |
| General & administrative                        |   | (360,838                               | )          | (451,842                              | )          | (1,211,067 | ) | (1,433,681 | ) |
| Other income (expense), net                         |   | (144,616                               | )          | (34,533                               | )          | (233,444 | ) | (58,151 | ) |
| Discontinued operations                             |   | —                                 |       | 70,314                                |       | — |   | 86,611 |   |
| Cumulative effect of change in accounting principal |   | —                                 |       | —                                |       | (105,777 | ) | — |   |
| Net loss                                            |   | $                                      | (216,202   | )                                     | $          | (129,650 | ) | $ | (828,607 | ) | $ | (753,838 | ) |

 

14

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**(7)****          ****Subsequent Event**

 

OnOctober 29, 2003, the Company successfully mediated a dispute with avendor.   The accompanying balance sheetreflects invoices payable to this vendor totaling $182,706.  Under the terms of the settlement agreement,the Company is to pay the vendor $25,000 on December 1, 2003, and execute anote for $100,000, bearing no interest, payable in 18 monthly installments of$5,200 beginning January 1, 2004, and one final installment of $6,400 on July1, 2005.  Collateral for the note willbe the Company’s Crystal Beach terminal facility.

 

**Item 2.****           ****Management’s Discussion and Analysis of Financial Conditionand Results of Operations.**

 

Thefollowing management’s discussion and analysis contains trend analysis andother forward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended.  Actual resultscould differ materially from those projected in the forward-looking statementsthroughout this document as a result of the risk factors set forth below in thesection entitled *Factors Affecting Future Results* and elsewhere in thisdocument.

 

**Critical Accounting Policies**

** **

Thefollowing accounting policies are considered by management to be the mostcritical to the fair presentation of the Company’s financial condition, resultsof operations and cash flows.  Thepolicies are consistently applied in the preparation of the accompanyingconsolidated financial statements; however, certain reclassifications have beenmade to the prior period statements to be consistent with the current presentation.

 

***RevenueRecognition Policy***

** **

TheCompany’s sales revenues are generated under back-to-back purchase and salescontracts.  Sales revenues arerecognized at the redelivery point, which is the point at which title to thegas transfers.  The Company’stransportation revenues are generated under contracts which have a stated feeper unit of production (Mcf, MMBtu, or Bbl) gathered or transported.  Transportation revenues are recognized atthe

 

15

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redelivery point, which is the point at whichanother party takes physical custody of the gas or liquid hydrocarbons.

 

*Propertyand Equipment*

 

Propertyand equipment is stated at cost, plus capitalized interest costs on majorpipeline projects during their construction period.  Additions and improvements that add to the productive capacity orextend the useful life of an asset are capitalized.  Expenditures for maintenance and repairs are charged to expenseas incurred.  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.

 

Impairmentlosses are recognized for long-lived assets used in operations when indicatorsof impairment are present and the undiscounted cash flows are not sufficient torecover the assets’ carrying value.  Theamount of impairment is measured by comparing the fair value of the asset toits carrying amount.

 

The Company provides forthe future asset retirement obligations related to the Shipwreck offshoreproduction platform because, eventually, law or regulation will require itsabandonment.  The present value of theestimated future asset retirement obligation, as of the date of acquisition,was capitalized to gas gathering,processing and transportation equipment.  The present value of the estimated future asset retirementobligation, as of the balance sheet date, is presented as a noncurrentliability.  Until the platform isultimately sold or retired, the Company will recognize (i) depreciation expenseon the additional capitalized costs; (ii) accretion expense as the presentvalue of the future asset retirement obligation increases with the passage oftime, and; (iii) the impact, if any, of changes in estimates of theliability.  The following table setsforth a reconciliation of the beginning and ending aggregate carrying amount ofasset retirement obligations for the nine months ended September 30, 2003:

 
| Beginning balance                  |   | $      | 202,007 |   |
|------------------------------------|--------|--------|---------|--------|
| Accretion                          |   | 10,854 |    |
| Revisions  in estimated cash flows |   | 81,356 |    |
| Ending  balance                    |   | $      | 294,217 |   |

 

The pro forma amounts onthe income statement show the effects of retroactive application of thestatement on loss from continuing operations and net loss as if the new methodwas already in effect prior to the periods presented.

