MIDCOAST ENERGY RESOURCES INC, 424B4, 1997-06-27

MIDCOAST ENERGY RESOURCES INC
424B4, 1997-06-27
CRUDE PETROLEUM & NATURAL GAS

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2,100,000 SHARES

[LOGO]

COMMON STOCK

------------------------

Of the 2,100,000 shares of common stock, par value $.01 per share (the
"Common Stock"), offered hereby (the "Offering"), 2,000,000 are being issued
and sold by Midcoast Energy Resources, Inc. ("Midcoast" or the "Company"),
and 100,000 are being offered by the Selling Stockholder. See "Principal
Stockholders" and "Selling Stockholder." The Company will not receive any of
the proceeds from the sale of shares of Common Stock by the Selling Stockholder.
The Common Stock is listed on the American Stock Exchange ("AMEX") under
the symbol "MRS." On June 26, 1997, the closing sales price of the Common
Stock on the AMEX was $16.94 per share. See "Price Range of Common Stock and
Dividend Policy."

THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" ON PAGE 11.
------------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
PROCEEDS PROCEEDS TO
PRICE TO UNDERWRITING TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) STOCKHOLDER
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share............................ $16.00 $1.04 $14.96 $14.96
Total(3)............................. $33,600,000 $2,184,000 $29,920,000 $1,496,000
- ------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) See "Underwriting" for information concerning indemnification of the
Underwriters and other information.
(2) Before deducting expenses of the Offering payable by the Company estimated
at $285,000.
(3) The Company has granted the Underwriters an option, exercisable within 30
days of the date hereof, to purchase up to 315,000 additional shares of
Common Stock at the Price to Public per share, less the Underwriting
Discount, for the purpose of covering over-allotments, if any. If the
Underwriters exercise such option in full, the total Price to Public,
Underwriting Discount, Proceeds to Company and Proceeds to Selling
Stockholder will be $38,640,000, $2,511,600, $34,632,400 and $1,496,000,
respectively. See "Underwriting."

------------------------
The shares of Common Stock are offered severally by the Underwriters when,
as and if delivered to and accepted by them, subject to their right to withdraw,
cancel or reject orders in whole or in part and subject to certain other
conditions. It is expected that delivery of certificates representing the shares
of Common Stock will be made against payment on or about July 2, 1997 at the
offices of Oppenheimer & Co., Inc., Oppenheimer Tower, World Financial Center,
New York, New York 10281.

------------------------

OPPENHEIMER & CO., INC.
A.G. EDWARDS & SONS, INC.
COLEMAN AND COMPANY SECURITIES, INC.

THE DATE OF THIS PROSPECTUS IS JUNE 27, 1997.
<PAGE>
[MAP OF MIDCOAST PIPELINE SYSTEMS IN MISSISSIPPI, ALABAMA AND TEXAS]

2
<PAGE>
AVAILABLE INFORMATION

The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information may be inspected and copied at the public
reference facilities maintained by the Commission, at Room 1024, Judiciary Plaza
Building, 450 Fifth Street, N.W., Washington, D.C. 20549, and the following
regional offices of the Commission: Seven World Trade Center, Suite 1300, New
York, New York 10048, and at Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661-2511. Copies of such material may be obtained at
prescribed rates from the Public Reference Section of the Commission at Room
1024, Judiciary Plaza Building, 450 Fifth St., N.W. Washington, D.C. 20549. The
Commission maintains an Internet web site (http://www.sec.gov) that contains
reports, proxy statements and other information regarding registrants that file
electronically with the Commission through its Electronic Data Gathering,
Analysis and Retrieval System (EDGAR) filing system. The Common Stock of the
Company is listed on the AMEX and its reports, proxy statements and other
Company information are available for inspection at the offices of the American
Stock Exchange, Inc., 86 Trinity Place, New York, New York 10006-1881.

The Company has filed with the Commission a Registration Statement on Form
S-1 (the "Registration Statement") under the Securities Act of 1933, as
amended (the "Securities Act"), with respect to the Common Stock offered
hereby. This Prospectus, filed as a part of the Registration Statement, does not
contain all the information set forth in the Registration Statement and the
exhibits and schedules thereto, certain portions of which have been omitted in
accordance with the rules and regulations of the Commission. For further
information with respect to the Company and the Common Stock offered hereby,
reference is made to the Registration Statement and to the exhibits and
schedules thereto, which may be inspected at the Commission's offices without
charge or copies of which may be obtained from the Commission upon payment of
the prescribed fees. Statements made in the Prospectus as to the contents of any
contract, agreement or document referred to are not necessarily complete, and in
each instance, reference is made to the copy of such contract or other document
filed or incorporated by reference as an exhibit to the Registration Statement,
and each such statement is qualified in its entirety by such reference.

The Company will provide without charge to each person who receives a copy
of this Prospectus, upon written or oral request of such person, a copy of any
of the information that is incorporated by reference in this Prospectus (not
including exhibits to the information that is incorporated by reference unless
the exhibits are themselves specifically incorporated by reference). Such
request should be directed to: Midcoast Energy Resources, Inc., Attention: Dan
C. Tutcher, 1100 Louisiana, Suite 2950, Houston, Texas 77002, (713) 650-8900.

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK
OFFERED HEREBY, INCLUDING OVER-ALLOTMENT, STABILIZING TRANSACTIONS, SYNDICATE
SHORT COVERING TRANSACTIONS, AND PENALTY BIDS. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."

3
<PAGE>
PROSPECTUS SUMMARY

THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO, APPEARING
ELSEWHERE IN THIS PROSPECTUS. INVESTORS SHOULD CAREFULLY CONSIDER THE
INFORMATION SET FORTH UNDER THE CAPTION "RISK FACTORS." UNLESS THE CONTEXT
INDICATES OTHERWISE, REFERENCES IN THIS PROSPECTUS TO THE "COMPANY" OR
"MIDCOAST" ARE TO MIDCOAST ENERGY RESOURCES, INC. AND ITS SUBSIDIARIES ON A
CONSOLIDATED BASIS. CERTAIN TERMS, INCLUDING SEVERAL TECHNICAL TERMS COMMONLY
USED IN THE NATURAL GAS INDUSTRY, ARE DEFINED IN THE GLOSSARY CONTAINED HEREIN.
UNLESS OTHERWISE INDICATED, ALL INFORMATION SET FORTH IN THIS PROSPECTUS ASSUMES
THAT THE UNDERWRITERS' OVER-ALLOTMENT OPTION WILL NOT BE EXERCISED.

THE COMPANY

The Company is primarily engaged in the transportation, gathering,
processing and marketing of natural gas and other petroleum products. The
Company owns and operates an interstate transmission pipeline system, two
intrastate transmission systems, 18 end-user systems and 25 gathering systems
representing over 1,000 miles of pipeline with an aggregate daily throughput
capacity of over 791 Mmcf/d. The Company's principal business consists of
providing transportation services through its pipelines to both end-users and
natural gas producers, providing natural gas marketing services to these
customers and processing natural gas. In connection with these services, the
Company acquires and constructs bypass pipelines to supply natural gas directly
to industrial and municipal end-users and provides access to pipeline systems
for natural gas producers through its gathering systems.

The Company's principal assets are located in two core geographic areas:
Alabama/Mississippi and Texas. The Company's key operations include (i) a
288-mile interstate transmission pipeline and two end-user pipelines in northern
Alabama (collectively, the "AlaTenn Systems"), (ii) the Magnolia system in the
Black Warrior Basin of central Alabama which consists of over 111 miles of
natural gas transmission and gathering pipelines and a 4,000 horsepower
compressor station (the "Magnolia System"), (iii) the Harmony gas processing
system in Mississippi which includes a sour gas processing plant and over 150
miles of natural gas gathering pipelines (the "Harmony System") and (iv) the
Company's Texas pipeline systems which consist of over 162 miles of gas
gathering and bypass pipelines.

Since the first quarter of 1994, the Company has grown significantly by
acquiring or constructing 32 pipeline systems at an aggregate cost of over $50
million, and increasing its average daily throughput by over twelve-fold to 280
Mmcf/d for the first quarter of 1997 after giving effect to the AlaTenn
Acquisition (defined below). Primarily as a result of these acquisitions, the
Company's EBITDA (as defined in the Glossary) increased to $12.7 million on a
pro forma basis in 1996 for the acquisition of the Harmony System (the "Harmony
Acquisition") and the AlaTenn Acquisition, from $0.6 million on a historical
basis in 1994. See "Unaudited Pro Forma Consolidated Financial Statements."

