U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-QSB (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Quarterly Period Ended December 31, 2003 ( ) TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT For the Transition Period from To -------- -------- Commission File No. 0-19485 ADVANCED FINANCIAL, INC. -------------------------------------------- (Name of small business issuer in its charter) DELAWARE 84-1069416 ------------------------------ ---------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 5425 Martindale, Shawnee, KS 66218 -------------------------------------- -------- (Address of principal executive offices) (Zip Code) Issuer's telephone number (913) 535-1072 APPLICABLE ONLY TO CORPORATE ISSUERS As of January 31, 2004, the Issuer had 5,867,222 shares of its common stock outstanding. Transitional Small Business Disclosure Format: Yes No X ----- ----- FORM 10-QSB Part 1 ------ Item 1. Financial Statements -------------------- Page ---- Unaudited Condensed Consolidated Balance Sheet -December 31, 2003 3 Unaudited Condensed Consolidated Statement of Operations for the three and nine months ended December 31, 2003 and 2002 4 Unaudited Condensed Consolidated Statement of Cash Flows for the nine months ended December 31, 2003 and 2002 Notes to Condensed Consolidated Financial Statements 6 Part II Items 1-6. 16 2 ADVANCED FINANCIAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEET December 31, 2003 ----------- ASSETS (Unaudited) Collection fees receivable $ 33,790 Finance receivables 6,423 Other 17,213 Property, furniture and equipment, net 43,202 Customer lists, net of amortization 224,612 Accrued interest receivable 100,219 Escrow deposit, net of $75,000 reserve -- ----------- Total Assets $ 425,459 =========== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) LIABILITIES Checks issued in excess of cash balances $ 89,692 Accounts payable and accrued expenses 252,005 Accounts payable - related parties 76,921 Notes payable 1,506,073 Dividends accrued-preferred stock of subsidiary 66,812 ----------- Total Liabilities 1,991,503 ----------- STOCKHOLDERS' EQUITY (DEFICIENCY) Preferred stock of subsidiary, Series A, $10.00 par value; 900 shares authorized, 900 shares issued and outstanding 9,000 Paid in capital, Series A Preferred Stock 891,000 Subscriptions receivable, Series A Preferred Stock (900,000) ----------- -- ----------- Preferred stock, Series B, $.005 par value; 1,000,000 shares authorized, none issued and outstanding -- ----------- Common stock, $.001 par value; 10,000,000 shares authorized, 5,867,222 issued an outstanding 5,867 Paid-in capital 1,253,259 Accumulated deficit (2,825,170) ----------- (1,566,044) ----------- Total Stockholders' Equity (Deficiency) (1,566,044) ----------- ----------- $ 425,459 =========== The accompanying notes are an integral part of these statements. 3 ADVANCED FINANCIAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Three Months Nine Months Nine Months 12/31/2003 12/31/2002 12/31/2003 12/31/2002 ----------- ----------- ----------- ----------- REVENUES Collection, servicing, and other fees $ 228,918 $ 213,732 $ 711,701 $ 788,900 Other 13,151 54,583 27,104 79,969 Interest 33,750 22 101,277 162 ----------- ----------- ----------- ----------- Total revenues 275,819 268,337 840,082 869,031 ----------- ----------- ----------- ----------- EXPENSES Operating expenses, including general and administrative costs 295,053 323,975 841,589 1,045,017 Interest 15,076 3,237 28,426 8,242 Depreciation and amortization 8,404 6,347 29,317 19,041 Escrow reserve -- -- -- 75,000 ----------- ----------- ----------- ----------- Total expenses 318,533 333,559 899,332 1,147,300 ----------- ----------- ----------- ----------- NET INCOME (LOSS) $ (42,714) $ (65,222) $ (59,250) $ (278,269) Subsidiary preferred stock dividends accrued (22,500) -- (67,500) -- ----------- ----------- ----------- ----------- EARNINGS (LOSS) FOR COMMON STOCK $ (65,214) $ (65,222) $ (126,750) $ (278,269) =========== =========== =========== =========== Weighted-average shares outstanding 5,867,222 5,866,137 5,867,222 5,866,137 =========== =========== =========== =========== Loss per common share $ (0.01) $ (0.01) $ (0.02) $ (0.05) =========== =========== =========== =========== The accompanying notes are an integral part of these statements. 4 ADVANCED FINANCIAL, INC. AND SUBSIDIARIES CONDENSED STATESMENTS OF CASH FLOWS (Unaudited) Nine Months Nine Months Dec 31, Dec 31, 2003 2002 --------- --------- Cash flows from operating activities Net income (loss) $ (59,250) $(278,269) Adjustments to reconcile net loss to net cash used in operating activities Depreciation and amortization 29,317 19,041 Escrow reserve -- 75,000 Net change in current assets and current liabilities (91,989) 12,137 --------- --------- Net cash used in operating activities (121,922) (172,091) --------- --------- Cash flows from investing activities Collections applied to finance receivables 24,573 51,449 Interest receivable-Gateway Energy Corporation (100,219) -- Acquisition escrow deposit -- (75,000) Acquisitions of property, furniture, and equipment 0 30,387 --------- --------- Net cash provided by (used in) investing activities (75,646) 6,836 --------- --------- Cash flows