** **

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

**Washington, D.C.  20549**

 

**FORM 10-QSB**

 

| **ý****  QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15 (D)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-----------------------------------------------------------------------------------------------------------------|
|                                                                                                            |
| **For the quarterly period ended March 31,  2004**                                                              |
|                                                                                                            |
| **o****  TRANSITION REPORT UNDER SECTION 13 OR  15(d) OF THE EXCHANGE ACT**                                |
|                                                                                                            |
| **For the transition period from  to**                                                                          |

 

**Commission FileNo.     ****0-6404**

 

**GATEWAY ENERGY CORPORATION**

(Exact name 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)

 

Check whether the issuer (1) filed all reports required to be filed bySection 13 or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days. Yes  ý No o

 

**APPLICABLE ONLY TO CORPORATE ISSUERS**

 

As of May 5, 2004, the Issuer had 15,686,039 shares of its common stockoutstanding.

 

Transitional Small Business Disclosure Format:  Yes    o    No    ý    

 

 

----

 

**FORM 10-QSB**

**Part I**

 
| **Item   1.** | **Financial Statements**                                                                                       |   |
|--------------------|----------------------------------------------------------------------------------------------------------------|--------|
|               |                                                                                                           |   |
|               | Unaudited Consolidated Balance Sheet  as of March 31, 2004                                                     |   |
|               |                                                                                                           |   |
|               | Unaudited Consolidated Statements of  Operations  for the three months ended March 31, 2004  and March 31,2003 |   |
|               |                                                                                                           |   |
|               | Unaudited Consolidated Statements of Cash  Flows  for the three months ended March 31, 2004  and March 31,2003 |   |
|               |                                                                                                           |   |
|               | Notes to Unaudited Consolidated Financial  Statements                                                          |   |

 

2

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**GATEWAY ENERGY CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEET**

**March 31, 2004**

**(Unaudited)**

 
| **ASSETS**                                                                                                    |   |        |      |
|---------------------------------------------------------------------------------------------------------------|--------|-------------|-----------|
| Current  Assets                                                                                               |   |        |      |
| Cash and cash equivalents                                                                                     |   | $           | 309,671   |   |
| Certificate of deposit                                                                                        |   | 5,745       |      |
| Trade accounts receivable                                                                                     |   | 1,062,453   |      |
| Inventories, at average cost                                                                                  |   | 49,374      |      |
| Prepaid expenses and other  assets                                                                            |   | 106,122     |      |
| Total current assets                                                                                          |   | 1,533,365   |      |
|                                                                                                          |   |        |      |
| Property  and Equipment, at cost                                                                              |   |        |      |
| Gas gathering, processing and  transportation                                                                 |   | 10,313,846  |      |
| Office furniture and other  equipment                                                                         |   | 815,566     |      |
|                                                                                                          |   | 11,129,412  |      |
| Less accumulated depreciation and amortization                                                                |   | 3,826,871   |      |
|                                                                                                          |   | 7,302,541   |      |
| Other  Assets                                                                                                 |   |        |      |
| Investment in AET license, net  of accumulated  amortization  of $128,367                                     |   | 292,683     |      |
| Other                                                                                                         |   | 135,788     |      |
|                                                                                                          |   | 428,471     |      |
|                                                                                                          |   | $           | 9,264,377 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                |   |        |      |
| Current  Liabilities                                                                                          |   |        |      |
| Accounts payable                                                                                              |   | $           | 1,098,538 |   |
| Accrued expenses and other  liabilities                                                                       |   | 100,299     |      |
| Notes payable                                                                                                 |   | 182,388     |      |
| Current maturities of long-term  debt                                                                         |   | 926,715     |      |
| Current maturities of capital  lease                                                                          |   | 9,798       |      |
| Total current liabilities                                                                                     |   | 2,317,738   |      |
|                                                                                                          |   |        |      |
| Noncurrent  Liabilities                                                                                       |   |        |      |
| Future asset retirement  obligations                                                                          |   | 304,578     |      |
| Payable to ADAC                                                                                               |   | 110,791     |      |
|                                                                                                          |   | 415,369     |      |
|                                                                                                          |   |        |      |
| Long-term  debt, less current maturities                                                                      |   | 2,144,847   |      |
| Long-term  capital lease, less current maturities                                                             |   | 83,103      |      |
|                                                                                                          |   |        |      |
| Commitments and Contingencies                                                                                 |   | —      |      |
|                                                                                                          |   |        |      |
| Stockholders’  Equity                                                                                    |   |        |      |
| Preferred stock – $1.00 par  value; 10,000 shares authorized;  no shares issued and outstanding          |   | —      |      |
| Common stock – $0.25 par value;  35,000,000 shares authorized;  15,686,039 shares issued and outstanding |   | 3,921,510   |      |
| Additional paid-in capital                                                                                    |   | 16,017,666  |      |
| Accumulated deficit                                                                                           |   | (15,635,856 | )         |
|                                                                                                          |   | 4,303,320   |      |
|                                                                                                          |   | $           | 9,264,377 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

3

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## **GATEWAY ENERGY CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

** **
|                                                                                             |   | **Three  Months Ended March 31,** |      |
|--------------------------------------------------------------------------------------------------|--------|-----------------------------------|-----------|
|                                                                                             |   | **2004**                          |      | **2003** |   |
| Operating revenues                                                                               |   |                              |      |   |   |
| Sales of natural gas                                                                             |   | $                                 | 5,045,810 |   | $ | 2,690,571 |   |
| Transportation of natural gas and liquids                                                        |   | 90,972                            |      | 107,151 |   |
| Treating and other                                                                               |   | 36,438                            |      | 36,369 |   |
|                                                                                             |   | 5,173,220                         |      | 2,834,091 |   |
| Operating costs and expenses                                                                     |   |                              |      |   |   |
| Cost of natural gas purchased                                                                    |   | 4,438,539                         |      | 2,108,808 |   |
| Operation and maintenance                                                                        |   | 227,664                           |      | 228,400 |   |
| Depreciation and amortization                                                                    |   | 158,984                           |      | 133,821 |   |
| Accretion expense                                                                                |   | 5,360                             |      | 3,618 |   |
| General and administrative                                                                       |   | 385,082                           |      | 395,358 |   |
|                                                                                             |   | 5,215,629                         |      | 2,870,005 |   |
| Operating loss                                                                                   |   | (42,409                           | )         | (35,914 | ) |
|                                                                                             |   |                              |      |   |   |
| Other income (expense)                                                                           |   |                              |      |   |   |
| Interest income                                                                                  |   | 1,049                             |      | 6,953 |   |
| Interest expense                                                                                 |   | (117,456                          | )         | (54,394 | ) |
| Interest capitalized                                                                             |   | —                            |      | 11,226 |   |
| Gain on disposal of assets                                                                       |   | —                            |      | 5,807 |   |
| Other income, net                                                                                |   | 79,067                            |      | 1,157 |   |
|                                                                                             |   | (37,340                           | )         | (29,251 | ) |
| Loss from continuing operations                                                                  |   | (79,749                           | )         | (65,165 | ) |
|                                                                                             |   |                              |      |   |   |
| Discontinued operations                                                                          |   |                              |      |   |   |
| Gain on disposal of properties                                                                   |   | 43,704                            |      | — |   |
|                                                                                             |   |                              |      |   |   |
| Loss before cumulative effect  of change in accounting principle                                 |   | (36,045                           | )         | (65,165 | ) |
|                                                                                             |   |                              |      |   |   |
| Cumulative effect of change in  accounting for future asset retirement obligations, net of taxes |   | —                            |      | (105,777 | ) |
|                                                                                             |   |                              |      |   |   |
| Net Loss                                                                                         |   | $                                 | (36,045   | ) | $ | (170,942 | ) |
|                                                                                             |   |                              |      |   |   |
| Basic and diluted loss per  share                                                                |   |                              |      |   |   |
| Continuing operations                                                                            |   | $                                 | —    |   | $ | — |   |
| Discontinued operations                                                                          |   | —                            |      | — |   |
| Cumulative effect of change in  accounting principle                                             |   | —                            |      | (0.01 | ) |
| Net loss                                                                                         |   | $                                 | —    |   | $ | (0.01 | ) |
|                                                                                             |   |                              |      |   |   |
| Weighted average number of  common shares outstanding:                                           |   |                              |      |   |   |
| Basic and diluted                                                                                |   | 15,686,040                        |      | 15,426,317 |   |

 

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

 