BUSINESS STRATEGY

The Company's principal business strategy is to increase its earnings and
cash flow by acquiring or constructing pipeline systems, aggressively pursuing
end-user customers, increasing the utilization of its existing pipeline systems
and processing plants in order to enhance the Company's profitability and
improving cost efficiencies.

The Company implements this strategy through the following steps:

o ACQUISITION OR CONSTRUCTION OF PIPELINE AND PROCESSING SYSTEMS. The
Company seeks to acquire or construct natural gas transmission,
end-user, gathering and processing systems which offer the opportunity
for increased utilization and expansion of the system due to their
proximity to geographic areas where municipal and industrial demand
for natural gas is growing or where drilling activity is expected to
increase. The Company seeks to acquire or construct additional

4
<PAGE>
transmission and gathering systems or processing facilities in its
core geographic areas of operation when the Company believes such
additional systems will enhance the overall profitability of the area
of operation.

o FOCUS ON END-USERS. As a result of recent regulatory changes, natural
gas customers have more flexibility to negotiate their natural gas
purchase and transportation contracts. The Company actively pursues
direct sales to these end-users, such as industrial plants and
municipalities, which are seeking alternative supplies to meet their
energy needs. The Company seeks to build pipeline systems directly
connecting these customers to transmission systems and to enter into
long-term transportation agreements that provide the Company with more
predictable gas throughput and cash flow. The Company also offers gas
marketing services to its end-user customers who usually incur a
reduced transportation cost by receiving natural gas through a
Company-owned pipeline.

o UTILIZATION OF EXISTING SYSTEMS' CAPACITY. After a system is acquired
or constructed, the Company begins an aggressive marketing effort to
fully utilize the system's capacity. As part of this process, the
Company focuses on providing quality service to its end-user and
natural gas producer customers. Many of the Company's existing
intrastate pipeline and processing systems were designed with excess
natural gas throughput capacity that provide the Company with
opportunities to pursue additional gas volumes with little incremental
capital cost and to provide high-margin "swing" sales during periods
of increased gas demand.

o COST EFFICIENCIES. The Company generally seeks to achieve
administrative and operational efficiencies by reducing overhead,
increasing utilization of equipment and personnel, capitalizing on the
geographic proximity of many of its systems and further integrating
gas transmission and marketing services. The Company also seeks to
acquire or construct additional transmission and gathering systems or
processing facilities in its core geographic areas of operation where
it can achieve administrative or operational efficiencies when
integrated with the Company's existing systems. The Company emphasizes
strict cost controls in all aspects of its business.

THE ALATENN ACQUISITION

Consistent with the Company's business strategy, in May 1997, Midcoast
acquired the AlaTenn Systems and their related pipeline and energy services
operations from Atrion Corporation ("Atrion") for cash consideration of
approximately $39.4 million and up to $2 million in contingent deferred payments
(the "AlaTenn Acquisition"). These operations include (i) a 288-mile
interstate transmission pipeline located in northern Alabama, Mississippi and
southern Tennessee that transports natural gas to eight industrial and 17
municipal customers (the "MIT System"), (ii) a 38-mile and a one-mile pipeline
in northern Alabama that primarily serve two large industrial customers (the
"Champion System" and "Monsanto System," respectively) and (iii) a natural
gas marketing company which primarily serves customers of the AlaTenn Systems.

The AlaTenn Acquisition complements the Company's operations in the
Alabama/Mississippi area, which include the Magnolia System, the Harmony System
and 11 other gathering and transmission systems. The Company believes there are
numerous opportunities for increasing the utilization of the AlaTenn Systems.
The Company also intends to pursue new construction and acquisition
opportunities in this core geographic area through additional transmission
systems that interconnect to or otherwise provide synergies with the AlaTenn
Systems and the Company's other pipeline systems in the area. The Company
further intends to make these systems more cost effective and emphasize its gas
marketing efforts throughout this region.

5
<PAGE>
THE OFFERING

Common Stock Offered by the
Company(1)......................... 2,000,000 shares
Common Stock Offered by Selling
Stockholder........................ 100,000 shares
---------
Total...................... 2,100,000 shares
=========
Common Stock Outstanding(1)(2):
Before the Offering............. 2,500,000 shares
After the Offering.............. 4,500,000 shares
Use of Proceeds...................... The net proceeds from the sale of the
Common Stock offered hereby will be used
to repay bank indebtedness incurred in
connection with the AlaTenn Acquisition.
See "Use of Proceeds."
AMEX Symbol.......................... MRS
- ------------

(1) Excludes 315,000 shares of Common Stock subject to purchase upon exercise of
the Underwriters' over-allotment option. See "Underwriting."

(2) Based on the number of shares of Common Stock outstanding on May 15, 1997.
Does not include (i) 100,000 shares of Common Stock issuable upon exercise
of outstanding warrants to purchase Common Stock exercisable at $14.20 per
share commencing in August 1998 ("Warrants"), (ii) 34,349 shares issuable
upon exercise of outstanding warrants to purchase Common Stock exercisable
at $7.85 per share ("Triumph Warrants") and (iii) 280,000 shares of Common
Stock reserved for issuance upon the exercise of outstanding stock options
under the Company's stock option plans. See "Management -- Executive
Compensation" and "Description of Capital Stock -- Outstanding Warrants."

6
<PAGE>
SUMMARY UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL AND OPERATING DATA

The following summary unaudited pro forma consolidated financial and
operating data for the year ended December 31, 1996 and the three months ended
March 31, 1997 give effect to (i) the Harmony Acquisition under the purchase
method of accounting, (ii) the AlaTenn Acquisition under the purchase method of
accounting and the related assumptions and adjustments described in the notes to
the Unaudited Pro Forma Consolidated Financial Statements, (iii) the incurrence
of $39.4 million in bank indebtedness (the "Acquisition Debt") to finance the
AlaTenn Acquisition, plus an estimated $475,000 in related financing costs and
(iv) the issuance and sale of 2,000,000 shares of Common Stock by the Company
pursuant to the Offering and the application of the net proceeds therefrom to
repay approximately $29.6 million of Acquisition Debt. The Unaudited Pro Forma
Consolidated Financial Statements have been prepared based upon assumptions
deemed appropriate by the Company and may not be indicative of actual results.
The summary unaudited pro forma statement of operations data give effect to the
Harmony Acquisition, the AlaTenn Acquisition and related financings as if such
transactions had occurred as of January 1, 1996. For balance sheet data purposes
pro forma adjustments give effect to the AlaTenn Acquisition, the Offering and
the application of the net proceeds therefrom (assuming no exercise of the
Underwriters' over-allotment option). The summary unaudited pro forma
consolidated financial and operating data should be read in conjunction with the
"Unaudited Pro Forma Consolidated Financial Statements," "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Consolidated Financial Statements" and "Combined Financial Statements" of
the three companies acquired from Atrion in the AlaTenn Acquisition (the
"AlaTenn Subsidiaries") and the "Historical Summary of Revenue and Direct
Operating Expenses" related to the Harmony System included elsewhere in this
Prospectus.