from financing activities Change in checks issued in excess of cash balances 89,692 -- Issuance of subsidiary preferred stock 900,000 -- Subsidiary preferred stock dividends accrued-net 68,425 -- Subscriptions receivable-subsidiary preferred stock (900,000) -- Payments on notes payable, net of advances (29,145) (14,340) Advances from related parties 26,400 153,446 --------- --------- Net cash provided by financing activities 155,372 139,106 --------- --------- Net increase (decrease) in cash (42,196) (26,149) Cash, beginning of period 42,196 37,794 --------- --------- Cash, end of period $ -- $ 11,645 ========= ========= Cash paid for interest $ 4,369 $ 9,014 Related party advances converted to Demand Note $ 508,787 $ -- The accompanying notes are an integral part of these statements. 5 Advanced Financial, Inc. and Subsidiaries NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS December 31, 2003 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A summary of the significant accounting policies applied in the preparation of the accompanying financial statements follows. 1. Organization and Principles of Consolidation Advanced Financial, Inc. (the Company) owns 100% of Allen Drilling Acquisition Company ("ADAC") (See Note 3 below) formerly AFI Mortgage Corp. and 100% of Cannon Financial Company (Cannon). Cannon collects debts for others for a fee and purchases charged-off credit card debt to collect at a profit from debtors located throughout the United States. On November 15, 1999, pursuant to an Asset Purchase Agreement between AIH Services, Inc. and Cannon, Cannon acquired certain assets for use in the operation and conduct of the businesses of AIH Services, Inc. known as AIH Receivable Management Services and AIH Early Recovery Systems. AIH Receivable Management Services and AIH Early Recovery Systems are engaged in the business of collecting nonperforming receivables on behalf of third parties. Cannon and AIH Services, Inc. combined operating assets and operations, and Cannon changed its name to AIH Receivable Management Services, Inc. (AIH) effective December 1, 1999. The consolidated financial statements include the accounts of the Company, ADAC and AIH. All significant intercompany accounts and transactions have been eliminated. 2. Finance Receivables And Revenue Recognition The Company accounts for its investment in finance receivables under the guidance of the American Institute of Certified Public Accountants Practice Bulletin 6, Amortization of Discounts on Certain Acquired Loans (PB6) using unique and exclusive static pools. The pools are established with underlying accounts having similar attributes, based on acquisition timing and by seller. Once a static pool is established, the accounts in the pool are not changed. Each pool is initially recorded at cost. Until it is determined that the amount and timing of collections are reasonably estimable and collection is probable, PB6 requires the receivable be accounted for under the cost-recovery method. All of the Company's pools are accounted for under the cost-recovery method. Application of the cost-recovery method requires that any amounts received be applied first against the recorded amount of the pool; when that amount has been reduced to zero, any additional amounts received are recognized as income. The discount between the cost of each pool of receivables purchased and the contractual receivable of the accounts in the pool is not recorded since the Company expects to collect a relatively small percentage of each pool's contractual receivable balance. 6 3. Property and Equipment Property, furniture, and equipment are stated at cost. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets; the lives have been determined by management to be seven years. 4. Income Taxes The Company accounts for income taxes under the asset and liability method where deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are recognized to the extent management believes that it is more likely than not that they will be realized. The Company has estimated net operating loss carryforwards of approximately $10.5 million as of March 31, 2003. These net operating losses will expire in the years ended March 31, 2009 through March 31, 2024. 5. Loss Per Common Share Loss per common share is based on the weighted average number of common shares outstanding during the periods presented. Because the effect of the inclusion of stock options and warrants is anti-dilutive, diluted per share information is not presented. 6. Stock-Based Compensation The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations in accounting for its employee stock options. Under APB 25, because the exercise price of employee stock options exceeds the market price of the underlying stock on the date of grant, no compensation expense is recorded. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123). 7. Customer Lists Intangible assets consist of customer lists obtained in acquisitions and are being evaluated annually for impairment. No impairment has been recognized in the nine months ended December 31, 2003. 