 

*AccountingPronouncements*

 

In June 2001, the FASBissued SFAS No. 143, “Accounting for Asset Retirement Obligations”, whichrequires that the fair value of the liability for asset retirement costs berecognized in an entity’s balance sheet, as both a liability and an increase inthe carrying values of such assets, in the periods in which such liabilitiescan be reasonably estimated.  It alsorequires allocation of such asset retirement cost to expense over its usefullife.  The Company has adopted thisstatement, which is effective for fiscal years beginning after June 15,2002.  The cumulative effect of adoptingthis statement was to increase net loss for the nine months ended September 30,2003 by $105,777, or less than $0.01 per common share.  The application of this statement is furtherdescribed above under the caption *Propertyand Equipment*.

 

In May 2003, the FASB issuedSFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity”.  SFAS No. 150 establishes standards for how an issuer classifiesand measures certain freestanding instruments with characteristics of bothliabilities and equity.  SFAS No. 150requires that an issuer classify a financial instrument that is within itsscope as a liability (or asset in some circumstances).  The Company adopted SFAS No. 150 effectiveJuly 1, 2003.

 

16

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The adoption of this statement did not have amaterial effect on the Company’s financial position, results of operations orcash flows.

 

***OtherAssets***

** **

TheCompany’s primary other asset, its license for a patented process to removenitrogen from streams of natural gas, is being amortized to expense over thelife of the underlying patents.  Thelatest of these patents expires in 2014.

 

*Use of Estimates*

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts 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.

 

**Results of Operations**

 

***General***

** **

TheHenry Hub closing index price for natural gas during the nine months endedSeptember 30, 2003 averaged $5.65 per MMBtu, compared to $4.94 for the sameperiod of the prior year.  In theaccompanying financial statements, the Company’s revenues from sales of naturalgas, along with the cost of purchased gas, increased proportionately from prioryear levels.  Because the Company buysand sells gas under “back-to-back” purchase and sale contracts designed tominimize commodity price risk, the Company’s net operating margin is relativelyinsensitive to fluctuations in the market price of gas.  Accordingly, the Company evaluates each ofits activities based on the operating margin it produces.  The Company defines operating margin asrevenues, less the cost of purchased gas and operating and maintenanceexpenses.  Management reviews andevaluates the operations of three main segments—Onshore operations, Offshoreoperations and Fort Cobb operations.

 

During2002 the Company sold 14 of its onshore pipeline systems and its interest in ajoint venture that owned a south Texas natural gas gathering system (the “SoldProperties”), and the operating results of those properties are presented inthe accompanying statement of operations for the three months and nine monthsended September 30, 2002 as discontinued operations.  The figures for those periods presented below have been restatedto remove the operating results of the Sold Properties.

 

# **ThreeMonths Ended September 30, 2003 Compared to September 30, 2002**

#  

# *TotalOperations*

#  

Thefollowing table sets forth information for the three months ended September 30,2003 and 2002:

 
|                          |   | **2003** |      | **2002** |   |
|-------------------------------|--------|----------|-----------|----------|--------|
| Revenues                      |   | $        | 4,585,514 |     | $      | 1,798,912 |   |
| Operating margin              |   | 550,301  |      | 419,497  |   |
| Depreciation and amortization |   | 158,968  |      | 133,086  |   |
|                               |        |          |           |          |        |  |  |

 

Operatingmargin for the three months ended September 30, 2003 increased $131,000compared to the same period of the prior year. Onshore operating margin increased $153,000, Offshore operating margindecreased $16,000, and Fort Cobb operating margin decreased $6,000.  Revenues were higher for the period due tohigher sale and transport volumes and stronger natural gas prices.  The average Henry Hub index price was $4.98for the three months, compared to $4.76 for the prior period.  These segments are discussed individuallybelow in greater detail.