<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, 1996 MARCH 31, 1997
------------------------------------ ------------------------------------
HISTORICAL HISTORICAL
-------------------- PRO FORMA -------------------- PRO FORMA
COMPANY ALATENN AS ADJUSTED COMPANY ALATENN AS ADJUSTED
-------- -------- ------------ -------- -------- ------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Operating revenues............... $29,415 $113,429 $146,406 $12,964 $32,055 $ 45,019
Operating income(1).............. 2,573 6,727 11,294 1,299 1,786 3,441
Interest expense................. 413 1 1,445 95 -- 314
Income before income taxes....... 1,914 7,275 10,152 1,132 1,790 3,059
Net income....................... 1,914 4,633 7,053 1,132 1,142 2,081
Net income applicable to common
shareholders................... 1,891 4,633 7,030 1,132 1,142 2,081
PER SHARE DATA:
Net income applicable to common
shareholders................... $ 1.00 -- $ 1.81 $ 0.45 -- $ 0.46
Weighted average number of common
shares outstanding............. 1,886 -- 3,886 2,500 -- 4,500
OTHER DATA:
Depreciation, depletion and
amortization................... $ 818 $ 584 $ 1,614 $ 255 $ 147 $ 437
General and administrative....... 1,223 3,961 3,632 374 873 856
EBITDA(2)........................ 3,193 7,311 12,710 1,494 1,933 3,818
Cash flow from operating
activities..................... 2,564 6,257 -- 2,948 542 --
Capital expenditures............. 9,391 331 -- 425 36 --
</TABLE>

MARCH 31, 1997
-------------------------
PRO FORMA
ACTUAL AS ADJUSTED
--------- ------------
(IN THOUSANDS)
BALANCE SHEET DATA:
Working capital.................. $ 1,722 $ 3,524
Property, plant and equipment,
net............................. 17,148 54,356
Total assets..................... 27,653 72,441
Long-term debt, net of current
portion(3)...................... 5,943 14,006
Shareholders' equity............. 14,583 44,218

7
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996 MARCH 31, 1997
-------------------------------- --------------------------------
HISTORICAL HISTORICAL
------------------- -------------------
COMPANY ALATENN PRO FORMA COMPANY ALATENN PRO FORMA
-------- -------- ---------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Miles of pipeline(4)............. 584 327 911 702 327 1,029
Operating pipeline systems:
Interstate transmission..... -- 1 1 -- 1 1
Intrastate transmission..... 2 -- 2 2 -- 2
End-user.................... 17 2 19 16 2 18
Gathering................... 24 -- 24 25 -- 25
-------- -------- ---------- -------- -------- ----------
Total operating pipeline
systems..................... 43 3 46 43 3 46
======== ======== ========== ======== ======== ==========

Natural gas transported or sold,
net (Mmcf/d)(5)................ 102 131 233 133 147 280
Daily volume capacity (Mmcf/d)... 574 210 784 581 210 791
</TABLE>
- ------------

(1) Operating revenues less operating expenses.

(2) See "Glossary" for a definition of EBITDA. EBITDA is not a measure of
operating income, operating performance, or liquidity under generally
accepted accounting principles. The Company includes EBITDA data because it
understands such data is used by certain investors to determine the
Company's historical ability to service its indebtedness.

(3) See Note 5 to the Company's "Consolidated Financial Statements."

(4) Includes all of the miles of pipeline of the various active pipelines that
the Company owns an interest in or operates.

(5) Includes natural gas volumes contracted for, transported or sold through the
Company's pipeline systems. Transported oil volumes have been converted to
an equivalent unit basis which is 6 Mcf to 1 Bbl, consistent with industry
standards, for the year ended December 31, 1996 and the three-month period
ended March 31, 1997.

8
<PAGE>
SUMMARY HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA

The summary historical consolidated financial and operating data for the
fiscal years ended December 31, 1994, 1995 and 1996, and for the three months
ended March 31, 1996 and 1997, set forth below, are derived from and should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included herein and the Company's
"Consolidated Financial Statements" and the notes thereto included elsewhere
in this Prospectus. The data for the three months ended March 31, 1996 and 1997
are derived from and qualified by reference to the Company's "Consolidated
Financial Statements" appearing elsewhere herein and, in the opinion of
management of the Company, includes all adjustments that are of a normal
recurring nature and necessary for a fair presentation. See "Selected
Historical Consolidated Financial Data," "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Consolidated Financial
Statements."

<TABLE>
<CAPTION>
FOR THE YEARS ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNT)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Operating revenues.................. $ 14,969 $ 15,622 $ 29,415 $ 5,584 $ 12,964
Operating income(1)................. 349 2,569 2,573 533 1,299
Interest expense.................... 189 339 413 120 95
Income before income taxes and
cumulative effect of a change in
accounting principle.............. 148 2,193 1,914 374 1,132
Net income.......................... 27 2,193 1,914 374 1,132
Net income (loss) applicable to
common shareholders............... (32) 2,134 1,891 359 1,132
PER SHARE DATA:
Net income (loss) applicable to
common shareholders............... $ (0.02) $ 1.48 $ 1.00 $ 0.24 $ 0.45
Weighted average number of common
shares outstanding................ 1,391 1,440 1,886 1,466 2,500
OTHER DATA:
Depreciation, depletion and
amortization...................... $ 259 $ 452 $ 818 $ 151 $ 255
General and administrative.......... 849 785 1,223 199 374
EBITDA(2)........................... 609 3,021 3,193 664 1,494
Cash flow from operating
activities........................ (515) 2,361 2,564 1,306 2,948
Capital expenditures................ 1,088 3,885 9,391 1,286 425
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(UNAUDITED)
(IN THOUSANDS, EXCEPT WHERE OTHERWISE INDICATED)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit)........... $ (1,105) $ (99) $ 1,135 $ (441) $ 1,722
Property, plant and equipment,
net............................... 4,994 8,206 16,965 8,171 17,148
Total assets........................ 7,272 11,089 27,303 11,887 27,653
Long-term debt, net of current
portion(3)........................ 1,781 3,961 4,015 3,442 5,943
Shareholders' equity................ 2,007 4,157 13,593 4,522 14,583
OPERATING DATA:
Miles of pipeline(4)................ 35 146 584 233 702
Operating pipeline systems:
Intrastate transmission........ 0 1 2 1 2
End-user....................... 11 11 17 12 16
Gathering...................... 5 5 24 11 25
--------- --------- --------- --------- ---------
Total operating pipeline
systems........................... 16 17 43 24 43
========= ========= ========= ========= =========
Natural gas volumes transported or
sold, net (Mmcf/d)(5)............. 31 44 102 113 133
Daily volume capacity (Mmcf/d)...... 182 302 574 462 581
</TABLE>
(FOOTNOTES ON FOLLOWING PAGE)

9
<PAGE>
- ------------

(1) Operating revenues less operating expenses.

(3) See Note 5 to the Company's "Consolidated Financial Statements."

(4) Includes all of the miles of pipeline of the various pipelines that the
Company owns an interest in or operates.

(5) Includes natural gas volumes contracted for, transported or sold through the
Company's pipeline systems. Transported oil volumes have been converted to
an equivalent unit basis which is 6 Mcf to 1 Bbl, consistent with industry
standards, for each of the years ended December 31, 1994, 1995 and 1996 and
the three-month period ended March 31, 1997.

10
<PAGE>
RISK FACTORS

In addition to other information in this Prospectus, the following factors
should be considered carefully by prospective investors in evaluating the
Company before purchasing the Common Stock offered hereby.

INTEGRATION OF RECENT ACQUISITIONS; LIMITED COMBINED OPERATING HISTORY

The Company has a limited operating history with regard to a significant
portion of its operations, including the AlaTenn Systems, which are
significantly larger than the Company's previous acquisitions and represents a
substantial increase in the scope of the Company's business. Since 1994, the
Company also acquired 29 other pipeline systems which collectively comprised
$7.9 million or 27% of the Company's revenues for the year ended 1996 and $11.4
million or 62% of the Company's property, plant and equipment at December 31,
1996. See "Business and Properties -- Principal Systems." The integration and
consolidation of the AlaTenn Acquisition and the Company's other recent
acquisitions will require substantial management time and financial and other
resources. While management believes that it has sufficient financial and
management resources to accomplish the integration of the AlaTenn Systems and
the Company's other recent acquisitions, there can be no assurances in this
regard or that the Company will not experience difficulties with customers,
personnel or operations. Any failure or any inability to successfully integrate
the AlaTenn Systems or any other significant acquisition may have a material
adverse effect on the Company's results of operations and financial condition.