8. Accounting Pronouncements and Recent Regulatory Developments In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. Goodwill and other intangible assets having an indefinite useful life acquired in business combinations completed after June 30, 2001, are no longer subject to amortization to earnings. Effective April 1, 2002, all goodwill and other intangible assets having an indefinite useful life are no longer amortized to earnings. The useful lives of other intangible assets must be reassessed, and the remaining amortization periods must be adjusted accordingly. Goodwill and other intangible assets having an indefinite useful life will be tested for 7 impairment annually, or more frequently if events or changes in circumstances indicate that the assets might be impaired, using a two-step impairment assessment. The first step of the goodwill impairment test compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired, and the second step of the impairment test is not necessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The Company adopted the provisions of SFAS 142 on April 1, 2002. There was no impairment charge upon completion of the impairment review as of March 31, 2003. Also in June 2001, the FASB issued SFAS 143, Accounting for Asset Retirement Obligations, which requires that the fair value of the liability for asset retirement costs be recognized in an entity's balance sheet, as both a liability and an increase in the carrying value of such assets, in the periods in which such liabilities can be reasonably estimated. It also requires allocation of such asset retirement cost to expense over its useful life. This Statement is effective for fiscal years beginning after June 15, 2002. The Company has determined the impact of this Statement on its consolidated financial position or results of operations is not material. In August 2001, the FASB issued SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 supersedes SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of and related literature and establishes a single accounting model, based on the framework established in SFAS 121, for long-lived assets to be disposed of by sale. The Company implemented the provisions of SFAS 144 as required on January 1, 2002. The adoption did not have a material effect on the Company's consolidated financial position or consolidated results of operations. In April 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections", to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that are similar to sale-leaseback transactions. The statement also amends other existing pronouncements. This statement is effective for fiscal years beginning after May 15, 2002. The Company has determined the impact of the statement on its consolidated financial position or results of operations is not material. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities", which addresses accounting and reporting for costs associated with exit and disposal activities and replaces Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)". This Statement is effective for exit or disposal activities that are initiated after December 31, 2002. The Company has determined the impact of the statement on its consolidated financial position or results of operations is not material. Effective July 30, 2002, the Sarbarnes-Oxley Act of 2002 (the "Act") was signed into law. The Act encompasses a broad range of new legislation designed to increase accountability of public companies and investor confidence. The Act establishes a new regulatory body, the "Public Company Accounting Oversight Board", under the auspices of the Securities and Exchange Commission (the "SEC") to oversee audits of companies offering equity or debt securities to the public, and further regulates and redefines the relationship between a registered public accounting firm and its audit clients. The Act establishes new disclosure requirement for public companies, financial certification standards for public 8 company CEOs and CFOs, restrictions on the ability of officers and directors to engage in certain types of transactions, accelerated reporting of certain types of transactions and new rules of analysts. In addition, the Act enhances a number of criminal penalties and enforcement measures available for securities related offenses. The SEC was directed to study and issue final rules to implement a number of directives contained in the Act, and some of the ensuing rules are discussed below. In August 2002, among other matters, the SEC adopted amendments to accelerate filing deadlines for certain public reports, and adopted new rules to implement Section 302 of the Act pertaining to financial statement certification and clarify disclosure controls and procedures. The Company is not subject to the accelerated filing deadlines at this time due to its size, however, it is subject to the financial statement certification and disclosure control rules. The Company intends to fully comply with all applicable new rules as they become effective. In December 2002, the FASB issued SFAS No. 148. "Accounting for Stock-Based Compensation" to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 of the same name to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement is effective for fiscal years and interim periods ending after December 15, 2002 and the Company has implemented this