4

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** **

**GATEWAY ENERGY CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                                    |   | **Three Months Ended March 31,** |    |
|-----------------------------------------------------------------------------------------|--------|----------------------------------|---------|
|                                                                                    |   | **2004**                         |    | **2003** |   |
|                                                                                    |   |                             |    |   |   |
| Cash flows from operating  activities                                                   |   |                             |    |   |   |
| Net loss                                                                                |   | $                                | (36,045 | ) | $ | (170,942 | ) |
| 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                                                           |   | 158,984                          |    | 133,821 |   |
| Gain on disposal of assets                                                              |   | —                           |    | (5,807 | ) |
| Discontinued operations – gain  on sale of properties                              |   | (43,704                          | )       | — |   |
| Stock option compensation                                                               |   | —                           |    | (15,803 | ) |
| Accretion expense                                                                       |   | 5,360                            |    | 3,618 |   |
| Amortization of debt discount  and debt issue costs                                     |   | 11,505                           |    | 6,917 |   |
| Reserve for ADAC guarantee                                                              |   | 2,184                            |    | — |   |
| Change in assets and  liabilities:                                                      |   |                             |    |   |   |
| Trade accounts receivable                                                               |   | 998,281                          |    | (731,371 | ) |
| Inventories, at average cost                                                            |   | (3,129                           | )       | (2,543 | ) |
| Prepaid expenses and other  assets                                                      |   | (42,013                          | )       | (154,541 | ) |
| Accounts payable                                                                        |   | (848,030                         | )       | 1,316,913 |   |
| Accrued expenses and other  liabilities                                                 |   | (24,387                          | )       | (40,654 | ) |
| Net cash provided by operating  activities                                              |   | 179,006                          |    | 445,385 |   |
|                                                                                    |   |                             |    |   |   |
| Cash flows from investing  activities                                                   |   |                             |    |   |   |
| Capital expenditures                                                                    |   | (27,072                          | )       | (1,124,570 | ) |
| Proceeds from sale of  properties                                                       |   | —                           |    | 14,500 |   |
| Proceeds from contingent  payment                                                       |   | 4,003                            |    | — |   |
| Decrease (increase) in  certificates of deposit                                         |   | 125,000                          |    | (663 | ) |
| Other assets                                                                            |   | 664                              |    | — |   |
| Net cash provided by (used in)  investing activities                                    |   | 102,595                          |    | (1,110,733 | ) |
|                                                                                    |   |                             |    |   |   |
| Cash flows from financing  activities                                                   |   |                             |    |   |   |
| Proceeds from borrowings                                                                |   | 128,000                          |    | 744,160 |   |
| Payments on borrowings                                                                  |   | (302,244                         | )       | (64,857 | ) |
| Debt issue costs                                                                        |   | (59                              | )       | 1,834 |   |
| Net cash (used in) provided by  financing activities                                    |   | (174,303                         | )       | 681,137 |   |
|                                                                                    |   |                             |    |   |   |
| Net increase in cash and cash  equivalents                                              |   | 107,298                          |    | 15,789 |   |
| Cash and cash equivalents at  beginning of period                                       |   | 202,373                          |    | 80,888 |   |
|                                                                                    |   |                             |    |   |   |
| Cash and cash equivalents at  end of period                                             |   | $                                | 309,671 |   | $ | 96,677 |   |
|                                                                                    |   |                             |    |   |   |
| Supplemental Disclosures of  Cash Flow Information:                                     |   |                             |    |   |   |
| Cash paid for interest  (including capitalized interest)                                |   | $                                | 68,697  |   | $ | 45,229 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

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**GATEWAYENERGY CORPORATION AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**(1)           Principles of Consolidation andNature of Business**

 

Theconsolidated financial statements include the accounts of Gateway EnergyCorporation and its wholly owned subsidiary companies, Gateway PipelineCompany, Gateway Offshore Pipeline Company, Gateway Energy Marketing Company,Fort Cobb Fuel Authority, L.L.C. and Gateway Processing Company.  All significant intercompany transactionshave been eliminated in consolidation.

 

The accompanying consolidated financial statements have been preparedby the Company, without audit.  In theopinion of management, such financial statements reflect all adjustmentsnecessary for a fair presentation of the financial position and results ofoperations in accordance with accounting principles generally accepted in theUnited States of America. The financial statements should be read inconjunction with the financial statements and the notes thereto included in theCompany’s Annual Report on Form 10-KSB for the year ended December 31, 2003.

 

The Companyowns and operates natural gas gathering, transportation and distributionsystems and related facilities in Texas and Oklahoma, and offshore in Texas andfederal waters of the Gulf of Mexico. The Company also has an exclusive license in the continental U.S. for apatented technology for the rejection of nitrogen from natural gas streams.

 

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

** **

A summary ofthe significant accounting policies consistently applied in the preparation ofthe accompanying consolidated financial statements follows.  Certain reclassifications have been made tothe prior period statements to be consistent with the current presentation.

 

***Revenue Recognition Policy***

** **

The Company’ssales 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 redelivery point, which is the point at which another party takes physicalcustody of the gas or liquid hydrocarbons.

 

*Propertyand Equipment*

 

Property andequipment is stated at cost, plus capitalized interest costs on major 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.  At March 31, 2004, propertyand equipment included $97,222 of equipment financed under a capital lease, net of $2,778 of accumulatedamortization.  Depreciation andamortization is provided using the straight-line method over estimated usefullives ranging from 6 to 30 years for pipeline systems, gas plant and processingequipment, and from 2 to 10 years for office furniture and other equipment.  Upon disposition or retirement of pipelinecomponents or gas plant components, any gain or loss is charged or credited toaccumulated depreciation.  When entirepipeline systems, gas plants or other property and equipment are retired orsold, any resulting gain or loss is credited to or charged against operations.

 

For the threemonths ended March 31, 2004 and 2003, depreciation expense was $151,807 and $126,644, respectively.

 

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, and any impairment so determined is recorded in thecurrent period.  There have been noimpairments of long-lived assets required during the three months ended March 31, 2004 and 2003.

 

*Asset Retirement Obligation*

 

The Companyprovides for the future asset retirement obligations related to the Shipwreckoffshore production platform because, eventually, law or regulation willrequire its abandonment.  The presentvalue of the estimated future asset retirement obligation, as of the date ofacquisition, was capitalized to gasgathering, processing

 

6

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andtransportation equipment. The present value of the estimated future asset retirement obligation,as of the balance sheet date, is presented as a noncurrent liability.  Until the platform is ultimately sold orretired, the Company will recognize (i) depreciation expense on the additionalcapitalized costs; (ii) accretion expense as the present value of the futureasset retirement obligation increases with the passage of time, and; (iii) theimpact, if any, of changes in estimates of the liability.  The following table sets forth areconciliation of the beginning and ending aggregate carrying amount of assetretirement obligations for the three months ended March 31, 2004:

 
| Beginning balance |   | $     | 299,218 |   |
|-------------------|--------|-------|---------|--------|
| Accretion         |   | 5,360 |    |
| Ending balance    |   | $     | 304,578 |   |

** **

**The Company adopted Statement ofFinancial Accounting Standards, or SFAS, No. 143, which requires recognition ofthe future asset retirement obligation, during the three months ended March 31,2003.  The cumulative effect of adoptingthis statement was to increase net loss for the three months ended March 31,2003 by $105,777, or $0.01 per common share.**

** **

***Other Assets***

** **

The Company’sprimary other asset, its license for a patented process to remove nitrogen fromnatural gas production, is being amortized to expense over the average 17-yearlife of the underlying patents. Investment in the license was $292,683 at March 31, 2004, net ofaccumulated amortization of $128,367.

 

*CashEquivalents and Supplemental Disclosure of Noncash Investing and FinancingActivities*

 

For purposesof the consolidated statements of cash flows, the Company considers all highlyliquid debt instruments purchased with original maturities of three months orless to be cash equivalents.

 

In the threemonths ended March 31, 2003, the Company recognized future asset retirementobligations related to prior periods totaling $202,007 pursuant to SFAS No.143, discussed above.  A portion of suchcosts—$96,230 (net of accumulated depreciation of $15,883)—was capitalized togas gathering, processing and transportation assets.  The remainder of these prior year costs was expensed as thecumulative, noncash effect of change in accounting principle.