 

17

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# *OnshoreOperations*

#  

Thefollowing table sets forth information for the three months ended September 30,2003 and 2002:

 
|                          |   | **2003** |      | **2002** |   |
|-------------------------------|--------|----------|-----------|----------|--------|
| Revenues                      |   | $        | 3,785,144 |     | $      | 1,077,020 |   |
| Operating margin              |   | 301,807  |      | 148,751  |   |
| Depreciation and amortization |   | 69,927   |      | 49,375   |   |
|                               |        |          |           |          |        |  |  |

 

Operatingmargin for Onshore operations increased by $153,000 from the same period of theprior year, mainly due to the impact of the Madisonville pipeline facilitieswhich started operations during second quarter 2003.

 

# *OffshoreOperations*

#  

Thefollowing table sets forth information for the three months ended September 30,2003 and 2002:

 
|                          |   | **2003** |    | **2002** |   |
|-------------------------------|--------|----------|---------|----------|--------|
| Revenues                      |   | $        | 170,182 |     | $      | 182,612 |   |
| Operating margin              |   | 109,675  |    | 125,609  |   |
| Depreciation and amortization |   | 40,540   |    | 35,413   |   |
|                               |        |          |         |          |        |  |  |

 

Operatingmargin for Offshore operations decreased in the third quarter by $16,000 fromthe same period of the prior year. The decrease was primarily due to declinesin natural gas and liquids volumes transported for producers in the areas ofGalveston Blocks 190L and 213L, and High Island Block 98L.

 

# *Fort CobbOperations*

#  

Thefollowing table sets forth information for the three months ended September 30,2003 and 2002:

 
|                          |   | **2003** |    | **2002** |   |
|-------------------------------|--------|----------|---------|----------|--------|
| Revenues                      |   | $        | 630,188 |     | $      | 539,280 |   |
| Operating margin              |   | 138,819  |    | 145,137  |   |
| Depreciation and amortization |   | 48,501   |    | 48,298   |   |
|                               |        |          |         |          |        |  |  |

 

Operatingmargin for Fort Cobb operations decreased $6,000 in the three months endedSeptember 30, 2003 from the same period of the prior year mainly due to 17%lower delivered volumes.  Fort Cobb’sbusiness normally peaks in the third and fourth quarters because a significantportion of its load comes from supplying natural gas to irrigation andcrop-drying customers.

 

# *Reconciliationof Operating Margin to Net Loss*

#  

Thefollowing table sets forth information for the three months ended September 30,2003 and 2002:

 
|                          |   | **2003** |     | **2002** |   |
|-------------------------------|--------|----------|----------|----------|--------|
| Operating margin              |   | $        | 550,301  |     | $      | 419,497 |   |
| Depreciation and amortization |   | (158,968 | )        | (133,086 | )      |
| Accretion                     |   | (102,081 | )        | —   |   |
| General and administrative    |   | (360,838 | )        | (451,842 | )      |
| Interest income               |   | 1,166    |     | 10,260   |   |
| Interest expense              |   | (139,228 | )        | (63,509  | )      |
| Interest capitalized          |   | —   |     | 18,837   |   |
| Other income (expense), net   |   | (6,554   | )        | (121     | )      |
| Discontinued operations       |   | —   |     | 70,314   |   |
| Net loss                      |   | $        | (216,202 | )        | $      | (129,650 | ) |

 

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Accretionexpense for the three months ended September 30, 2003 included $81,356recognized in connection with changes in estimated future asset retirementcosts.

 

Generaland administrative expenses for the quarter are 20% lower than for the sameperiod of last year.  The decrease wasprimarily due to lower salaries, employee related and other costs, includingthe non-cash impact of a downward revaluation of employee stock options thatwere repriced in 1999.  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.

 

Interestincome varies directly with the balance on deposit in the Company’s certificatesof deposit and short-term money market accounts.  Interest expense fluctuates directly with the amount ofoutstanding long-term debt and the amount of borrowings under the Company’srevolving credit agreement.  Interestexpense of $18,837 related to the Madisonville term loan was capitalized duringthe three months ended September 30, 2002. Interest expense for the three months ended September 30, 2003 included$67,500 recognized in connection with the reserve for the ADAC guarantee.