statement. The Company intends to continue using the intrinsic method of accounting for stock-based compensation first allowed under APB Option No. 25, "Accounting for Stock Issued to Employees". Therefore, the impact of adopting SFAS No. 148 on the consolidated financial statements of the Company is limited to the expanded disclosure requirements of the statement. In January 2003, the SEC adopted rules implementing Sections 406 and 407 of the Act. Section 406 of the Act requires public companies to annually disclose whether the company has adopted a code of ethics for its principal executive and financial officers, and if it has not, to explain why it has not. Additionally, the rules will require disclosure on a Form 8-K filing any amendments to or waivers from the code of ethics relating to those officers. Section 407 of the Act required public companies to disclose annually whether it has at least one "audit committee financial expert", as defined in the rules, on the Company's audit committee, and if so, the name of the audit committee financial expert and whether the expert is independent of management. A company that does not have an audit committee financial expert will be required to disclose this fact and explain why it has no such expert. Both rules are effective for small business issuers' annual reports for fiscal years ending on or after December 15, 2003. The Company intends to comply with these rules on a timely basis. Also in January 2003, the SEC adopted rules implementing section 401(a) of the Act, which required public companies to disclose "all material off-balance sheet financing transactions, arrangements, obligations (including contingent obligations), and other relationships of the issuer with consolidated entities or other persons, that may have a material current or future effect on financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenues or expenses." The rules require an additional section in Management's Discussion and Analysis for the presentation of this new disclosure, and there are additional rules for companies that are not small business issuers. The rules are effective for interim and annual filings for periods ending on or after June 15, 2003. The impact of adopting this statement on the consolidated financial position or results of operations is not material. 9 9. Use of Estimates In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. NOTE B - BANKRUPTCY AND REORGANIZATION As a result of numerous events, on November 7, 1997 (the Filing Date), the Predecessor Company filed a voluntary petition for reorganization in the United States Bankruptcy Court for the District of Kansas (Bankruptcy Court) under Chapter 11 of the United States Bankruptcy Code (Bankruptcy Code). On November 13, 1998, the Bankruptcy Court confirmed the Company's First Amended Joint Plan of Reorganization (the Plan) dated July 29, 1998. Until February 19, 1999, the Company operated its business as debtor in possession. On February 19, 1999 (the effective date), all material conditions precedent to the Plan becoming binding were resolved, the Plan became effective, and the following provisions of the Plan commenced: Argus Investment Group, Inc. (Argus) formerly First Mortgage Investment Co. (FMIC), a creditor of the Company, released its secured claims against, and acquired certain assets in exchange for 1,800,000 shares of Company common stock of the Company; these shares initially constituted 60% of the 3,000,000 new shares issued as part of the Company's recapitalization and reorganization and an option to acquire an additional 3,000,000 shares at $.50 per share or $1,500,000. Argus is controlled by Phillip J. Holtgraves, a member of the Board of Directors of the Company and the father of Charles A. Holtgraves, the Company's Chairman and President. The Company issued shares of common stock and warrants and made partial payments to certain other creditors in exchange for a release of their claims. The creditors received 900,000 shares of Company common stock; these shares constituted 30% of the 3,000,000 new shares issued as a part of the Company's recapitalization and reorganization. The creditors also received 900,000 warrants each of which allowed the holder to purchase one share of common stock per warrant at a price of $1.25. The warrants are callable by the Company at 130% of the strike price and expired on March 31, 2002. Shares held by preferred and common stockholders of the Predecessor Company were canceled; these stockholders received 300,000 shares of new Company common stock, constituting 10% of the 3,000,000 new shares issued as part of the Company's recapitalization and reorganization. NOTE C - GOING CONCERN The accompanying consolidated financial statements have been prepared on going concern basis, which contemplates the Company's continuity of operations, realization of assets, and liquidation of liabilities in the ordinary course of business. These statements do not reflect adjustments that might result if the Company is unable to continue as a going concern. As a result of continued poor operating performance such matters are subject to significant uncertainty. 