 

The Company agreed to pay toADAC $24,000, in exchange for its consent to modify the Madisonville term loanterms, ratably over a twelve-month period beginning the earlier of the monthfollowing maturity of the balloon note or the month following ADAC’s exerciseof their option to prepay the balloon note as discussed in Note 4.  The present value of this obligation is$18,641, using an imputed interest rate of 10%, and is included in the amountpayable to ADAC, with a corresponding amount capitalized to deferred loan costson the accompanying balance sheet.  Thisamount will be amortized to interest expense ratably over the life of the termloan.

 

*IncomeTaxes*

 

Deferred taxassets and liabilities are recognized for the expected future tax consequencesof events that have been included in the financial statements or income taxreturns. Under this method, deferred tax assets and liabilities are determinedbased on the difference between the financial statement and tax bases of assetsand liabilities as measured by the enacted tax rates expected to apply whenthese differences reverse. Deferred tax assets are reduced by a valuationallowance when it is more likely than not that they will not be realized.  The deferred tax provision is the result ofchanges in deferred tax assets and liabilities.

 

*Stock-BasedCompensation*

 

The Companyaccounts for its stock-based employee compensation plan under the recognitionand measurement principles of Accounting Principles Board Opinion No. 25,“Accounting for 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 plan had an exerciseprice equal to the market value of the underlying common stock at the date ofgrant.

 

7

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At March 31,2004, the fair value of the Company’s stock-based awards to employees wasestimated using a Black-Scholes option pricing model.  The Black-Scholes model was developed for use in estimating thefair value of traded options which have no vesting restrictions and are fullytransferable.  In addition, theBlack-Scholes model requires the input of highly subjective assumptionsincluding the expected stock price volatility. Because the Company’s stock-based awards have characteristicssignificantly different from those of traded options, and because changes inthe subjective input can materially affect the fair value estimate, inmanagement’s opinion, the existing models do not necessarily provide a reliablesingle measure of the fair value of its stock-based awards to employees.  The fair value of the Company’s stock-basedawards, including the repriced options, was estimated assuming no expecteddividends and the following weighted average assumptions for the three monthsended March 31, 2004 and 2003:

 
|                            |   | **March 31,** |   |
|---------------------------------|--------|---------------|--------|
|                            |   | **2004**      |   | **2003** |   |
| Expected life in years          |   | 4.8           |   | 5.1 |   |
| Expected stock price volatility |   | 86            | %      | 96 | % |
| Risk-free interest rate         |   | 2.97          | %      | 3.82 | % |
| Average fair value per option   |   | $             | 0.19   |   | $ | 0.19 |   |
|                                 |        |               |        |  |  |  |  |

 

For pro formapurposes, the estimated value of the Company’s stock-based awards to employeesis amortized over the options’ vesting period. The following table illustrates the effect on net loss and net loss pershare if the Company had applied the fair value recognition provisions of SFASNo. 123, “Accounting for Stock-Based Compensation,” to its stock-based employeecompensation for the three months ended March 31, 2004 and 2003:

 
|                                                                                                                                         |   | **March 31,** |    |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|---------|
|                                                                                                                                         |   | **2004**      |    | **2003** |   |
| Net loss – as reported                                                                                                                  |   | $             | (36,045 | ) | $ | (170,942 | ) |
| Deduct total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | (5,522        | )       | (3,766 | ) |
| Net loss – pro forma                                                                                                                    |   | $             | (41,567 | ) | $ | (174,708 | ) |
|                                                                                                                                         |   |          |    |   |   |
| Basic and diluted net loss per share – as  reported                                                                                     |   | $             | —  |   | $ | (0.01 | ) |
| Basic and diluted net loss per share – pro  forma                                                                                       |   | $             | —  |   | $ | (0.01 | ) |

* *

*EarningsPer Share*

 

Basic earningsper share is computed by dividing net earnings or loss by the weighted averagenumber 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.  For the three months ended March 31, 2004and 2003, the diluted loss per common share is the same as basic loss per sharesince the effect of 34,526 and 23,345, respectively, potentially dilutivecommon shares arising from outstanding stock options and warrants wasanti-dilutive.

 

*Use ofEstimates*

 

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.

 

8

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**(3)**                                 CapitalExpenditures

** **

The Companymade total capital expenditures of approximately $1,124,570 in the three monthsended March 31, 2003, primarily in connection with the construction of thepipelines servicing the Madisonville plant—a four-inch gathering line, athree-inch injection line and the ten-inch pipeline to transport the pipelinequality gas.  These pipelines arecollectively referred to as the pipeline facilities.  The pipeline facilities became operational during May 2003 inconjunction with the startup of the Madisonville plant.  See discussion of the project financing inNote 4.

 

**(4)**                                 Debt

 

*Notes Payable*

 

The Company’s revolvingcredit agreement provides for maximum available borrowings of up to $250,000through May 22, 2004, and is renewable annually.  Principal outstanding under the agreement accrues interest at avariable rate, based on the bank’s prime rate index plus 1.25%, with a minimumrate of 8%.  The interest rate at March31, 2004 was 8%.  The balance under theagreement is due upon demand, or if no demand is made, at maturity, and isrenewable annually.  Costs of obtainingthis debt are being charged to interest expense ratably over the maturityperiod of the note.  Fort Cobb uses theproceeds from time to time for general working capital purposes.  The agreement, along with the Fort Cobb termnote discussed below, is collateralized with the assets of Fort Cobb andguaranteed by the Company.  The Companyhad $67,612 of available borrowings under the agreementas of March 31, 2004.

 

TheCompany had an operating line of credit agreement that provided for maximumavailable borrowings of $500,000 through June 2003.  Interest was payable monthly at 5.3% per annum and principal wasdue on demand, or if no demand was made, at maturity.  The Company liquidated the $500,000 certificate of deposit whichserved as collateral for the line and repaid the line of credit during June2003.

 

*Long-termDebt*

 

Long-term debtat March 31, 2004 consisted of the following:

 
| Subordinated notes                  |   | $         | 234,327   |   |
|-------------------------------------|--------|-----------|-----------|--------|
| Term note – Fort Cobb          |   | 544,264   |      |
| Term note – Madisonville       |   | 1,269,458 |      |
| Balloon note – Madisonville    |   | 900,000   |      |
| Term note – Fort Cobb vehicles |   | 44,872    |      |
| Trade note payable                  |   | 78,641    |      |
|                                |   | 3,071,562 |      |
| Less current maturities             |   | 926,715   |      |
|                                |   | $         | 2,144,847 |   |

* *

*SubordinatedNotes*

 

In connectionwith the recapitalization that was effective March 1, 1997, the Company issuedsubordinated promissory notes with a face amount of $1,171,700.  The stated interest rate is 10% payablequarterly with equal annual principal payments beginning on March 1, 2000 andcontinuing through March 1, 2004.  TheCompany calculated the fair market value of the notes to be $978,000 at March1, 1997 and recorded the difference between fair value and the face amount asdiscount on subordinated notes.  Thediscount is being amortized to interest expense using the interest method overthe term of the subordinated notes. Such charge to interest expense was $4,611 for the three months ended March31, 2004 and $6,917 for the three months ended March 31, 2003.  As a result, the effective interest rate ofthe subordinated notes is 15%.

 

At March 31, 2004,the final principal payment totaling $234,327 which was due under these notes on March 1, 2004remained unpaid.  Under the terms of thesubordinated notes, the Company has a sixty-day period in which to make thispayment and prevent acceleration of the remaining outstanding principal.  Due to the

 

9

----

 

subordinated rights of the note holders, the Companywas able to obtain a limited waiver from the bank for the violation of aMadisonville term loan agreement covenant not to allow such a default.

 

This final paymentof principal and interest is expected to be paid from the proceeds of therights/follow-on offering described in Note 5. The subordinated note holders have been separately notified that theywill continue to receive interest at an annual rate of 10% on the finalprincipal installment outstanding until such time as it is paid.

 

***Term Note – Fort Cobb***

** **

Effective June 1, 2001, FortCobb borrowed $750,000 from a bank. Principal outstanding under the note accrues interest at a variablerate, based on the bank’s prime rate index plus 1.25%, with a minimum rate of8%.  The interest rate at March 31, 2004was 8%.  The note requires monthlypayments of approximately $13,000, with the balance under the note due June 1,2008.  Costs of obtaining this debt arebeing charged to interest expense ratably over the maturity period of the note.  Fort Cobb used the proceeds to refinance itsprevious borrowings from the Company, and the Company used the proceeds forgeneral corporate purposes.