RAPID GROWTH; DEPENDENCE ON ACQUISITIONS

The Company has grown rapidly in recent years primarily due to its
acquisition and construction of a number of pipelines. A key part of the
Company's business strategy is continuous growth through strategic acquisitions.
The Company will consider and evaluate acquisitions on a continuous basis, and a
period of rapid growth could place a significant strain on the Company's
management, operations and other resources. There can be no assurance that the
Company will continue to be able to identify attractive or willing acquisition
candidates, or that the Company will be able to acquire such candidates on
economically acceptable terms. The Company will compete with other intrastate
and interstate pipeline companies for suitable acquisition candidates in the
future. The Company's growth strategy is also capital intensive in nature and
depends in large measure on its ability to successfully acquire or construct
additional pipeline systems. The Company's ability to grow through acquisitions
and manage such growth will require the Company to continue to invest in its
operational, financial and management information systems and to attract,
retain, motivate and effectively manage its employees. The inability of the
Company's management to manage growth effectively would have a material adverse
effect on the financial condition, results of operations and business of the
Company. As the Company pursues its acquisition strategy in the future, its
financial position and results of operations may fluctuate significantly from
period to period. Additionally, in connection with any acquisition made by the
Company, including the AlaTenn Acquisition, there may be liabilities that the
Company fails or is unable to discover, including liabilities arising from
non-compliance with governmental regulation and environmental laws by prior
owners, and for which the Company, as a successor owner, may be responsible. See
"Business and Properties -- Business Strategy."

RELIANCE ON OFFICERS, DIRECTORS AND KEY EMPLOYEES

The Company is dependent on the services of certain key management
personnel, the loss of whose services could have a material adverse effect on
the Company. In particular, the Company depends on the services of Dan C.
Tutcher, Chairman of the Board, President and Chief Executive Officer, I. J.
Berthelot, II, Vice President of Operations, Chief Engineer and director, and
Richard A. Robert, Chief Financial Officer and Treasurer. Each of these
individuals is party to an employment agreement with the Company. There can be
no assurance that any of these persons will remain employed by the Company, or
that these persons will not participate in businesses that compete with the
Company in the future. In seeking qualified personnel, the Company will be
required to compete with companies having greater financial and other resources
than the Company. Since the Company's future success will depend on its ability
to attract and

11
<PAGE>
retain qualified personnel, the inability to do so could have a materially
adverse affect on its business. See "Management."

ABILITY TO SECURE ADDITIONAL FINANCING

The Company's growth strategy is capital intensive in nature and depends in
large measure on its ability to successfully acquire or construct additional
pipeline systems. The ability of the Company to generate cash flow and obtain
financing from third parties will depend on the Company's future performance and
liquidity. The Company's strategy of acquiring or constructing pipelines is
dependent upon its ability to obtain financing for such acquisitions and
construction projects. The Company expects to utilize its existing credit
facilities (the "Credit Agreement") provided by Bank One, Texas N.A. ("Bank
One") to borrow a portion of the funds required for any given transaction or
project. Pursuant to the Credit Agreement, the Company's current aggregate
borrowing availability is limited to $46.5 million and is subject to semi-annual
borrowing base redeterminations based on the performance of the Company's
existing assets and certain events such as the Company's acquisition or
disposition of assets through new construction or acquisition activity. If funds
under the Credit Agreement are not available to fund acquisition and
construction projects, the Company would seek to obtain such financing from the
sale of equity securities or other debt financing. There can be no assurance
that any such other financing would be available on terms acceptable to the
Company. Should sufficient capital not be available, the Company may not be able
to continue to implement its acquisition strategy. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Capital
Resources and Liquidity" and "Business and Properties."

RISKS OF COMPETITION FROM LARGER COMPETITORS

The Company has numerous competitors in its geographic areas of operations,
many of which are larger pipeline companies with more extensive pipeline
networks. Many of these competitors, particularly those affiliated with major
integrated oil and interstate and intrastate pipeline companies, have financial
resources substantially greater than those of the Company and have access to
supplies of natural gas substantially greater than those available to the
Company. In particular, Southern Natural Gas, Inc. ("Southern"), a subsidiary
of Sonat, Inc. ("Sonat") has filed an application with the Federal Energy
Regulatory Commission ("FERC") to build a 110-mile pipeline from Tuscaloosa,
Alabama to northern Alabama to provide gas to two municipal customers in that
geographic area. Those two customers, accounting for approximately 26% or $3
million of the AlaTenn Subsidiaries' gross margin in 1996, have entered into a
20-year contract with Southern to provide natural gas transportation services if
the proposed pipeline is constructed. Since these contracts with Southern cover
substantially all of the current natural gas requirements of these two
customers, if the pipeline is constructed, the Company will lose the firm
transportation gas volumes of these customers at some point in the future unless
the Company is able to renew the contracts or obtain new customers. If the Sonat
pipeline is constructed, it may have a material adverse effect on the financial
condition, results of operations and business of the Company. See "Business and
Properties -- Competition."

FACTORS AFFECTING INTERSTATE PIPELINE OPERATIONS

The MIT System is subject to regulation as an interstate pipeline by FERC,
which entails numerous legislative and regulatory restrictions that are subject
to change and could affect the MIT System to various degrees. Significant
interstate regulatory factors that have affected or may affect the MIT System
from time to time include the following (i) potential inability to obtain
authorization for additional allowable firm throughput and rate increases from
regulatory authorities in adequate amounts on a timely basis, (ii) uncertainties
relating to interstate pipeline restructuring pursuant to FERC Order No. 636
("Order 636") and new requirements for gas supply resulting from such
restructuring, (iii) attempts by large volume customers or gas suppliers to
construct gas facilities to connect to an interstate pipeline or other source of
gas supply in order to bypass the Company's systems, (iv) uncertainties related
to customers' projected energy requirements and (v) uncertainties related to
regulation of interstate pipelines which supply

12
<PAGE>
distribution companies. See "Business and Properties -- Natural Gas Supply"
and "Business and Properties -- Rate and Regulatory Matters."

FLUCTUATIONS IN DEMAND DUE TO WEATHER

The Company has had quarter-to-quarter fluctuations in its financial
results in the past due to changes in demand for natural gas primarily because
of weather. Although, historically, quarter-to-quarter fluctuations resulting
from weather variations have not been significant, the acquisitions of Magnolia
and the MIT System are expected to increase the impact that weather conditions
have on the Company's financial results. In particular, demand on both the
Magnolia System and the MIT System is expected to fluctuate due to weather
variations because of the large municipal or other seasonal customers which are
served by these systems. There can be no assurances that the Company's efforts
to minimize such effects will have any impact on future quarter to quarter
fluctuations due to changes in demand resulting from weather conditions. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation -- General."

RISK OF ADVERSE PRICE CHANGES OR GAS MARKETING OPERATIONS

As part of its natural gas marketing activities, the Company buys natural
gas on the spot market for customers served by pipeline systems owned by the
Company and for sales to those customers. Generally, natural gas is purchased
under contracts that contain terms allowing prices to be determined by
prevailing market conditions. Concurrently, the Company resells the gas at
higher prices under sales contracts which are compatible as to term, price
escalation, renegotiation and other material matters. The Company earns the
difference between the gas purchase price it pays and the sales price it
receives. Gas marketing is characterized by a high degree of competition and
narrow margins. The profitability of the natural gas marketing operations of the
Company depends in large part on the ability of the Company's management to
assess and respond to changing market conditions in negotiating these natural
gas purchase and sale agreements. As a consequence of the increase in
competition in the industry and volatility of natural gas prices there has been
a reluctance of end-users to enter into long-term purchase contracts. Moreover,
consumers have shown an increased willingness to switch fuels between gas and
alternate fuels in response to relative price fluctuations in the market. The
inability of management to respond appropriately to changing market conditions
could have a negative effect on the Company's profitability. The Company's gas
marketing activities which utilize third-party transporters also exposes the
Company to economic risk resulting from imbalances or nominated volume
discrepancies which can result either in penalties having a negative impact on
earnings or a transaction gain, depending on how and when imbalances are
corrected. See "Business and Properties -- Major Customers."

RISKS OF INADEQUATE GAS SUPPLIES

The Company has historically purchased substantially all of its gas from
unaffiliated third parties and on the spot market. These purchase contracts may
be affected by factors beyond both the Company's and the gas suppliers' control
such as capacity constraints, temporary regional supply shortages, and, with
regard to its gathering systems, other parties having control over the drilling
of new wells, inability of wells to deliver gas at required pipeline quality and
pressure, and depletion of reserves. The future performance of the Company will
depend to a great extent on the throughput levels achieved by the Company with
respect to its existing pipelines and the pipelines acquired or constructed by
it in the future. In order to maintain the throughput on its gathering systems
at current levels, the Company must access new natural gas supplies to offset
the natural decline in reserves as such supplies are produced. See "Business
and Properties -- Natural Gas Supply."