10 With the completion of the Madisonville Project, and the possible pending venture with Gateway Energy Corporation (all as described later), the Company has determined that the ability to generate long-term value for the common shareholders could be enhanced if the present Company operations, (AIH Receivable Management Services, Inc.) were sold. The Company would then concentrate its growth efforts in the energy industry focusing primarily on natural gas. The Company, as of the filing of this quarterly report, has entered into preliminary negotiations to participate in an additional venture with Gateway Energy Corporation, which project agreement has a possible execution date early in the calendar year 2004 and a first phase start up date in the third quarter of calendar year 2004. Management believes this industry and the future acquisitions and project ventures with Gateway Energy could bring profits and capital to sustain future growth and operations. In accordance with the above business strategy, an agreement in principal has been entered into with an entity controlled by the Company's principal creditor and majority stockholder, Argus, wherein the common shares of AIH would be exchanged for the debt held by Argus related to the AIH operations. The Board of Directors has engaged an investment banking firm (Morgan Stanley) to determine the fair market value as of September 30, 2003, of the AIH operations. The exchange transaction is anticipated to result in a gain to the Company. Upon completion of the exchange transaction, the Company intends to amend its Certificate of Incorporation to effect a 1 for 3 reverse stock split and a name change. In order to minimize costs, the Company intends to solicit the consents of the Company's common shareholders (in lieu of a proxy) for these and certain other matters as quickly as possible after receipt of the fair market valuation report discussed above. Argus, the holder of over 71% of the presently outstanding common stock of the Company has indicated its intent to vote in favor of the above. NOTE D - ACQUISITIONS AND AGREEMENTS 1. AFI Capital Corporation Agreement In July 2001, the Company entered into a four-year agreement with AFI Capital Corporation (Capital), a Nebraska corporation. Pursuant to the agreement, Capital will provide financial, acquisition, and general public company business consulting services. Compensation for such services will be based on a successful-efforts basis and will consist primarily of the Company's common equity. The Company will issue to Capital approximately 308,350 shares of its common stock (post reverse split basis) in connection with this July 2001 Agreement upon completion of the transactions described above. In addition, the proposed acquisition transaction discussed in Note 2 below is subject to the terms and conditions of this agreement, wherein Capital would be compensated if the acquisition is consummated. Larry J. Horbach, who was appointed assistant secretary of the Company, and elected to fill a vacant Company director position in March 2003, is the president and a director of AFI Capital Corporation. 11 2. Allen Drilling Acquisition Company Agreement On June 7, 2001, the Company executed a Letter of Intent, which Letter of Intent was amended in February 2002, to acquire, through a wholly owned subsidiary, 100% of the Common Stock of a private company in the energy field services ( primarily natural gas) industry. On April 22, 2002, the Company executed a definitive Stock Purchase Agreement, the closing of which was subject to several conditions, one of which included certain matters with respect to the financing of the acquisition transaction. As a result of a material adverse change in the operating results for the company to be acquired, the transaction could not close primarily due to the financing requirement matters. As of December 31, 2003, $75,000 of escrow earnest money deposits remain in the hands of the Seller. Given the above, it is more likely than not, that the transaction can be closed under the terms and conditions as set forth in the definitive Stock Purchase Agreement, thus necessitating several modifications to the Agreement's terms and conditions, including the total consideration to be paid. In addition, a closing will be depended upon a favorable re-valuation of the company's fixed assets and the availability of adequate financing at reasonable rates. Due to the uncertainty of the above matters, and the potential non-recovery of the escrow deposit in the event the transaction is not closed, a reserve of $75,000 has been established for the escrow deposit. 