 

***Term Note – Madisonville***

** **

Effective February 21, 2002, Gateway Pipeline Company and GatewayProcessing Company, as the borrowers, entered into a term note agreement with abank.  During November 2003, the termnote agreement was amended, effective November 15, 2003, to modify provisionsgoverning intercompany debt payments from the borrowers to Gateway EnergyCorporation.  Effective March 31, 2004,the term note agreement was amended to extend an interest-only period for themonths of April through July 2004.  Allother terms and conditions of the term note, including the maturity date,remained the same.  The term noteagreement was modified to provide the Company additional working capital duringthe period that additional costs are likely to be incurred to effect therights/follow-on offering described in Note 5. The Company agreed to pay to ADAC $24,000, in exchange for its consentto modify the loan terms, ratably over a twelve-month period beginning theearlier of the month following maturity of the balloon note or the monthfollowing ADAC’s exercise of their option to prepay the balloon note asdiscussed below.  The present value of thisobligation is $18,641, using an imputed interest rate of 10%, and is includedin the amount payable to ADAC, with a corresponding amount capitalized todeferred loan costs on the accompanying balance sheet.

 

Under the term note, as amended effective March 31, 2004, the borrowersborrowed $1.5 million in multiple advances. The January, February and March 2004 payments of principal and interestwere each $54,819.  The monthly notepayments for April through July 2004 will be interest only at a fixed rate of7.25%.  Thereafter the note requires 16monthly payments of principal and interest of $70,000, with a final payment ofapproximately $174,000, representing unpaid principal and accrued, but unpaid,interest due at the December 31, 2005 maturity date.  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 construction of theMadisonville pipeline facilities.  Theterm note is collateralized with the Company’s economic interest in the Madisonvilleproject and the Waxahachie pipeline system, and the Company has guaranteed theloan and pledged the common stock of the borrowers.  The term note agreement contains cross collateral and crossdefault provisions linking it to the balloon note, described below.

 

The term note is expected to be retired in July or August 2004 with theproceeds of the rights/follow-on offering described in Note 5.

 

*Balloon Note – Madisonville*

 

Effective March 31, 2003, the borrowers entered into a balloon noteagreement with a bank, under which they borrowed $900,000 in multipleadvances.  Principal outstanding underthe balloon note accrues interest at a fixed rate of 7.25% and the note willmature after thirty-six months, or March 31, 2006.  The monthly note payments represent interest only on the totalbalance outstanding.  Costs of securingthis debt are being charged to interest expense ratably over the maturityperiod of the note.  The borrowers usedthe proceeds to finance the remaining construction costs of the Madisonvillepipeline facilities, and to fund the principal and interest payments that weredue under the Company’s subordinated note agreements on March 1, 2003.

 

10

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The balloon note is collateralized with letters of credit obtainedthrough Allen Drilling Acquisition Company, a Nebraska corporation, referred toherein as ADAC.  Charles A. Holtgraves,a director of the Company, is President and a director of ADAC, and Larry J.Horbach, a director of the Company, is Secretary of ADAC and a director of theparent company of ADAC.  Mr. Holtgravesowns directly no shares of ADAC common stock, and owns 14.65% of an entity thatowns 55.56% of the ADAC senior preferred stock.  Such preferred stock has a stated dividend rate equal totwo-thirds of any Madisonville payments received by ADAC pursuant to theagreement discussed below.  Mr. Horbachowns no ADAC common or preferred stock.

 

Under the terms of the agreement with ADAC, dated March 6, 2003, ADACagreed to provide security acceptable to the Company’s primary bank to allowthe Company to borrow the proceeds of the balloon note.  In exchange, ADAC will receive, during theterm of the balloon note, one-half of the price upside portion only, if any, ofthe monthly fee to be received by the Company pursuant to the Madisonvilleproject agreements.  Under the ADACagreement, ADAC will have the option to either: (i) receive at the end of theterm of the balloon note a lump-sum payment, which when added to the paymentsreceived, if any, for the price upside portion, will result in a 15% pre-taxinternal rate of return on the $900,000, or (ii) pay off the balloon note on orbefore the end of the balloon note term in exchange for a one-third 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 Cobb subsidiary.  The ADACagreement contains cross collateral and cross default provisions linking it tothe Madisonville term note, described above.

 

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.  For the three months ended March31, 2004, interest expense was charged $33,750 reflecting theCompany’s obligation under the guarantee, and cash price upside payments toADAC totaled $36,622.  In theaccompanying consolidated balance sheet as of March 31, 2004, the noncurrentpayable to ADAC includes a reserve of $92,150 for such amountsnot yet paid.  If ADAC elects to pay offthe balloon note at maturity or before, the reserve for the ADAC guarantee willbe credited to income.

 

*Term Note – Fort CobbVehicles*

 

Effective March 2003, Fort Cobb borrowed $57,900 from a bank to buythree replacement service vehicles.  Thenote requires monthly principal and interest payments of $1,387, reflectinginterest at 6.99%, and matures on March 25, 2007.

 

*Trade Note Payable*

 

Effective October 2003, in connection with the settlement of a disputemediation, the Company executed a trade note for $100,000, bearing no interest,payable in eighteen monthly installments of $5,200 and one final installment of$6,400.  The note is secured by a lienon the Company’s Crystal Beach terminal facility.  Interest expense is being recognized over the life of the note atan imputed rate of 10%; accordingly, the obligation was recorded at its presentvalue of $91,290.

 

*Letters of Credit*

 

As of March 31,2004, the Company had outstanding letters of credit totaling $800,000.

 

**(5)**                                 Rights/Follow-onOffering and Private Offering

** **

EffectiveMarch 9, 2004, the Company entered into letters of intent with The InvestLincGroup, a Chicago based financial company focused on emerging growth businessesunder which InvestLinc will assist the Company in raising approximately $12,000,000through a combination of a rights/follow-on offering of its common stock andthe formation of a new limited liability company, GEC Development, LLC,referred to as GEC, funded by the Company and capital from InvestLinc.

 

11

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Therights/follow-on offering is intended to raise approximately $3,000,000 net tothe Company.  It will be structuredinitially as a rights offering under which current stockholders will be offeredthe opportunity to acquire the stock before it is offered to others throughInvestLinc’s broker-dealer network. Proceeds from the offering are expected to be sufficient to retire thesubordinated notes and the Madisonville term note, and to make a meaningfulcapital investment in GEC.

 

GEC isexpected to be funded with $1,500,000 from the Company and $8,500,000 in equityfrom InvestLinc sources.  These fundswill be used by GEC to invest only in high nitrogen natural gas projects in thecontinental United States.  None of ourcurrent operations or future activities involving the Madisonville project willbe included in projects undertaken by GEC. GEC projects may include investment in and acquisition of high nitrogennatural gas reserves, acquisition of acreage expected to produce such reserves,drilling and completion of natural gas wells, and construction of pipelines andinstallation of nitrogen rejection units using our licensed MehraProcess®.  The Company will manage GECand develop the high nitrogen natural gas projects.  We will benefit to the extent that we own an interest in thefinancial position, results of operations and cash flows of GEC.

 

We willreceive 5% ownership interest in exchange for our $2,500 founder’s contributionand a 20% ownership interest in exchange for an exclusive sublicense of theMehra Process to GEC.  We will have theopportunity to increase our ownership interest further by making the capitalinvestment of up to $1,500,000 and based on the performance of GEC over time.

 

Closing of therights/follow-on offering and funding of GEC are independent of each other, andeach is subject to its own closing conditions, including a requirement forInvestLinc to secure at least $8,000,000 for GEC.  The transactions are expected to close in late July or early August2004.

 

**(6)**                                 Commitmentsand Contingencies

** **

In connection with securingthe balloon note described in Note 4 that was used to finance part of theconstruction costs of the Madisonville pipeline facilities, the Company isobligated at ADAC’s option to either: (i) pay at the end of the term of theballoon note a lump-sum, which when added to the payments made, if any, for theprice upside portion, will result in ADAC receiving a 15% pre-tax internal rateof return on the $900,000, or (ii) convey to ADAC a one-third ownershipinterest in the pipeline facilities in exchange for ADAC paying off the balloonnote on or before the end of the balloon note term.  The Company is obligated to pay the periodic interest payments tothe bank during the three-year term of the balloon note.

 

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.  For the three months ended March31, 2004, interest expense was charged $33,750 reflecting theCompany’s obligation under the guarantee, and cash price upside payments toADAC totaled $36,622.  In theaccompanying consolidated balance sheet as of March 31, 2004, the noncurrentpayable to ADAC includes a reserve of $92,150 for such amountsnot yet paid.  If ADAC elects to pay offthe balloon note at maturity or before, the reserve portion of the ADAC payablewill be credited to income.