 

Otherincome (expense), net for the period includes mainly the write-off ofuncollectible accounts receivable.

 

# **Nine MonthsEnded September 30, 2003 Compared to September 30, 2002**

#  

# *TotalOperations*

#  

Thefollowing table sets forth information for the nine months ended September 30,2003 and 2002:

 
|                          |   | **2003**  |      | **2002**  |   |
|-------------------------------|--------|-----------|-----------|-----------|--------|
| Revenues                      |   | $         | 9,837,101 |      | $      | 4,648,631 |   |
| Operating margin              |   | 1,259,677 |      | 1,051,139 |   |
| Depreciation and amortization |   | 435,915   |      | 399,756   |   |
|                               |        |           |           |           |        |  |  |

 

Operatingmargin for the nine months ended September 30, 2003 increased $209,000 comparedto the same period of the prior year. Onshore operating margin increased $314,000, Fort Cobb operating marginincreased $13,000, and Offshore operating margin decreased $118,000.  Revenues were higher for the period due tohigher sale and transport volumes and stronger natural gas prices.  The average Henry Hub index price was $5.65for the nine months, compared to $4.94 for the prior period.  Operating margins were not proportionallyaffected due to the corresponding increase in the cost of purchased gas.  These segments are discussed individuallybelow in greater detail.

 

# *OnshoreOperations*

#  

Thefollowing table sets forth information for the nine months ended September 30,2003 and 2002:

 
|                          |   | **2003** |      | **2002** |   |
|-------------------------------|--------|----------|-----------|----------|--------|
| Revenues                      |   | $        | 7,732,972 |     | $      | 2,802,724 |   |
| Operating margin              |   | 663,877  |      | 349,990  |   |
| Depreciation and amortization |   | 178,025  |      | 146,385  |   |
|                               |        |          |           |          |        |  |  |

 

Operatingmargin for onshore operations increased $314,000 in the nine months endedSeptember 30, 2003 from the same period of the prior year, mainly due to theimpact of the Madisonville pipeline facilities which started operations duringsecond quarter 2003.

 

# *OffshoreOperations*

#  

Thefollowing table sets forth information for the nine months ended September 30,2003 and 2002:

 

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|                          |   | **2003** |    | **2002** |   |
|-------------------------------|--------|----------|---------|----------|--------|
| Revenues                      |   | $        | 478,253 |     | $      | 590,777 |   |
| Operating margin              |   | 287,698  |    | 405,566  |   |
| Depreciation and amortization |   | 112,390  |    | 106,239  |   |
|                               |        |          |         |          |        |  |  |

 

Operating margin forOffshore operations decreased $118,000 in the nine months ended September 30,2003 from the same period of the prior year. The decrease was primarily due to declines in natural gas and liquidsvolumes transported for producers in the areas of Galveston Blocks 190L and213L,and High Island Block 98L.

 

# *Fort CobbOperations*

 

Thefollowing table sets forth information for the nine months ended September 30,2003 and 2002:

 
|                          |   | **2003** |      | **2002** |   |
|-------------------------------|--------|----------|-----------|----------|--------|
| Revenues                      |   | $        | 1,625,876 |     | $      | 1,255,130 |   |
| Operating margin              |   | 308,102  |      | 295,583  |   |
| Depreciation and amortization |   | 145,500  |      | 147,132  |   |
|                               |        |          |           |          |        |  |  |

 

Operatingmargin for Fort Cobb operations increased $13,000 in the nine months endedSeptember 30, 2003 from the same period of the prior year.  A small decrease in delivered volumes wasmore than offset by a reduction in operating costs.  Fort Cobb’s business normally peaks in the third and fourthquarters because a significant portion of its load comes from supplying naturalgas to irrigation and crop-drying customers.