3. The Gateway Energy/Madisonville Project Agreement On March 6, 2003, the Company executed an Agreement which was closed on April 30, 2003, with Gateway Energy Corporation and certain of its subsidiaries of Houston, Texas ("Gateway") under which it provided, through the Company's wholly-owned subsidiary, Allen Drilling Acquisition Company ("ADAC"), $900,000 of credit enhancements in the form of Letters of Credit. These credit enhancements enabled Gateway to obtain additional financing, in the form of a three year Balloon Note from a Houston bank to complete the construction of certain natural gas pipeline facilities ("Pipeline Facilities") located in Madison County, Texas, (The "Madisonville Project"). ADAC secured the Letters of Credit through the private placement of a new series of participating preferred stock (the "Series A"), to two investor groups. The Certificate of Designation for the Series A provides, among other things, for dividend payments to the named holders thereof, equal to sixty-six and two thirds, (66.67%) of cash distributions received by ADAC from Gateway, and an unanimous vote of the Series A to exercise the Equity Participation Option as further described below. The Agreement provides, among other things, that ADAC will receive, during the term of the additional financing, one-half (50%) of the price upside portion only, if any, of the monthly fee to be received by Gateway from the Madisonville Project. The Agreement also provides that ADAC will have the option to either: (i) receive at the end of the Balloon Note term a lump-sum payment, which when added to the payments received, if any, for the price upside portion, will result in a 15% pre-tax internal rate of return on the $900,000, or (ii) to exercise the Equity Participation Option by paying off the Balloon Note on or before the end of the Balloon Note term in exchange for a thirty-three and one-third (33.33%) ownership interest in the Pipeline Facilities from that date forward. Gateway is obligated to pay the periodic interest payments on the Balloon Note during the three year term of the Balloon Note. Further, Gateway has granted liens to ADAC, subordinate to its banks, on its economic interest in the Madisonville Project and certain other natural gas operating systems and natural gas operating assets. The Agreement contains cross collateral and cross default provisions linking it to an additional Gateway term note at the same bank, the proceeds of which were used by Gateway to fund the Madisonville Project. 12 The Madisonville Project is operated under a long-term agreement between Gateway, Hanover Compression Limited Partnership, and Redwood Energy Production, L. P. and is designed to treat gas to remove impurities from the gas to enable the gas to meet pipeline sales quality specifications. The Madisonville Project employs the state-of-the-art, patented, absorption based technology developed by Advanced Extraction Technologies, Inc., for which Gateway has the exclusive U. S. license, to remove nitrogen from the gas. During the quarter ended December 31, 2003, the Company's wholly owned subsidiary (ADAC) accrued $33,750, the minimum guaranteed return. It also accrued a Series Preferred Stock dividend payable of $22,500, representing 66-2/3% of such minimum guaranteed return. These dividends are not payable until such time as ADAC receives project cash distributions from Gateway. The plant was deemed to be in service on October 1, 2003, which is the date that the price up side provisions of the agreement become effective. NOTE E - NOTES PAYABLE At December 31, Notes Payable consisted of the following: Due ARGUS, $1,346,058 interest at prime, due on demand, secured by substantially all of he Company's assets. Due AFI Capital Corporation, $75,000, interest at 8%, unsecured, due on demand. Due bank, $85,015 under a $100,000 Line of Credit, interest at 2% over prime, unsecured, due March 31, 2004 guaranteed by a director of the company. NOTE F - ACCOUNTS PAYABLE - RELATED PARTIES Accounts payable - related parties consisted of amounts advanced to the Company by ARGUS ($26,400) and AFI Capital ($50,521). No interest or repayment terms exist. Effective October 1, 2003, $508,787 of open advances to the Company by ARGUS were converted to demand notes payable, with interest at prime. NOTE G- OTHER RELATED PARTY TRANSACTION As of September 30, 2003, the Company had advanced to Balance In Full, Inc. ("BIF") $10,676, in connection with the acquisition of certain accounts. Charles A. Holtgraves, the Company's President, is the 100% owner of BIF. BIF places delinquent charged off credit card accounts with AIH for collection services, for which BIF pays to AIH fees for collection services. The fees paid are comparable to non related party accounts. During the quarter ended December 31, 2003, such advance was repaid by BIF. 13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. GENERAL - ------- As described in PART 1 hereof, the Company's Plan of Reorganization was confirmed by the United States Bankruptcy Court on November 13, 1998 and became effective on February 19, 1999. In accordance with the American Institute of Certified Public Accountants Statement Position No. 