 

On March 9, 2004,the Company entered into letters of intent with an outside financial servicesfirm for the purpose of raising capital. See Note 5.

 

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

 

**(7)**                                 RelatedParty Transactions

 

The Company agreed to pay to ADAC $24,000, in exchange for its consentto modify the terms of the Madisonville term loan, ratably over a twelve-monthperiod beginning the earlier of the month following maturity of the balloonnote or the month following ADAC’s exercise of their option to prepay theballoon note as discussed in Note 4. The present value of this obligation is $18,641, using an imputedinterest rate of 10%, and is included in the

 

12

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amount payable to ADAC, witha corresponding amount capitalized to deferred loan costs on the accompanyingbalance sheet.

 

Accruedexpenses and other liabilities as of March 31, 2004 included unpaid directors’fees of $36,000.

 

**(8)**                                 SegmentDisclosures

 

All of theCompany’s operations are in the continental 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 and Oklahoma.  Offshore operations include natural gas andliquid hydrocarbon gathering and transportation activities in the Gulf ofMexico in Texas and federal waters.  Theprincipal markets for the onshore segment are industrial customers, and for theoffshore segment they are affiliates of large intrastate and interstatepipeline companies.  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.

 

The accountingpolicies of the reportable segments are the same as those described in Note2.  The Company evaluates the segmentsbased on operating margin, defined as revenues less cost of purchased gas andoperating and maintenance expenses. Such amounts are before general and administrative expense,depreciation, interest income or expense or income taxes.  Inter-segment sales of $422,000 and $483,000were eliminated during consolidation for the three months ended March 31, 2004and 2003.

 

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

 
|                                                           |   | **Three  Months Ended March 31,** |      |
|----------------------------------------------------------------|--------|-----------------------------------|-----------|
|                                                           |   | **2004**                          |      | **2003** |   |
| **Onshore Operations**                                         |   |                              |      |   |   |
| Revenues                                                       |   | $                                 | 4,458,619 |   | $ | 1,980,731 |   |
| Operating margin                                               |   | 331,872                           |      | 217,783 |   |
| Depreciation and amortization                                  |   | 71,669                            |      | 49,414 |   |
| Interest expense                                               |   | 99,053                            |      | 36,458 |   |
| Capital expenditures                                           |   | 17,778                            |      | 1,049,026 |   |
| Total assets                                                   |   | 5,657,656                         |      | 5,981,544 |   |
|                                                           |   |                              |      |   |   |
| **Offshore Operations**                                        |   |                              |      |   |   |
| Revenues                                                       |   | 114,145                           |      | 143,265 |   |
| Operating margin                                               |   | 50,310                            |      | 77,001 |   |
| Depreciation and amortization                                  |   | 37,692                            |      | 35,909 |   |
| Total assets                                                   |   | 1,443,919                         |      | 1,777,961 |   |
|                                                           |   |                              |      |   |   |
| **Fort Cobb Operations**                                       |   |                              |      |   |   |
| Revenues                                                       |   | 600,456                           |      | 710,095 |   |
| Operating margin                                               |   | 124,835                           |      | 202,099 |   |
| Depreciation and amortization                                  |   | 49,623                            |      | 48,498 |   |
| Interest expense                                               |   | 18,403                            |      | 17,936 |   |
| Capital expenditures                                           |   | 9,294                             |      | 75,544 |   |
| Total assets                                                   |   | 2,162,802                         |      | 2,451,423 |   |
|                                                           |   |                              |      |   |   |
| **Total**                                                      |   |                              |      |   |   |
| Revenues                                                       |   | 5,173,220                         |      | 2,834,091 |   |
| Operating margin                                               |   | 507,017                           |      | 496,883 |   |
| Depreciation and amortization                                  |   | 158,984                           |      | 133,821 |   |
| Interest expense                                               |   | 117,456                           |      | 54,394 |   |
| Capital expenditures                                           |   | 27,072                            |      | 1,124,570 |   |
| Total assets                                                   |   | 9,264,377                         |      | 10,210,928 |   |
|                                                           |   |                              |      |   |   |
| **Reconciliation to net loss**                                 |   |                              |      |   |   |
| Operating margin                                               |   | $                                 | 507,017   |   | $ | 496,883 |   |
| Depreciation and amortization                                  |   | 158,984                           |      | 133,821 |   |
| Accretion expense                                              |   | 5,360                             |      | 3,618 |   |
| General and administrative                                     |   | 385,082                           |      | 395,358 |   |
| Interest expense                                               |   | 117,456                           |      | 54,394 |   |
| Other income, net                                              |   | 80,116                            |      | 25,143 |   |
| Discontinued operations – gain on disposal  of properties |   | 43,704                            |      | — |   |
| Cumulative effect of change in accounting  principle           |   | —                            |      | (105,777 | ) |
| Net loss                                                       |   | $                                 | (36,045   | ) | $ | (170,942 | ) |

 

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

 

The followingmanagement’s discussion and analysis contains trend analysis and otherforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933, as amended, and Section 21E of the Securities Exchange Act of1934, as amended.  Actual results coulddiffer 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 AffectingFuture Results” and elsewhere in this document.

 

**Critical Accounting Policies**

** **

The followingaccounting policies are considered by management to be the most critical to thefair presentation of the Company’s financial condition, results of operationsand cash flows.  The policies areconsistently applied in the preparation of the accompanying consolidatedfinancial statements; however, certain reclassifications have been made to theprior period statements to be consistent with the current presentation.

 

***Revenue Recognition Policy***

** **

The Company’ssales 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’s transportationrevenues are generated under contracts which have a stated fee per unit ofproduction (Mcf, MMBtu, or Bbl) gathered or transported.  Transportation revenues are recognized atthe redelivery point, which is the point at which another party takes physicalcustody of the gas or liquid hydrocarbons.

 

*Propertyand Equipment*

 

Property andequipment is stated at cost, plus capitalized interest costs on major pipelineprojects during 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.

 

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.

 

*Asset Retirement Obligation*

 

The Companyprovides for the future asset retirement obligations related to the Shipwreckoffshore production platform because, eventually, law or regulation willrequire its abandonment.  The presentvalue of the estimated future asset retirement obligation, as of the date ofacquisition, was capitalized to gasgathering, processing and transportation equipment.  The present value of the estimated futureasset retirement obligation, as of the balance sheet date, is presented as anoncurrent liability.  Until theplatform is ultimately sold or retired, the Company will recognize (i)depreciation expense on the additional capitalized costs; (ii) accretionexpense as the present value of the future asset retirement obligationincreases with the passage of time, and; (iii) the impact, if any, of changesin estimates of the liability.  Thefollowing table sets forth a reconciliation of the beginning and endingaggregate carrying amount of asset retirement obligations for the three monthsended March 31, 2004:

 
| Beginning balance |   | $     | 299,218 |   |
|-------------------|--------|-------|---------|--------|
| Accretion         |   | 5,360 |    |
| Ending balance    |   | $     | 304,578 |   |

** **

**The Company adopted Statement ofFinancial Accounting Standards, or SFAS, No. 143, which requires recognition ofthe future asset retirement obligations, during the three months ended March31, 2003.  The cumulative effect ofadopting this statement was to increase net loss for the three months endedMarch 31, 2003 by $105,777, or $0.01 per common share.**

** **

***Other Assets***

** **

The Company’sprimary other asset, its license for a patented process to remove nitrogen fromstreams of natural gas, is being amortized to expense over the averageremaining life of the underlying patents.

 

14

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*Use ofEstimates*

 

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***

** **

The Henry Hubclosing index price for natural gas during the three months ended March 31,2004 averaged $5.69 per MMBtu, compared to $6.03 for the same period of theprior year.  In the accompanyingfinancial statements, the Company’s revenues from sales of natural gas, alongwith the cost of purchased gas, increased proportionately from prior yearlevels.  Because the Company buys andsells gas under “back-to-back” purchase and sale contracts designed to minimizecommodity 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.