 

# *Reconciliationof Operating Margin to Net Loss*

#  

Thefollowing table sets forth information for the nine months ended September 30,2003 and 2002:

 
|                                                 |   | **2003**   |      | **2002**   |   |
|------------------------------------------------------|--------|------------|-----------|------------|--------|
| Operating margin                                     |   | $          | 1,259,677 |       | $      | 1,051,139 |   |
| Depreciation and amortization                        |   | (435,915   | )         | (399,756   | )      |
| Accretion                                            |   | (102,081   | )         | —     |   |
| General and administrative                           |   | (1,211,067 | )         | (1,433,681 | )      |
| Interest income                                      |   | 13,791     |      | 37,273     |   |
| Interest expense                                     |   | (279,974   | )         | (170,293   | )      |
| Interest capitalized                                 |   | 24,466     |      | 37,395     |   |
| Gain on disposal of assets                           |   | 5,807      |      | —     |   |
| Other income (expense), net                          |   | 2,466      |      | 37,474     |   |
| Discontinued operations                              |   | —     |      | 86,611     |   |
| Cumulative effect of change in accounting  principal |   | (105,777   | )         | —     |   |
| Net loss                                             |   | $          | (828,607  | )          | $      | (753,838 | ) |

 

Accretion for the ninemonths ended September 30, 2003 included $81,356 recognized in connection withchanges in estimated future asset retirement costs.

 

General and administrativeexpenses decreased 16% in the nine months ended September 30, 2003 compared tothe same period of the prior year.  Thedecrease was primarily due to lower salaries, employee related and other costs.

 

Interest income variesdirectly with the balance on deposit in the Company’s certificates of depositand short-term money market accounts. Interest expense fluctuates directly with the amount of outstandinglong-term debt and the amount of borrowings under the Company’s revolvingcredit agreement.  Interest expense of$24,466 and $37,395 related to the Company’s Madisonville term loan

 

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was capitalized during the nine months endedSeptember 30, 2003 and 2002.  Interestexpense for the nine months ended September 30, 2003 included $67,500recognized in connection with the reserve for the ADAC guarantee.

 

Other income for the periodsincludes refunds, late fees and penalties charged by Fort Cobb andmiscellaneous adjustments.

 

## **Liquidity and Capital Resources**

##  

Going forward, the Company’sstrategy is to maximize the potential of currently owned properties, toconstruct new pipeline systems and treating facilities, and to acquireproperties that meet its economic performance hurdles.  The Company is assessing its future cashflow requirements and is developing a plan of action to ensure that its needsare met.

 

The Company sold 14 non-coreonshore natural gas gathering systems located in Texas, Oklahoma and Louisiana,effective August 1, 2002.  Cash of$839,000 was received at closing, and a contingent payment of $20,806 wasreceived November 12, 2003 based on the subsequent performance of theassets.  Additionally, the Company soldits interest in an onshore joint venture that owned a south Texas natural gasgathering system for $85,000.  The saleof these non-core assets (approximately 58 miles of pipeline) was part of anoverall strategy begun several years ago to rationalize the Company’s assetbase, sell those that are non-core and focus on and expand those that generatethe most cash flow and/or provide the greatest growth potential.  The Company has cash and cash equivalentsand certificates of deposit totaling $249,576 at September 30, 2003.

 

TheCompany’s operating line of credit agreement provided for maximum availableborrowings of $500,000 through June 2003. Interest was payable monthly at 5.3% per annum and principal was due ondemand, or if no demand was made, at maturity. The Company liquidated the $500,000 certificate of deposit which servedas collateral for the line and repaid the line of credit during June 2003.

 

The Company’s revolvingcredit agreement provides for maximum available borrowings up to $250,000through May 22, 2004.  Principaloutstanding under the agreement accrues interest at a variable rate, based onthe bank’s prime rate index plus 11⁄4%, with a minimum rate of 8%.  The balance under the agreement is due upondemand, or if no demand is made, at maturity and is renewable annually.  Fort Cobb uses the proceeds from time totime for general working capital purposes. The agreement is collateralized withthe assets of Fort Cobb, and guaranteed by the Company.  The Company had $58,635 of availableborrowings under the agreement as of September 30, 2003.