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code, the Company accounted for the reorganization using "Fresh-Start Reporting," whereby all remaining assets and liabilities were adjusted to their fair market values as of February 19, 1999. This discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, competition, which has and will continue to put price pressure on the Company's third party collection business, the cost and availability of capital to finance its portfolio receivables, and overall macro-economic conditions. The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report. Particular reference is made to NOTE C - GOING CONCERN included herein in this Form 10QSB under Part I, Notes To Condensed Consolidated Financial Statements for information with respect to the Company's future plans. Assuming that the transactions contemplated therein are consummated as proposed, the accompanying information will be significantly impacted by these transactions. RESULTS OF OPERATIONS - --------------------- Three Month's Ended December 31, 2002 And 2003 - ------------------------------------------------ Liquidity and Capital Resources - ------------------------------- The Company had a cash balance of $11,645 and a negative balance of $89,692 at December 31, 2002 and 2003 respectively. The Company's working capital requirements are being funded by Argus Investment Group, Inc. ("ARGUS ") the Company's majority shareholder, On February 5, 1999, ARGUS agreed to make available to the Company a line of credit in the amount of $875,000 for five years with an interest rate of 7% annually. This line of credit was used to acquire charged off credit card debt. During the year ended March 31, 2001, the maximum was reached under the line of credit and Argus converted such amount to common stock and entered into a series of prime rate demand secured notes with the Company and advances. The balance due under the secured notes at December 31, 2002 and 2003 was $902,747 and $1,346,058 respectively. In addition, Argus had advanced under open non interest bearing advances $359,286 as of December 31, 2002. On October 1, 2003, $508,787 of open non interest bearing advances were converted to a prime rate demand note. 14 As of December 31, 2002 and 2003, the Company's total assets were $405,677 and $425,459 respectively, and stockholders' equity was a deficit of $1,305,040 and $1,553,045 respectively. Argus has agreed to continue to provide funding as and when required by the Company to meet its cash flow requirements. Operations - ---------- Consolidated operations for the quarters ended December 31, 2002 and 2003 resulted in net losses of $65,222 and $42,714 respectively on collection, servicing and fee gross income of $213,732 and $228,918. Revenues from the collection of the Company's portfolio receivables are recognized only after the cost of such portfolios has been recovered. During the periods, the Company recovered $68,469 and $39,938 from its portfolio receivables of which $16,179 and $2,826 was applied to reduce the carrying value of its finance receivables asset leaving a portfolio carrying value of $37,450 and $6,423 at December 31, 2002 and 2003 respectively. Operating expenses, including general and administrative costs, for the quarter ended December 31, 2003, were $295,053 compared to $323,975 for the same period in 2002 which was a decrease of 9% between 2003 and 2002. The reduction was primarily a reflection of a reduction in payroll resulting from the Company's continued efforts in a re-organization and streamlining of various employee departments resulting in fewer full time employees. RESULTS OF OPERATIONS - --------------------- Nine Month's Ended December 31, 2002 And 2003 - ---------------------------------------------- Operations - ---------- Consolidated operations for nine months ended December 31, resulted in a net loss of $278,269 in 2002 and $59,250 in 2003 on collection, servicing and fee gross income of $788,900 and $711,701. The 2003 revenues include $101,250 of accrued minimum guaranteed interest return with respect to the Madisonville Project. In addition, ADAC, the Company's wholly owned subsidiary (which subsidiary holds the Madisonville Project investments) generated net income of $96,013 for the nine months ended December 31, 2003. Revenues from the collection of the Company's portfolio receivables are recognized only after the cost of such portfolios has been recovered. During the nine month periods ended December 31, 2002 and 2003, the Company recovered $210,300 and $97,885 respectively from its portfolio receivables of which $51,449 and $24,573 was applied to reduce the carrying value of its finance receivables asset. As of December 31, 2002 and 2003, the remaining outstanding balance of the receivables portfolio was approximately $14,000,000. 15 Operating expenses, including general and administrative costs, for the nine months ended December 31, 2002 and 2003, were $1,147,300 and $899,332 respectively, which was a decrease of approximately 28% between 2002 and 2003. The reduction was primarily a reflection of a reduction in payroll resulting from a re-organization and streamlining of various employee departments resulting in fewer full time employees and a general downsizing of the RMS operations. During the quarter ended June 30, 2002, the Company provided a reserve of $75,000 with respect to an escrow deposit for an earnest deposit on a possible acquisition transaction as there is no assurance that the delayed transaction can be closed. Part II Item 1. Legal Proceedings None Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Description 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K None SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ADVANCED FINANCIAL, INC. (Registrant) Dated: February 15, 2004 /s/ Charles A. Holtgraves ----------------- ----------------------------------- Charles A. Holtgraves Chairman, President, and Treasurer