 

# **ThreeMonths Ended March 31, 2004 Compared to Three Months Ended March 31, 2003**

#  

# *TotalOperations*

 
|                          |   | **Three  Months Ended March 31,** |      |
|-------------------------------|--------|-----------------------------------|-----------|
|                          |   | **2004**                          |      | **2003** |   |
| Revenues                      |   | $                                 | 5,173,220 |   | $ | 2,834,091 |   |
| Operating margin              |   | 507,017                           |      | 496,883 |   |
| Depreciation and amortization |   | 158,984                           |      | 133,821 |   |
|                               |        |                                   |           |  |  |  |  |

 

Operatingmargins for the three months ended March 31, 2004 increased $10,000 compared tothe same period of the prior year.  Anincrease in Onshore operating margins of $114,000 was partially offset by adecrease in Fort Cobb operating margins of $77,000 and Offshore operating marginsof $27,000.  These segments are discussedindividually below in greater detail.

 

# *OnshoreOperations*

 
|                          |   | **Three  Months Ended March 31,** |      |
|-------------------------------|--------|-----------------------------------|-----------|
|                          |   | **2004**                          |      | **2003** |   |
| Revenues                      |   | $                                 | 4,458,619 |   | $ | 1,980,731 |   |
| Operating margin              |   | 331,872                           |      | 217,783 |   |
| Depreciation and amortization |   | 71,669                            |      | 49,414 |   |
|                               |        |                                   |           |  |  |  |  |

 

Operating marginsfor onshore operations increased in the first quarter by $114,000 from the sameperiod of the prior year.  The increasewas mainly due to the May 2003 commencement of operations of the pipelinefacilities servicing the Madisonville plant, partially offset by thesubstitiution for a gas sales contract of a transport-only contract with lessfavorable terms.

 

# *OffshoreOperations*

 
|                          |   | **Three  Months Ended March 31,** |    |
|-------------------------------|--------|-----------------------------------|---------|
|                          |   | **2004**                          |    | **2003** |   |
| Revenues                      |   | $                                 | 114,145 |   | $ | 143,265 |   |
| Operating margin              |   | 50,310                            |    | 77,001 |   |
| Depreciation and amortization |   | 37,692                            |    | 35,909 |   |
|                               |        |                                   |         |  |  |  |  |

 

Operatingmargins for offshore operations decreased in the first quarter by $27,000 fromthe same period of the prior year, and are directly related to lower throughputvolumes from Galveston Blocks 190L and 213L, and High Island Block 98L.

 

15

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# *FortCobb Operations*

 
|                          |   | **Three  Months Ended March 31,** |    |
|-------------------------------|--------|-----------------------------------|---------|
|                          |   | **2004**                          |    | **2003** |   |
| Revenues                      |   | $                                 | 600,456 |   | $ | 710,095 |   |
| Operating margin              |   | 124,835                           |    | 202,099 |   |
| Depreciation and amortization |   | 49,623                            |    | 48,498 |   |
|                               |        |                                   |         |  |  |  |  |

 

Operatingmargins for Fort Cobb operations decreased in the first quarter by $77,000 fromthe same period of the prior year due to a 26% decrease in sales volumes.  Volume fluctuations for the utility aredirectly related to weather patterns and levels of farming activity in theservice area.

 

# *OperationsSupport*

 
|                                                           |   | **Three  Months Ended March 31,** |    |
|----------------------------------------------------------------|--------|-----------------------------------|---------|
|                                                           |   | **2004**                          |    | **2003** |   |
| General and administrative                                     |   | $                                 | 385,082 |   | $ | 395,358 |   |
| Interest income                                                |   | 1,049                             |    | 6,953 |   |
| Interest expense                                               |   | (117,456                          | )       | (54,394 | ) |
| Interest capitalized                                           |   | —                            |    | 11,226 |   |
| Gain on disposal of assets                                     |   | —                            |    | 5,807 |   |
| Other income, net                                              |   | 79,067                            |    | 1,157 |   |
| Discontinued operations – gain on disposal  of properties |   | 43,704                            |    | — |   |
| Cumulative effect of change in accounting  principle           |   | —                            |    | (105,777 | ) |
|                                                                |        |                                   |         |  |  |  |  |

 

General andadministrative expenses for the quarter are down 3% from the same period oflast year, mainly due to reduced legal expenses and rent costs, partiallyoffset by an increase in employee related and other costs, including the non-cash impact of a prior yeardownward revaluation of employee stock options that were repriced in 1999.  Under the Financial Accounting StandardsBoard Interpretation 44, “Interpretationof APB Opinion 25”, the Company is required to account for these optionsunder variable award accounting, due to the change in the option exerciseprice.  Variable award accountingrequires recognition of compensation expense (or income) under certaincircumstances when the market price of the Company’s stock exceeds the exerciseprice of the stock option.

 

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

 

Interestexpense fluctuates directly with the amount of outstanding long-term debt andthe amount of borrowings under the Company’s bank revolving creditagreement.  Interest expense incurred onthe debt to finance the Madisonville project construction during the threemonths ended March 31, 2003 was capitalized.

 

**On April 21, 2004, but effective March 31, 2004, theCompany factored the majority of its receivable from Enron North America Corp.and received $24,433, representing $0.20 on the dollar for its claim.  This amount is reflected in the accompanyingstatement of operations as other income for the three months ended March 31,2004.  Other income for that period alsoincludes the adjustment of approximately $48,000 of amounts previously chargedto expense.**

** **

Discontinuedoperations presented above reflect additional cash proceeds related to theCompany’s sale of 14 non-core natural gas gathering systems located in Texas,Oklahoma and Louisiana, effective August 1, 2002.  A contingent payment of up to $260,000 was to be received in thefourth quarter of 2003 based on subsequent performance of the assets.  The Company received a contingent payment of$20,806 in December 2003 and recorded that amount as gain on discontinuedoperations for the year ended December 31, 2003.  The Company received $4,003 in January 2004 and $39,701 in April2004 and recorded those amounts as gain on discontinued operations for thethree months ended March 31, 2004.

 

The cumulativeeffect of change in accounting principle represents the aggregate difference inretained earnings that resulted from retroactively applying the provisions ofSFAS No. 143 to all prior years affected by the new accounting rules.

 

16

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**Liquidityand Capital Resources**

 

In March 2004,we entered into a letter of intent with a Chicago-based financial company calledthe InvestLinc Group to secure funding to exploit the Company’s licensedtechnology to remove nitrogen from high nitrogen natural gas production.  Under the letter of intent a new limitedliability company, GEC Development, LLC, will be formed.  We refer to this entity as GEC.  GEC’s initial capital is expected to be atleast $10 million, as discussed below. We are actively pursuing several projects that will employ our nitrogenrejection technology.  If GEC issuccessfully formed, then GEC will finance and have an ownership interest inthe high nitrogen natural gas projects we develop, employing an exclusivesublicense that we will grant for the technology to reject the nitrogen.  We will manage GEC’s activities and receivecompensation for such services under a mangement services agreement yet to benegotiated.  We will provide GEC withthe first right to participate in all high nitrogen natural gas projects wedevelop, and if GEC declines to pursue a high nitrogen natural gas project, wecan pursue it on our own.

 

We willbenefit to the extent that we own an interest in the financial position,results of operations and cash flows of GEC. We will receive 5% ownership interest in exchange for our $2,500founder’s contribution, and a 20% ownership interest in exchange for grantingto GEC an exclusive sublicense for the Mehra Process, and we will have theopportunity to increase our ownership interest further by making the capitalinvestment of up to $1.5 million, as discussed below, and based on the performanceof GEC over time.  The majority of GEC’sinitial capital will come from InvestLinc’s sources.  The InvestLinc Group is obligated to provide at least $8 millionin capital for GEC.  We intend tomaximize our ownership interest in GEC. We expect, through a rights/follow-on offering, to raise capital fromcurrent stockholders and others in an amount sufficient to allow us to retirecertain debt and invest up to $1.5 million of Gateway money in GEC.  If we are able to contribute the full $1.5million, and if we can achieve certain financial goals over time, we can own upto approximately 45% of GEC.

 

As we increaseour involvement in this high nitrogen natural gas niche, we expect that amajority of our operating income will be derived from our ownership interest inand management fees from GEC.  Overtime, we expect that our fee-based operating income from our current gathering,transportation, distribution and marketing activities will become lesssignificant, except as they support GEC.

 

In the event therights/follow-on offering is not successful, our search for new capital wouldcontinue, and such new capital may take any of several forms, including but notlimited to: (i) the sale of common stock or preferred stock, convertible intocommon stock on some basis; (ii) an asset-backed revolving credit facility withattached common stock purchase warrants; or, (iii) a direct private placementallowing the creation of a financial joint venture company into which theCompany would contribute assets in exchange for a meaningful equityinterest.  If we are successful raisingnew capital, then the resultant projects will yield greater results to theCompany in less time.  Any of the abovestructures may result in issuance of additional common stock, and may thereforehave some short-term dilutive effect on current shareholders.  However, any dilutive effect is expected tobe more than offset by long-term increases in the enterprise value of theCompany.