CHANGES IN GOVERNMENT REGULATION AND CONTINUING INDUSTRY TRANSITION

Changes in the regulatory environment for the natural gas transportation
industry, most notably Order 636, have profoundly affected the economics and
structure of the natural gas transmission industry, and may continue to do so in
the future. There can be no assurance that such evolution will ultimately result
in greater opportunities for smaller gas pipeline companies. Furthermore, there
can be no assurance that such

13
<PAGE>
regulations will be effective in meeting their goals of creating a level playing
field for all natural gas buyers and sellers. FERC could issue new regulations
which may subject some portion of the Company's unregulated business activity to
FERC regulation, subject the MIT System to additional regulation or adversely
affect the conduct of the Company's business. The construction, operation,
maintenance and safety of the Company's intrastate pipelines are typically
regulated by the state regulatory commissions with jurisdictional authority. As
in the case of potential federal regulatory changes, there can be no assurances
that state regulatory measures will not adversely affect the Company's
intrastate business and financial condition. In such events, state regulatory
authorities could temporarily suspend or hinder operations in a particular
state, depending on the authority's view of its jurisdiction. Regulators at the
state level have generally followed FERC's lead by allowing increased
competition behind local distribution companies ("LDCs"); however, there can
be no assurance that every state will follow this practice. See "Business and
Properties -- Rate and Regulatory Matters."

LIABILITIES AND COSTS UNDER ENVIRONMENTAL LAWS

The Company is subject to federal, state and local laws, regulations and
ordinances relating to the environment, health and safety, waste management, and
transportation of hydrocarbons and chemical products. Various governmental
authorities have the power to enforce compliance with these regulations and the
permits issued pursuant to them, and violators are subject to civil and criminal
penalties, including civil fines, injunctions, or both. Liability may be
incurred without regard to fault for the cost of remediation of contaminated
areas. Private parties, including the owners of property through which the
Company's pipelines pass, may also have the right to pursue legal actions to
enforce compliance and seek damages for noncompliance with environmental laws
and regulations. The Company will make expenditures in connection with
environmental matters as part of its normal operations and capital expenditures
and the possibility exists that stricter laws, regulations or enforcement
policies could significantly increase the Company's compliance costs and the
cost of any remediation which may become necessary. There is inherent risk of
the incurrence of environmental costs and liabilities in the Company's business
due to its handling of oil, gas and petroleum products, historical industry
waste disposal practices and prior use of gas flow meters containing mercury.
There can be no assurance that material environmental costs and liabilities will
not be incurred by the Company. Furthermore, there can be no assurance that the
Company's environmental impairment insurance will provide sufficient coverage in
the event an environmental claim is made against the Company. An uninsured or
underinsured claim of sufficient magnitude could have a material adverse effect
on the Company's financial condition. Additionally, in connection with any
acquisition made by the Company, including the AlaTenn Acquisition, there may be
liabilities that the Company fails or is unable to discover, including
liabilities arising from non-compliance with governmental regulation and
environmental laws by prior owners, and for which the Company, as a successor
owner, may be responsible. See "Business and Properties -- Rate and Regulatory
Matters" and "Business and Properties -- Insurance."

HAZARDS AND OPERATING RISKS OF PIPELINE OPERATIONS

The Company's operations are subject to the many hazards inherent in the
natural gas transmission industry. These include damage to pipelines, related
equipment and surrounding properties caused by hurricanes, floods, fires and
other acts of God, inadvertent damage from construction and farm equipment,
leakage of natural gas and other hydrocarbons, fires and explosions, and other
hazards that could also result in personal injury and loss of life, pollution
and suspension of operations. The Company maintains such insurance protection as
it believes to be adequate against normal risks in its operations. There is no
assurance that any such insurance protection will be sufficient or effective
under all circumstances or against all hazards to which the Company may be
subject. The occurrence of a significant event not fully insured against could
materially adversely affect the Company's operations and financial condition. No
assurance can be given that the Company will be able to maintain adequate
insurance in the future at rates it considers reasonable. See "Business and
Properties -- Insurance." Should catastrophic conditions occur which interrupt
delivery of gas for any reason, such occurrence could have a material impact on
the profitability of the Company's operations.

14
<PAGE>
NO ASSURANCE OF FUTURE DIVIDENDS

The holders of the Common Stock are entitled to receive dividends if, when
and as declared by the board of directors of the Company (the "Board") out of
funds legally available therefor. The Company's current policy is to declare
quarterly cash dividends at a rate of $.08 per share of Common Stock. The amount
of future cash dividends, if any, will depend upon future earnings, capital
requirements, covenants contained in various financing agreements of the Company
and its subsidiaries, the financial condition of the Company and certain other
factors. Accordingly, there can be no assurance that dividends will be paid by
the Company in the future. See "Price Range of Common Stock and Dividend
Policy."

LIMITED TRADING MARKET FOR COMMON STOCK

The Company's Common Stock is traded on the AMEX. Average daily trading
volume for the Common Stock as reported by the AMEX for the first quarter 1997
was approximately 4,900 shares. Despite the increase in the number of shares of
Common Stock to be publicly held as a result of the Offering, there can be no
assurance that a more active trading market in the Common Stock will develop.
Because there is a small public float in the Common Stock and it is thinly
traded, sales of small amounts of Common Stock in the public market could
materially adversely affect the market price for the Common Stock. Sales of
Common Stock, or the perception that such sales could occur, could materially
adversely affect prevailing market prices for the Common Stock and may make it
more difficult for the Company to sell shares of Common Stock in the future at
times and for prices that it deems appropriate. Upon completion of the Offering,
the Company will have 4,500,000 shares of Common Stock outstanding (4,815,000
shares if the Underwriters' over-allotment option is exercised in full). The
2,100,000 shares of Common Stock sold in the Offering (2,415,000 shares if the
Underwriters' over-allotment option is exercised in full) will be freely
transferable without restriction or registration under the Securities Act,
unless purchased by persons deemed to be affiliates of the Company (as that term
is defined under the Securities Act). Substantially all of the remaining
2,500,000 shares of Common Stock outstanding immediately following the Offering
will be transferable without restriction or registration under the Securities
Act, except for approximately 1,200,000 shares purchased by persons deemed to be
affiliates of the Company (as that term is defined under the Securities Act)
which will be subject to the volume restrictions under Rule 144. See "Shares
Eligible for Future Sale."

FORWARD LOOKING STATEMENTS

This Prospectus includes forward looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. All
statements other than statements of historical fact included in this report are
forward looking statements. Such forward looking statements include, without
limitation, statements under "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Capital Resources and Liquidity" and
"Business and Properties" regarding the Company's estimate of the sufficiency
of existing capital resources, its ability to raise additional capital to fund
cash requirements for future operations, whether funds provided by operations
will be sufficient to meet its operational needs in the foreseeable future and
its ability to utilize net operating loss ("NOL") carryforwards prior to their
expiration. Although the Company believes that the expectations reflected in
such forward looking statements are reasonable, it can give no assurance that
such expectations reflected in such forward looking statements will prove to be
correct. The ability to achieve the Company's expectations is contingent upon a
number of factors which include (i) the timely approval of the Company's
acquisition candidates by appropriate governmental and regulatory agencies, (ii)
the effect of any current or future competition, (iii) the retention of key
personnel and (iv) the Company's ability to obtain sufficient financing to fund
operations and the timing of such financing. Important factors that could cause
actual results to differ materially from the Company's expectations are
disclosed in this report, including without limitation those statements made in
conjunction with the forward looking statements included in this report.

15
<PAGE>
USE OF PROCEEDS

The net proceeds to the Company from the sale of the 2,000,000 shares of
Common Stock offered by the Company hereby will be approximately $29.6 million
($34.3 million if the Underwriters' over-allotment option is exercised in full)
after deducting the underwriting discount and estimated offering expenses to be
paid by the Company. The Company will not receive any proceeds from the sale of
Common Stock by the Selling Stockholder.