 

Effective June 1, 2001, Fort Cobb borrowed $750,000 from a bank.  Principal outstanding under the note accruesinterest at a variable rate, based on the bank’s prime rate index plus 11⁄4%,with a minimum rate of 8%.  The noterequires monthly payments of approximately $13,000, with the balance under thenote due June 1, 2008.  Fort Cobb usedthe proceeds to refinance its borrowings.

 

Effective February 21, 2002, Gateway Pipeline Company and GatewayProcessing Company (the “Borrowers”) entered into a term credit agreement witha bank.  During July 2003 the agreementwas amended, effective March 31, 2003, to extend the interest only period toSeptember 30, 2003.  All other terms andconditions of the agreement, including the maturity date, remained the same.  Under the agreement, as amended effectiveMarch 31, 2003, the Borrowers borrowed $1.5 million in multiple advances.  The monthly note payments through September30, 2003 represent interest only at a fixed rate of 71⁄4%.  Thereafter the note requires 26 monthlypayments of principal and interest of $54,818.54, with a final payment ofunpaid principal, and accrued but unpaid interest due at the December 31, 2005maturity date.  Costs of securing thisdebt are being charged to interest expense ratably over the maturity period ofthe note.  The Borrowers used theproceeds to finance the construction of the Pipeline Facilities.  The agreement is collateralized with theCompany’s economic interest in the Madisonville project and the Waxahachiepipeline system, and the Company has guaranteed the loan and pledged the commonstock of the Borrowers.  The agreementcontains cross collateral and cross default provisions linking it to theBalloon Note, described below.

 

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Effective March 31, 2003, the Company entered into a balloon creditagreement (the “Balloon Note”).  Underthe Balloon Note agreement, the Borrowers borrowed $900,000 in multipleadvances.  Principal outstanding underthe Balloon Note accrues interest at a fixed rate of 71⁄4% and the note will matureafter thirty-six months.  The monthlynote payments represent interest only on the total balance outstanding.  Costs of securing this debt will be chargedto interest expense ratably over the maturity period of the note.  The Borrowers used the proceeds to financethe remaining construction costs of the Pipeline Facilities, and to fund theprincipal and interest payments which were due under the Company’s subordinatednote agreements on March 1, 2003.

 

The Balloon Note is collateralized with letters of credit obtainedthrough Allen Drilling Acquisition Company, a Nebraska corporation(“ADAC”).  Charles A. Holtgraves, adirector of the Company, is President and a director of ADAC, and Larry J.Horbach, a director of the Company, is Secretary and a director of ADAC.  Mr. Holtgraves owns directly no shares ofADAC common stock, and owns 14.65% of an entity that owns 55.56% of the ADACsenior preferred stock.  Such preferredstock has a stated dividend rate equal to two-thirds (66-2/3%) of anyMadisonville payments received by ADAC pursuant to the Agreement discussedbelow.  Mr. Horbach owns no ADAC commonor preferred stock.

 

Under the terms of theagreement with ADAC, dated March 6, 2003 (the “Agreement”), ADAC agreed toprovide security acceptable to the Company’s primary bank to allow the Companyto borrow the proceeds of the Balloon Note. In exchange, ADAC will receive, during the term of the Balloon Note,one-half (50%) of the price upside portion only, if any, of the monthly fee tobe received by the Company pursuant to the Madisonville projectagreements.  Under the Agreement, ADAChas the option to either: (i) receive at the end of the term of the BalloonNote a lump-sum payment, which when added to the payments received, if any, forthe price upside portion, will result in a 15% pre-tax internal rate of returnon the $900,000, or (ii) pay off the Balloon Note on or before the end of theBalloon Note term in exchange for a one-third (33-1/3%) ownership interest inthe Pipeline Facilities from that date forward.  The Company is obligated to pay the periodic interest payments tothe bank during the three-year term of the Balloon Note.  Further, the Company granted liens, subordinateto the Company’s bank liens, on the Company’s economic interest in the Madisonvilleproject, its Waxahachie pipeline system, and its Fort Cobb subsidiary.