 

Until we are ableto successfully raise additional growth capital, we will execute our growthstrategy through strategic alliances in high nitrogen natural gasprojects.  Also, any currently ownedproperties are subject to sale under the right circumstances (valuation andtiming) if the proceeds from any such sale could be effectively redeployed intoone or more high nitrogen natural gas projects.  We may not be able to raise outside capital or be able to sellassets on terms favorable to the Company. Without a significant infusion of new capital, we believe we canparticipate in the construction of new nitrogen rejection facilities andgenerate new cash flows to the Company, but progress will be significantlyslower.

 

Net cashprovided by operating activities totaled $179,000 for the three months endedMarch 31, 2004, compared to $445,000 during the same period of the previousyear.  The Company has cash and cashequivalents and certificates of deposit totaling $315,416 at March 31, 2004.

 

The Companysold 14 non-core natural gas gathering systems located in Texas, Oklahoma andLouisiana, effective August 1, 2002.  Acontingent payment of up to $260,000 was to be received in the fourth quarterof 2003 based on subsequent performance of the assets.  The Company received a contingent payment of$20,806 in December 2003 and recorded that amount as gain on discontinuedoperations for the year ended December 31, 2003.  The Company received $4,003 in January 2004 and $39,701 in April2004 and recorded those amounts as gain on discontinued operations for thethree months ended March 31, 2004.

 

At March 31,2004, the Company’s long-term debt to total capitalization, including long-termobligations under capital leases, was approximately 34%.

 

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At March 31, 2004,the final principal payment totaling $234,327 which was due under the subordinated notes on March 1,2004 remained unpaid.  Under the termsof the subordinated notes, the Company has a sixty-day period in which to makethis payment and prevent acceleration of the remaining outstandingprincipal.  Due to the subordinatedrights of the note holders, the Company was able to obtain a limited waiverfrom the bank for the violation of a Madisonville term loan agreement covenantnot to allow such a default.

 

This final paymentof principal and interest on the subordinated notes is expected to be paid fromthe proceeds of the rights/follow-on offering described above and in Note 5 tothe Consolidated Financial Statements. The subordinated note holders have been separately notified that theywill continue to receive interest at 10% on the final principal installmentoutstanding until such time as it is paid.

 

The Company’s revolvingcredit agreement provides for maximum available borrowings of up to $250,000through May 22, 2004, and is renewable annually.  Principal outstanding under the agreement accrues interest at avariable rate, based on the bank’s prime rate index plus 1.25%, with a minimumrate of 8%.  The interest rate at March31, 2004 was 8%.  The balance under theagreement is due upon demand, or if no demand is made, at maturity, and isrenewable annually.  Costs of obtainingthis debt are being charged to interest expense ratably over the maturityperiod of the note.  Fort Cobb uses theproceeds from time to time for general working capital purposes.  The agreement, along with the Fort Cobb termnote discussed below, is collateralized with the assets of Fort Cobb andguaranteed by the Company.  The Companyhad $67,612 of available borrowings under the agreementas of March 31, 2004.

 

Effective June 1, 2001, FortCobb borrowed $750,000 from a bank. Principal outstanding under the note accrues interest at a variablerate, based on the bank’s prime rate index plus 1.25%, with a minimum rate of8%.  The interest rate at March 31, 2004was 8%.  The note requires monthlypayments of approximately $13,000, with the balance under the note due June 1,2008.  Costs of obtaining this debt arebeing charged to interest expense ratably over the maturity period of thenote.  Fort Cobb used the proceeds torefinance its previous borrowings from the Company, and then the Company usedthe proceeds for general corporate purposes.

 

Effective February 21, 2002, Gateway Pipeline Company and GatewayProcessing Company, as the borrowers, entered into a term note agreement with abank.  During November 2003, the termnote agreement was amended, effective November 15, 2003, to modify provisionsgoverning intercompany debt payments from the borrowers to Gateway EnergyCorporation.  Effective March 31, 2004,the term note agreement was amended to extend an interest-only period for themonths of April through July 2004.  Allother terms and conditions of the term note, including the maturity date,remained the same.  The term noteagreement was modified to provide the Company additional working capital duringthe period that additional costs are likely to be incurred to effect therights/follow-on offering described above. The Company agreed to pay to ADAC $24,000, in exchange for its consentto modify the loan terms, ratably over a twelve-month period beginning theearlier of the month following maturity of the balloon note or the monthfollowing ADAC’s exercise of their option to prepay the balloon note asdiscussed below.  The present value of thisobligation is $18,641, using an imputed interest rate of 10%, and is includedin the amount payable to ADAC, with a corresponding amount capitalized todeferred loan costs on the accompanying balance sheet.

 

Under the term note, as amended effective March 31, 2004, the borrowersborrowed $1.5 million in multiple advances. The January, February and March 2004 payments of principal and interestwere each $54,819.  The monthly notepayments for April through July 2004 will be interest only at a fixed rate of7.25%.  Thereafter the note requires 16monthly payments of principal and interest of $70,000, with a final payment ofapproximately $174,000, representing unpaid principal, and accrued but unpaidinterest due at the December 31, 2005 maturity date.  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 construction of theMadisonville pipeline facilities.  Theterm note is collateralized with the Company’s economic interest in theMadisonville project and the Waxahachie pipeline system, and the Company hasguaranteed the loan and pledged the common stock of the borrowers.  The term note agreement contains crosscollateral and cross default provisions linking it to the balloon note,described below.

 

The term note is expected to be retired in July or August 2004 with theproceeds of the rights/follow-on offering described above and in Note 5 to theConsolidated Financial Statements.

 

Effective March 31, 2003, the Company entered into a balloon noteagreement with a bank.  Under theballoon note agreement, the borrowers borrowed $900,000 in multipleadvances.  Principal outstanding underthe balloon note accrues interest at a fixed rate of 7.25% and the note willmature after thirty-six months, or March 31, 2006.  The monthly note payments represent interest only on the totalbalance outstanding.  Costs of securingthis

 

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debt are being charged tointerest expense ratably over the maturity period of the note.  The borrowers used the proceeds to financethe remaining construction costs of the Madisonville pipeline facilities, andto fund the principal and interest payments that were due under the Company’ssubordinated note agreements on March 1, 2003.

 

The balloon note is collateralized with letters of credit obtainedthrough Allen Drilling Acquisition Company, a Nebraska corporation.  Charles A. Holtgraves, a director of theCompany, is President and a director of ADAC, and Larry J. Horbach, a directorof the Company, is Secretary of ADAC and a director of the parent company ofADAC.  Mr. Holtgraves owns directly noshares of ADAC common stock, and owns 14.65% of an entity that owns 55.56% ofthe ADAC senior preferred stock.  Suchpreferred stock has a stated dividend rate equal to two-thirds of anyMadisonville payments received by ADAC pursuant to the ADAC argreementdiscussed below.  Mr. Horbach owns noADAC common or preferred stock.

 

Under the terms of the ADAC agreement, dated March 6, 2003, ADAC agreedto provide security acceptable to the Company’s primary bank to allow theCompany to borrow the proceeds of the balloon note.  In exchange, ADAC will receive, during the term of the balloonnote, one-half of the price upside portion only, if any, of the monthly fee tobe received by the Company pursuant to the Madisonville projectagreements.  Under the ADAC agreement,ADAC will 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 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,subordinate to the Company’s bank liens, on the Company’s economic interest inthe Madisonville project, its Waxahachie pipeline system, and its Fort Cobbsubsidiary.  The Agreement containscross collateral and cross default provisions linking it to the Madisonvilleterm note, described above.

 

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.  Such accruals increased interestexpense in the accompanying financial statements by $33,750 for the threemonths ended March 31, 2004, and cash price upside payments to ADAC totaled$36,622.  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 $1,387, reflectinginterest at 6.99%, and matures on March 25, 2007.

 

Effective October 2003, in connection with the settlement of a disputemediation, the Company executed a trade note for $100,000, bearing no interest,payable in eighteen monthly installments of $5,200 and one final installment of$6,400.  The note is secured by a lien onthe Company’s Crystal Beach terminal facility. Interest expense is being recognized over the life of the note at animputed rate of 10%; accordingly, the obligation was recorded at its presentvalue of $91,290.