The Company will use the proceeds of the Offering to pay down a portion of
the Company's existing indebtedness under the Credit Agreement representing the
Acquisition Debt. The Credit Agreement currently provides borrowing availability
as follows (i) a $13.0 million facility, of which $3.0 million can be used for
working capital needs and $10.0 million is available for issuance of letters of
credit, with an initial commitment expiring in August 1999 (the "Working
Capital Facility"), (ii) a $38.5 million reducing revolving line of credit (the
"Reducing Revolver") which reduces monthly and expires in August 1999, of
which a $7.0 million bridge portion (the "Equity Bridge") matures in August
1997, and (iii) a $5.0 million reducing revolving line of credit for use by the
MIT System expiring in August 1999 (the "MIT Revolver"). See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Capital Resources and Liquidity."

The current interest rate under the Credit Agreement varies at the
Company's option subject to certain limitations. The per annum interest rate for
the Reducing Revolver and the MIT Revolver is either the Bank One base rate plus
.25% or the London Interbank Offering Rate plus 2.50% when the outstanding
principal loan balance is less than 50% of the Borrowing Base (as defined in the
Credit Agreement and the MIT Revolver) amount. When such loan balance is greater
than .50% of the Borrowing Base, the per annum interest rate options for the
Reducing Revolver and the MIT Revolver increase to the Bank One base rate plus
.50% or the London Interbank Offering Rate plus 2.75%. With respect to the
Working Capital Facility, the per annum interest is the Bank One base rate plus
.50%.

The proceeds of the Offering will be used to pay down $22.6 million of the
Reducing Revolver and the entire outstanding balance of the Equity Bridge.
Following the reduction of the Credit Agreement with the proceeds of the
Offering, the outstanding indebtedness under the Credit Agreement will be
approximately $13.2 million and the available borrowings thereunder will be
approximately $33.3 million, ($8.5 million and $38.0 million, respectively, if
the Underwriters' over-allotment option is exercised in full). The outstanding
indebtedness under the Credit Agreement has been used for various acquisitions
by the Company, including the AlaTenn Acquisition. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Capital
Resources and Liquidity."

16
<PAGE>
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY

The Company's Common Stock had no established trading market during the
three years prior to August 9, 1996, when it began trading on the AMEX under the
symbol "MRS." The following table sets forth the high and low sales prices for
the Common Stock as reported on the American Stock Exchange Composite Tape:

PRICE RANGE COMMON
-------------------- STOCK
HIGH LOW DIVIDENDS
--- --- ---------
Year Ended December 31, 1996:
Third Quarter (from August 9,
1996)........................... $ 10 1/4 $ 9 1/16 $ .08
Fourth Quarter.................. 10 7/8 9 3/4 .08
Year Ended December 31, 1997:
First Quarter................... $ 17 1/2 $ 10 1/4 $ .08
Second Quarter (through June 26,
1997)........................... 17 3/8 13 5/8 .08

On June 26, 1997, the closing price per share for the Common Stock, as
reported by the AMEX, was $16.94 per share, and there were approximately 310
record holders of Common Stock.

The Company historically paid dividends on its 5% cumulative preferred
stock, which was redeemed in May 1996. Dividends on the Common Stock were
initiated in August 1996 and have been paid in each successive quarter. See
"Description of Capital Stock."

It is the Company's current policy to continue to pay a quarterly dividend;
however, the amount of future cash dividends, if any, will depend upon future
earnings, results of operations, capital requirements, covenants contained in
various financing agreements of the Company and its subsidiaries, the financial
condition of the Company and certain other factors. Accordingly, there can be no
assurance that dividends will be paid by the Company on the future. See "Risk
Factors" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Capital Resources and Liquidity."

17
<PAGE>
CAPITALIZATION

The following table sets forth (i) the capitalization of the Company as of
March 31, 1997, (ii) the pro forma combined capitalization of the Company after
giving effect to the completion and financing of the AlaTenn Acquisition as if
it had occurred on that date and (iii) the pro forma combined capitalization of
the Company as adjusted for the Offering and the application of the net proceeds
therefrom as described in "Use of Proceeds" (assuming net proceeds to the
Company of approximately $29.6 million and no exercise of the Underwriters'
over-allotment option). The following table should be read in conjunction with
"Use of Proceeds," "Unaudited Pro Forma Consolidated Financial Statements,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Capital Resources and Liquidity" and "Consolidated Financial
Statements" included elsewhere in this Prospectus.

AS OF MARCH 31, 1997
---------------------------
PRO FORMA
ACTUAL AS ADJUSTED
------------ ------------
(IN THOUSANDS)
Total long-term debt, net of current
portion .......................................... $ 5,943 $ 14,006
Shareholders' equity:
Common Stock, $.01 par value; 10,000,000
shares authorized; 2,500,000 shares
issued and outstanding, 4,500,000
issued and outstanding as adjusted(1) ....... 25 45
Paid-in capital .................................. 26,941 56,556
Accumulated deficit .............................. (12,352) (12,352)
Unearned compensation ............................ (31) (31)
------------ ------------
Total shareholders' equity ....................... $ 14,583 $ 44,218
------------ ------------
Total capitalization ............................. $ 20,526 $ 58,224
============ ============

- ------------
(1) Does not include (i) 100,000 shares of Common Stock issuable upon the
exercise of the Warrants, (ii) 34,349 shares issuable upon the exercise of
the Triumph Warrants, (iii) 280,000 shares of Common Stock reserved for
issuance upon the exercise of outstanding stock options under the Company's
stock option plans and (iv) the issuance of shares of Common Stock on
exercise of the over-allotment option granted to the Underwriters. See
"Management -- Executive Compensation," "Description of Capital
Stock -- Outstanding Warrants" and "Underwriting."

18
<PAGE>
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

The selected historical consolidated financial information for the fiscal
years ended December 31, 1992, 1993, 1994, 1995 and 1996, and for the
three-month periods ended March 31, 1996 and 1997, set forth below is derived
from and should be read in conjunction with the Company's "Consolidated
Financial Statements" and accompanying notes appearing elsewhere in this
Prospectus. The data for the three-month periods ended March 31, 1996 and 1997
are derived from and qualified by reference to the Company's "Consolidated
Financial Statements" appearing elsewhere herein and, in the opinion of
management of the Company, includes all adjustments that are of a normal
recurring nature and necessary for a fair presentation. See "Managements
Discussion and Analysis of Financial Condition and Results of Operations" and
the Company's "Consolidated Financial Statements."

<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
---------------------------------------------------- --------------------
1992(1) 1993 1994 1995 1996 1996 1997
------- --------- --------- --------- --------- --------- ---------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Operating revenues................. $ 5,103 $ 17,757 $ 14,969 $ 15,622 $ 29,415 $ 5,584 $ 12,964
Operating income(2)................ 146 1,273 349 2,569 2,573 533 1,299
Interest expense................... 31 178 189 339 413 120 95
Income before income taxes and
cumulative effect of a change in
accounting principle............. 135 818 148 2,193 1,914 374 1,132
Net income......................... 135 765 27 2,193 1,914 374 1,132
Net income (loss) applicable to
common shareholders.............. 117 706 (32) 2,134 1,891 359 1,132
PER SHARE DATA:
Net income (loss) applicable to
common shareholders.............. $ 0.09 $ 0.52 $ (0.02) $ 1.48 $ 1.00 $ 0.24 $ 0.45
Weighted average number of common
shares outstanding............... 1,353 1,360 1,391 1,440 1,886 1,466 2,500
OTHER DATA:
Depreciation, depletion and
amortization..................... $ 57 $ 264 $ 259 $ 452 $ 818 $ 151 $ 255
General and administrative......... 168 889 849 785 1,223 199 374
EBITDA(3).......................... 202 1,538 609 3,021 3,193 664 1,494
Cash flow from operating
activities....................... 289 815 (515) 2,361 2,564 1,306 2,948
Capital expenditures............... 1,303 955 1,088 3,885 9,391 1,286 425
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
---------------------------------------------------- --------------------
1992 1993 1994 1995 1996 1996 1997
------- --------- --------- --------- --------- --------- ---------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit).......... $ (387) $ (393) $ (1,105) $ (99) $ 1,135 $ (441) $ 1,722
Property, plant and equipment,
net.............................. 3,467 2,780 4,994 8,206 16,965 8,171 17,148
Total assets....................... 5,567 6,439 7,272 11,089 27,303 11,887 27,653
Long-term debt, net of current
portion.......................... 2,052 670 1,781 3,961 4,015 3,442 5,943
Shareholders' equity............... 1,315 2,029 2,007 4,157 13,593 4,522 14,583
</TABLE>

- ------------

(1) Reflects eight months of operations from the Company's incorporation in May
1992.