 

The Company believes that it is likely that ADAC will elect to pay offthe Balloon Note in exchange for an ownership interest in the PipelineFacilities; however, it is beyond the Company’s control.  Therefore, the minimum return guaranteed toADAC by the Company is being accrued ratably over the three-year term of theBalloon Note, and reduced by periodic price upside payments, if any, paid toADAC.  If ADAC elects to pay off theBalloon Note at maturity or before, the reserve for the ADAC guarantee will becredited to income.

 

Effective March 2003, Fort Cobb borrowed $57,900 from a bank to buythree replacement service vehicles.  Thenote requires monthly principal and interest payments of $1,386.50, reflectinginterest at 6.99%, and matures on March 25, 2007.

 

Absent significantacquisitions or development projects, the Company will continue to fund itsoperations through internally generated funds and available cash and bankborrowings as needed.  The Companybelieves its cash flows from such sources will be sufficient to fund itsongoing operations for the foreseeable future. Any significant property acquisitions or development projects willrequire outside project financing.

 

At September 30, 2003, theCompany’s long-term debt to total capitalization was approximately 35%.

 

On October 29, 2003, theCompany successfully mediated a dispute with a vendor.   The accompanying balance sheet reflectsinvoices payable to this vendor totaling $182,706.  Under the terms of the settlement agreement, the Company is topay the vendor $25,000 on December 1, 2003, and

 

22

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execute a note for $100,000, bearing nointerest, payable in 18 monthly installments of $5,200 beginning January 1,2004, and one final installment of $6,400 on July 1, 2005.  Collateral for the note will be theCompany’s Crystal Beach terminal facility.

 

Natural gas prices asrepresented by the NYMEX Henry Hub index averaged $5.65 and $4.94 for the ninemonths ended September 30, 2003 and 2002. The natural gas industry is generally optimistic about long-termprospects based on expected demand, the cost of developing prospects and thesales price of natural gas.  The Company’soperating margin is not directly affected by the price of natural gas since gasgathering and transportation are generally based on  fee arrangements and sales are made under back-to-back purchaseand sales arrangements.  However,natural gas prices can affect exploration and development and result in higheror lower volumes available for gathering and transportation.

 

**Off-BalanceSheet Arrangements**

 

In connection with the saleof 14 non-core natural gas gathering systems located in Texas, Oklahoma andLouisiana effective August 1, 2002, the Company received a contingent paymentof $20,806 on November 12, 2003 based on the subsequent performance of theassets.

 

In connection with securingthe Balloon Note, the Company will be obligated at ADAC’s option to either: (i)pay at the end of the term of the Balloon Note a lump-sum, which when added tothe payments made, if any, for the price upside portion, will result in ADACreceiving a 15% pre-tax internal rate of return on the $900,000, or (ii) conveyto ADAC a one-third (33-1/3%) ownership interest in the Pipeline Facilities inexchange for ADAC paying off the Balloon Note on or before the end of theBalloon Note term.

 

**Factors Affecting Future Results**

 

The principal objective ofthe 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.

 

The Company is actively pursuing several projects that will employ itsnitrogen rejection technology.  TheCompany has a technological advantage in this niche, due to its exclusive U.S.license for the nitrogen rejection process. The Company’s process competes favorably with other processes, as it cancost effectively adapt to variable gas flow rates and variable levels ofnitrogen content in the gas.  And,unlike the major competing process, it is unaffected by the presence of carbondioxide in the gas.  It can thereforeeconomically treat relatively small volumes of gas—as little as 5,000 Mcf perday—where variable gas flow and composition is common.  Successful completion of these projects willdepend upon the ability of the Company to market the technology to the producercommunity, and to obtain financing on terms satisfactory to the Company forconstruction of nitrogen rejection plants and/or acquisition of workinginterests in the high nitrogen properties.