 

As of March 31, 2004, the Company had outstanding letters of credittotaling $800,000.

 

Until we are ableto successfully raise additional capital, we will execute our growth strategythrough strategic alliances in high nitrogen natural gas projects.  We may not be successful finding capital onterms acceptable to us.  Development ofhigh nitrogen natural gas reserves and installation of treating plants isexpected to create substantial growth in earnings and cash flows.

 

Absentsignificant acquisitions or development projects, the Company will continue tofund its operations through internally generated funds and available cash, thecertificate of deposit and bank borrowings as needed.

 

Natural gasprices as represented by the NYMEX Henry Hub index averaged $5.69 and $6.03 forthe three months ended March 31, 2004 and 2003, respectively.  The natural gas industry is generallyoptimistic about long-term prospects based on expected demand, the cost ofdeveloping prospects and the sales price of natural gas.  Apart from the Madisonville pipeline facilities,the Company’s operating margin is not significantly affected by the price ofnatural gas since gas gathering and transportation are generally based on feearrangements and sales of natural gas are made under back-to-back purchase andsales arrangements.  However, naturalgas prices can affect exploration and development and result in higher or lowervolumes available for gathering and transportation.

 

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**Off-BalanceSheet Arrangements**

 

In connectionwith securing the balloon note, the Company will be obligated at ADAC’s optionto either: (i) pay at the end of the term of the balloon note a lump-sum, whichwhen added to the payments made, if any, for the price upside portion, willresult in ADAC receiving a 15% pre-tax internal rate of return on the $900,000,or (ii) convey to ADAC a thirty-three and one-third percent ownership interestin the pipeline facilities in exchange for ADAC paying off the balloon note onor before the end of the balloon note term.

 

**FactorsAffecting Future Results**

 

Going forward,the Company’s strategy is to maximize the potential of currently ownedproperties, construct, own and operate new treating plants to remove nitrogenfrom natural gas and related pipeline systems and acquire and produce highnitrogen natural gas reserves.  All ofthe high nitrogen natural gas operations are expected to take place through theoperations of GEC, described above in “Liquidity and Capital Resources.”  The exclusive license for the patented processto reject nitrogen from natural gas streams, together with our extensivedatabase of sub-quality (high nitrogen) natural gas prone areas in the U.S.,comprises the primary vehicle for the growth of our high nitrogen natural gasbusiness, and will require significant additional capital to exploit.  For approximately the past three years, wehave been attempting to obtain capital funding for projects utilizing ournitrogen rejection technology.  Duringthat time, one project, the Madisonville plant, has been developed using ourlicensed technology.

 

High nitrogen gasis natural gas that contains nitrogen, either alone or in conjunction withother contaminants, in excess of the maximum percentage, usually 4%, by volumeacceptable to most pipeline companies. About 16% of the domestic natural gas resource base (approximately 24Tcf of proven reserves) is estimated by the Gas Technology Institute to besubquality because of the nitrogen content. Most of the country’s current high nitrogen natural gas production islocated in southwestern Kansas; however, there are substantial high nitrogennatural gas reserves in other parts of the country.  The Company’s target projects are located in geographic areaswith well known 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.

 

We have atechnological advantage in this niche, due to our exclusive license in thecontinental U.S. for the nitrogen rejection process.  The Mehra Process competes favorably with other processes, as itcan cost 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 and certain liquids in the gas. It can therefore economically treat relatively small volumes of gas—aslittle as 1,000 Mcf per day—where variable gas flow and composition iscommon.  Successful completion of theseprojects will depend upon the ability of the Company to market the technologyto the producer community, and to obtain financing on terms satisfactory to theCompany for construction of nitrogen rejection plants and/or acquisition ofworking interests in the high nitrogen properties.

 

Execution of ourstrategies discussed above depends in part on our success raising capital inthe rights/follow-on offering discussed above in “Liquidity and CapitalResources.”  The proceeds from theoffering are expected to be sufficient to retire the subordinated notes and theMadisonville term note, and also make a meaningful capital contribution to GEC,but we may not be successful raising capital in the rights/follow-onoffering.  If less than the maximumoffering is sold, it is likely the Company’s primary bank will require that asubstantial portion of the new capital be used to pay down the Madisonvilleterm note.  In such a case, there may ormay not be any funds available for the Company to invest in GEC.

 

Since most ofGEC’s capital is expected to come from InvestLinc’s capital sources, formationof GEC is not dependent on the success of the rights/follow-on offering.  If the Company makes no cash contribution toGEC, our minimum interest in GEC will be 20% before payout, and 25% afterpayout, of the private investors’ initial investment plus additional amounts soas to yield a 15% internal rate of return on that investment.

 

Since our strategy is topursue high nitrogen natural gas projects first through GEC, our success willdepend in part on the success of InvestLinc raising capital for GEC.  InvestLinc is obligated to raise aminimum of $8 million to capitalize GEC. We are dependent upon InvestLinc to raise these funds.  If InvestLinc cannot raise this amount of capital,GEC may not be formed and, if not formed, we will be required to abandon ourstrategy to exploit high nitrogen natural gas projects through GEC.  In such an event, we will be dependent oncapital from other sources including funds from the rights/follow-on offering,costly project-by-project financing with middle-market

 

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capital providers or strategic affiliations, either of which wouldrequire us to assign the majority of the economic benefits in the high nitrogennatural gas projects to others.  Wecould also sell selected properties, which might have an adverse effect uponour long-term financial position and cash flows.

 

There arereasons that GEC may not be formed even if InvestLinc is successful raising theminimum level of capital.  Formation ofGEC is subject to the following conditions:

 

•                                          Negotiationand documentation of definitive legal agreements, including an operatingagreement for GEC.  Initial drafts ofthese documents have been produced but not agreed to by InvestLinc or its counsel.

 

•                                          Wecannot have suffered any material adverse change to our business.

 

•                                          InvestLincis requiring certain modifications to our license agreement with AET.  These modifications have not yet beenspecified.  We do not know whether AETwill agree to them when they are specified.

 

•                                          Ourprincipal executives, Michael T. Fadden and Scott D. Heflin, must agree toexecute new employment/noncompete agreements with the Company.  Neither InvestLinc nor its counsel hasagreed to the final terms of those agreements.

 

If InvestLincsecures the $8,000,000 of minimum capital by July 31 or any later date as theparties agree to, and we for any reason elect not to close, we must payInvestLinc a penalty of $250,000 along with reasonable out-of-pocket expensesnot to exceed $100,000.  If GEC is notfomed for some reason, but the rights/follow-on offering is successful, we willuse a portion of such capital to pursue high nitrogen natural gas projects onour own.

 

Our operationsare significantly affected by factors which are outside the Company’scontrol.  Gas gathering and processingis dependent on throughput volume. Pipeline throughput 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 gasretail sales are affected by weather. Much of the retail demand is for cropirrigation and drying.  Above normalprecipitation in the growing season and hot, dry weather in the fall cansignificantly reduce demand for natural gas on the Fort Cobb distributionsystem.

 

**Item3.  Controls and Procedures**

 

As of May 13, 2004, 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.

 

###### **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                                                     |

 

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| **Item 6.** | **Exhibits and Reports on Form 8-K.** |
|-------------|---------------------------------------|
|        |
|        | a)                                    | Exhibits: |
|        |                                  | 4(b)(5) | Second  Amendment to First Amended and Restated Credit Agreement with Southwest Bank  of Texas, dated November 15, 2003, for the Madisonville term note |
|        |                                  | 4(b)(6) | Third  Amendment to First Amended and Restated Credit Agreement with Southwest Bank  of Texas, dated March 31, 2004, for the Madisonville term note |
|        |                                  | 11 | Statement  Regarding Computation of Per Share Earnings |
|        |                                  | 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: |
|        |                                  | January 23,  2004 – Change in auditors from Deloitte and Touche LLP to Pannell Kerr Forster  of Texas, P.C. |
|        |                                  |   |   |
|        |                                  | March 12,  2004 – Announcement of InvestLinc letters of intent. |

 

**SIGNATURES**

** **

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

 
|         | GATEWAY  ENERGY CORPORATION             |
|--------------|-----------------------------------------|
|         |                                    |
|         | /s/ Michael T. Fadden                   |   |
|         | President and Chief Executive Officer   |   |
|         |                                    |   |
|         | /s/ Scott D. Heflin                     |   |
|         | Chief Financial Officer & Treasurer |   |
|         |                                    |
| May 13, 2004 |                                    |   |
| (Date)       |                                    |   |

 

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