(2) Operating revenues less operating expenses.

(3) See "Glossary" for a definition of EBITDA. EBITDA is not a measure of
operating income, operating performance, or liquidity under generally
accepted accounting principles. The Company includes EBITDA data because it
understands such data is used by certain investors to determine the
Company's historical ability to service its indebtedness.

19
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS

The following unaudited pro forma consolidated statements of operations of
the Company for the year ended December 31, 1996 and the three months ended
March 31, 1997 and the unaudited pro forma consolidated balance sheet of the
Company as of March 31, 1997 (the "Unaudited Pro Forma Consolidated Financial
Statements") give effect to (i) the Harmony Acquisition under the purchase
method of accounting, (ii) the AlaTenn Acquisition under the purchase method of
accounting, (iii) the borrowing by the Company of $39.4 million, plus an
estimated $475,000 in related financing costs, to finance the AlaTenn
Acquisition and (iv) the issuance and sale of 2,000,000 shares of the Company's
Common Stock pursuant to the Offering and the application of the estimated net
proceeds therefrom to reduce the Acquisition Debt incurred by the AlaTenn
Acquisition.

The unaudited pro forma consolidated statements of operations for the year
ended December 31, 1996 and the three months ended March 31, 1997 were prepared
assuming that the transactions described above were consummated as of the
beginning of each period presented. The unaudited pro forma consolidated balance
sheet as of March 31, 1997 includes the historical purchase accounting entries
made for the Harmony Acquisition and was prepared assuming that the transactions
described in (ii), (iii), and (iv) above were consummated as of March 31, 1997.

The Unaudited Pro Forma Consolidated Financial Statements are based upon
the historical consolidated and combined financial statements of the Company and
the AlaTenn Subsidiaries and the historical summary of revenue and direct
operating expenses of the Harmony System included elsewhere in this Prospectus
and should be read in conjunction with those consolidated and combined financial
statements and historical summary and the notes thereto. Because of the seasonal
nature of the Company's and the AlaTenn Subsidiaries' operations, among other
factors, the results of the interim periods presented are not necessarily
indicative of the results to be expected of an entire year.

The pro forma adjustments and the resulting Unaudited Pro Forma
Consolidated Financial Statements have been prepared based upon available
information and certain assumptions and estimates deemed appropriate by the
Company. A final determination of required purchase accounting adjustments,
including the possible incurrence of a maximum of $2 million in contingent
payments and the allocation of the purchase price to the assets acquired and
liabilities assumed based on their respective fair values, has not yet been made
for the AlaTenn Acquisition. Accordingly, the purchase accounting adjustments
for the AlaTenn Acquisition reflected in the pro forma information are
preliminary and have been made solely for purposes of developing such
information. The Company's management believes, however, that the pro forma
adjustments and the underlying assumptions and estimates reasonably present the
significant effects of the transactions reflected thereby and that any
subsequent changes in the underlying assumptions and estimates will not
materially affect the Unaudited Pro Forma Consolidated Financial Statements
presented herein. The Unaudited Pro Forma Consolidated Financial Statements do
not purport to represent what the Company's financial position or results of
operations actually would have been had the Harmony Acquisition, AlaTenn
Acquisition and the Offering occurred on the dates indicated or to project the
Company's financial position or results of operations for any future date or
period. Furthermore, the Unaudited Pro Forma Consolidated Financial Statements
do not reflect changes that may occur as the result of post-combination
activities and other matters (except as described in note 2). The results of
operations of the Harmony Acquisition have been included with the Company's
actual results of operations since its acquisition in October 1996 and the
results of operations of the AlaTenn Subsidiaries will be included with the
Company's actual results of operations only from May 30, 1997, the date on which
the AlaTenn Acquisition was consummated.

20
<PAGE>
MIDCOAST ENERGY RESOURCES, INC.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL -------------------------------------------------------
----------------------- HARMONY ALATENN
ALATENN ACQUISITION ACQUISITION COMBINED OFFERING
COMPANY SUBSIDIARIES ADJUSTMENTS ADJUSTMENTS OPERATIONS ADJUSTMENTS
------- ------------ ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
OPERATING REVENUES:
Sale of natural gas and
transportation fees............... $26,496 $113,429 $139,925
Natural gas processing revenue...... 2,460 -- $ 3,562(a) 6,022
Other revenue....................... 459 -- 459
------- ------------ ----------- ----------
Total operating revenues....... 29,415 113,429 3,562 146,406
------- ------------ ----------- ----------
OPERATING EXPENSES:
Cost of natural gas and
transportation fees............... 23,170 102,157 125,327
Natural gas processing costs........ 1,443 -- 2,908(a) 4,351
Depreciation, depletion and
amortization...................... 818 584 71(b) $ 141(b) 1,614
General and administrative.......... 1,223 3,961 (1,552)(c) 3,632
Other expenses...................... 188 -- 188
------- ------------ ----------- ----------- ----------
Total operating expenses....... 26,842 106,702 2,979 (1,411) 135,112
------- ------------ ----------- ----------- ----------
Operating income............... 2,573 6,727 583 1,411 11,294
NON-OPERATING ITEMS:
Interest expense.................... (413 ) (1) (186)(d) (3,242)(d) (3,842) $ 2,397(d)
Minority interest in consolidated
subsidiaries...................... (198 ) -- (198)
Other income (expense), net......... (48 ) 549 501
------- ------------ ----------- ----------- ---------- -----------
INCOME BEFORE INCOME TAXES.............. 1,914 7,275 397 (1,831) 7,755 2,397
PROVISION FOR INCOME TAXES.............. -- (2,642) (20)(e) 2,274(e) (388) (2,711)(f)
------- ------------ ----------- ----------- ---------- -----------
Net income..................... 1,914 4,633 377 443 7,367 (314)
5% CUMULATIVE PREFERRED STOCK
DIVIDENDS............................. (23 ) -- (23)
------- ------------ ----------- ----------- ---------- -----------
NET INCOME APPLICABLE TO COMMON
SHAREHOLDERS.......................... $1,891 $ 4,633 $ 377 $ 443 $ 7,344 $ (314)
======= ============ =========== =========== ========== ===========
NET INCOME PER SHARE.................... $ 1.00 $ 3.89
======= ==========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING........................... 1,886 1,886 2,000(i)
======= ========== ===========
</TABLE>

COMBINED
OPERATIONS
AND OFFERING
------------
OPERATING REVENUES:
Sale of natural gas and
transportation fees............... $139,925
Natural gas processing revenue...... 6,022
Other revenue....................... 459
------------
Total operating revenues....... 146,406
------------
OPERATING EXPENSES:
Cost of natural gas and
transportation fees............... 125,327
Natural gas processing costs........ 4,351
Depreciation, depletion and
amortization...................... 1,614
General and administrative.......... 3,632
Other expenses...................... 188
------------
Total operating expenses....... 135,112
------------
Operating income............... 11,294
NON-OPERATING ITEMS:
Interest expense.................... (1,445)
Minority interest in consolidated
subsidiaries...................... (198)
Other income (expense), net......... 501
------------
INCOME BEFORE INCOME TAXES.............. 10,152
PROVISION FOR INCOME TAXES.............. (3,099)
------------
Net income..................... 7,053
5% CUMULATIVE PREFERRED STOCK
DIVIDENDS............................. (23)
------------
NET INCOME APPLICABLE TO COMMON
SHAREHOLDERS.......................... $ 7,030
============
NET INCOME PER SHARE.................... $ 1.81
============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING........................... 3,886
============

See accompanying notes to unaudited pro forma consolidated financial statements
including notes 2 and 3 for parenthetical references to pro forma adjustments.

21
<PAGE>
MIDCOAST ENERGY RESOURCES, INC.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

See accompanying notes to unaudited pro forma consolidated financial statements
including notes 2 and 3 for parenthetical references to pro forma adjustments.