 

High nitrogen gas is natural gas that contains nitrogen, in excess ofthe maximum percentage (usually 4%) by volume of total inerts acceptable tomost pipeline companies.  About 16% ofthe domestic natural gas resource base (approximately 24 Tcf of provenreserves) is estimated by the Gas Technology Institute to be subquality becauseof the nitrogen content.  Most of thecountry’s current high nitrogen natural gas production is located insouthwestern Kansas; however, there are substantial high nitrogen natural gasreserves in other parts of the country. The Company’s target projects are located in geographic areas with wellknown concentrations of high nitrogen natural gas reserves.  Much of this high nitrogen natural gasremains undeveloped or shut-in because it cannot meet pipeline qualityspecifications and it is geographically separated from the large (100,000 Mcfper day or larger) cryogenic nitrogen rejection plants located primarily inKansas.  The Company’s process is wellsuited to treat these “stranded” reserves.

 

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Creation of long-term valuefor the common stockholder depends in part upon successful acquisition orconstruction of additional assets which will add to cash flows and generateattractive returns.  Access toreasonably priced long-term capital will significantly impact the Company’sability to acquire or construct additional properties, enabling overhead coststo be spread over a larger asset base. There are many companies participatingin the midstream segment of the natural gas industry, many with resourcesgreater than the Company. Greater competition for profitable operations canincrease prices and make it more difficult to acquire assets at reasonablemultiples of cash flow.  However, muchof the Company’s focus is on high nitrogen natural gas projects where there islimited competition.  Such projects willhave to be developed or constructed using creative financing methods.  The Company believes that, with itsexperienced personnel and its licensed nitrogen rejection process, it will beable to compete in this environment and will be able to find and financeattractive investments which will compliment its existing properties.

 

Operations are significantlyaffected by factors which are outside the Company’s control.  Gas gathering and processing revenues aredependent on throughput volume.  Pipelinethroughput is dependent on natural gas production which is significantlyaffected by natural gas prices as prices affect the willingness of producers toinvest the required capital to obtain geological and geophysical information,to drill development or exploratory wells, and to rework or maximize productionon existing wells. Natural gas prices are currently at levels which shouldprovide adequate incentive to producers; however, there is no assurance thatsuch prices will remain at current levels, and that producers will reactpositively to the current prices.

 

Natural gas retail sales areaffected by weather. Much of the retail demand is for crop irrigation anddrying.  Above normal precipitation inthe growing season and hot, dry weather in the fall can significantly reducedemand for natural gas on the Fort Cobb distribution system.

 

**Forward-Looking Statements – Safe Harbor Provisions**

 

This report contains certainforward-looking statements intended to be covered by the safe harbors providedunder Federal securities law and regulation. To the extent such statements are not recitations of historical fact,forward-looking statements involve risks and uncertainties.  Where the company expresses an expectationor belief as to future results or events, such expression is made in good faithand believed to have a reasonable basis in fact.  However, there can be no assurance that such expectation orbelief will actually result or be achieved.

 

**Item 3.  Controlsand Procedures**

 

As of November 14, 2003, underthe supervision and with the participation of the Company’s Chief ExecutiveOfficer and the Chief Financial Officer, management has evaluated theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures.  Based upon thatevaluation, the Chief Executive Officer and the Chief Financial Officerconcluded that the Company’s disclosure controls and procedures were effectiveas of that date.  There were nosignificant changes in the Company’s internal controls during the fiscalquarter covered by this report that have materially affected, or are reasonablylikely to materially affect, the Company’s internal control over financialreporting.

 

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###### **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:

 

11            Statement Regarding Computation of Per ShareEarnings

31.1         Section 302 Certification of Chief Executive Officer

31.2         Section 302 Certification of Chief Financial Officer

32.1         Section 906 Certification of Chief Executive Officer

32.2         Section 906 Certification of Chief Financial Officer

 

b)    Reports on Form 8-K:

August14, 2003 – Selected financial results for the quarter ended June 30, 2003.

 

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15 (d) of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|               | /s/ Michael T.  Fadden                 |                                   | /s/ Scott D.  Heflin |   |
|--------------------|----------------------------------------|----------------------------------------|----------------------|--------|
|               | Chief Executive Officer and  President | Chief Financial Officer and  Treasurer |
|               |                                   |
| November  14, 2003 |                                   |                                   |
| (Date)             |                                   |
|                    |                                        |                                        |                      |        |  |

 

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