22
<PAGE>
MIDCOAST ENERGY RESOURCES, INC.
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
AS OF MARCH 31, 1997
(IN THOUSANDS)

<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL ---------------------------------------------------------
------------------------ ALATENN COMBINED
ALATENN ACQUISITION COMBINED OFFERING OPERATIONS
ASSETS COMPANY ACQUISITIONS ADJUSTMENTS OPERATIONS ADJUSTMENTS AND OFFERING
-------- ------------- ------------ ----------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents........ $ 3,041 $ -- $ 3,041 $ 3,041
Accounts receivable.............. 5,021 7,961 12,982 12,982
Other current assets............. -- 859 $ (204)(g) 655 655
-------- ------------- ------------ ----------- -------------
Total current assets........ 8,062 8,820 (204) 16,678 16,678
-------- ------------- ------------ ----------- -------------
PROPERTY, PLANT AND EQUIPMENT, at
cost:
Natural gas transmission
facilities..................... 12,142 24,287 8,811 45,240 45,240
Natural gas processing
facilities..................... 3,789 -- 3,789 3,789
Other property, plant and
equipment...................... 2,949 4,132 (22)(g) 7,059 7,059
-------- ------------- ------------ ----------- -------------
18,880 28,419 8,789 56,088 56,088
ACCUMULATED DEPRECIATION, DEPLETION
AND AMORTIZATION................... (1,732 ) (15,837) 15,837(g) (1,732) (1,732)
-------- ------------- ------------ ----------- -------------
17,148 12,582 24,626 54,356 54,356
OTHER ASSETS, net of amortization.... 2,443 1,468 (829)(g) 1,407 1,407
(1,675)(h)
-------- ------------- ------------ ----------- -------------
Total assets................ $27,653 $ 22,870 $ 21,918 $ 72,441 $ 72,441
======== ============= ============ =========== =============
LIABILITIES AND
SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued
liabilities.................... $ 6,061 $ 6,988 $ (175)(g) $ 12,874 $ 12,874
Current portion of deferred
income......................... 83 -- 83 83
Current portion of long-term debt
payable to banks............... 197 -- 10,757(h) 10,954 $(10,757)(i) 197
-------- ------------- ------------ ----------- ------------ -------------
Total current liabilities... 6,341 6,988 10,582 23,911 (10,757) 13,154
-------- ------------- ------------ ----------- ------------ -------------
LONG-TERM DEBT PAYABLE TO BANKS...... 5,943 -- 26,941(h) 32,884 (18,878)(i) 14,006
OTHER DEFERRED LIABILITIES AND
CREDITS:
Deferred income taxes............ -- 1,534 (1,534)(g) -- --
Unamortized investment tax
credits........................ -- 223 (223)(g) -- --
Deferred income and other........ 131 965 (688)(g) 408 408
-------- ------------- ------------ ----------- -------------
131 2,722 (2,445) 408 408
-------- ------------- ------------ ----------- -------------
MINORITY INTEREST IN
CONSOLIDATED SUBSIDIARIES.......... 655 -- 655 655
COMMITMENTS AND CONTINGENCIES........ -- (g)
SHAREHOLDERS' EQUITY:
Common stock..................... 25 6 (6)(g) 25 20(i) 45
Paid-in capital.................. 26,941 11,276 (11,276)(g) 26,941 29,615(i) 56,556
Retained earnings (deficit)...... (12,352 ) 1,878 (1,878)(g) (12,352) (12,352)
Unearned compensation............ (31 ) -- (31) (31)
-------- ------------- ------------ ----------- ------------ -------------
Total shareholders'
equity.................... 14,583 13,160 (13,160) 14,583 29,635 44,218
-------- ------------- ------------ ----------- -------------
Total liabilities and
shareholders' equity...... $27,653 $ 22,870 $ 21,918 $ 72,441 $ 72,441
======== ============= ============ =========== =============
</TABLE>

See accompanying notes to unaudited pro forma consolidated financial statements
including notes 2 and 3 for parenthetical references to pro forma adjustments.

23
<PAGE>
MIDCOAST ENERGY RESOURCES, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 1996 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND AS OF MARCH 31, 1997

1. BASIS OF PRESENTATION

The unaudited pro forma consolidated balance sheet is presented assuming
the AlaTenn Acquisition and the Offering occurred on March 31, 1997. No pro
forma balance sheet adjustments are required for the Harmony Acquisition because
the acquisition occurred prior to March 31, 1997 and its effects are already
reflected in the Company's historical balance sheet. The unaudited pro forma
consolidated statements of operations for the year ended December 31, 1996 and
the three months ended March 31, 1997 are presented as if the AlaTenn
Acquisition and the Offering occurred at the beginning of each period presented.
The Unaudited Pro Forma Consolidated Financial Statements may not necessarily be
indicative of the results which would actually have occurred if the AlaTenn
Acquisition had been in effect on the date or for the periods indicated or which
may result in the future.

2. PRO FORMA ADJUSTMENTS -- STATEMENTS OF OPERATIONS

The pro forma adjustments to the unaudited pro forma consolidated
statements of operations reflect the following:

(a) HARMONY SYSTEM -- The adjustments represent the revenues and
direct operating expenses of the Harmony Acquisition for the period prior
to August 1996.

(b) DEPRECIATION -- The adjustment reflects the pro forma
depreciation expense based on the allocation of the purchase price to the
depreciable assets of the Harmony System and AlaTenn Subsidiaries and the
continued use of historical depreciation methods for all assets.

(c) GENERAL AND ADMINISTRATIVE EXPENSES -- A portion of the
historical amounts incurred by the AlaTenn Subsidiaries for general and
administrative expenses represent parent company allocations. The
adjustment reflects reduction of such amounts based on Midcoast's projected
actual cost of providing such corporate services. The historical amounts
have been reduced by $755,000 for the twelve-month period ended December
31, 1996 and $283,000 for the three months ended March 31, 1997. In
addition, general and administrative expenses have been reduced by $797,000
for the year ended December 31, 1996 and $179,000 for the three months
ended March 31, 1997 to reflect the replacement of three AlaTenn
Subsidiaries' officers with Midcoast management and other cost reductions,
primarily costs associated with benefit plans that will remain with Atrion.

(d) INTEREST EXPENSE -- The acquisition adjustments for interest
expense reflect interest computed on the additional indebtedness incurred
for the Harmony Acquisition and the AlaTenn Acquisition assuming they were
financed entirely with debt. The principal amount of indebtedness incurred
was approximately $43.5 million, including related financing costs, and the
interest rate used to calculate the interest expense on the acquisition
cost financed through the Reducing Revolver and the MIT Revolver was 8.43%
and the remaining acquisition cost financed through the short-term Working
Capital Facility was 9.0% (the Company's current effective interest rate).
Interest expense also includes amortization of financing costs. The
offering adjustment for interest expense reflects the reduction of debt
incurred for the acquisitions using the estimated net proceeds of $29.6
million from the Offering.

(e) INCOME TAXES -- The acquisition adjustment for income taxes
represent the tax effect of the foregoing acquisition pro forma adjustments
computed at a 39% statutory income tax rate which reflects both federal and
state income tax rates, as well as the utilization of Midcoast's NOL
carryforward.

(f) INCOME TAXES (NOL LIMITATION) -- The Offering adjustment for
income taxes represent the tax effect of the foregoing Offering pro forma
adjustments computed at a 39% statutory income tax

24
<PAGE>
MIDCOAST ENERGY RESOURCES, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED
FINANCIAL STATEMENTS -- (CONTINUED)

rate, which reflects both federal and state income tax rates, as well as
the annual limitation on the utilization of Midcoast's NOL carryforward
resulting from the Offering due to a change in stockholder control as
provided in Section 382 of the Internal Revenue Code.

3. PRO FORMA ADJUSTMENTS -- BALANCE SHEET

The pro forma adjustments to the unaudited pro forma consolidated balance
sheet reflect the following:

(g) ALLOCATION OF PURCHASE PRICE -- The adjustments reflect the
recording of the AlaTenn Acquisition using the purchase method of
accounting and the allocation of the purchase price (not including a
maximum of $2 million in contingent payments) based on the Company's
estimate of the fair value of the assets and liabilities acquired. The
allocation of the purchase price is preliminary, as valuation and other
studies have not been finalized; however, it is not expected that any
goodwill will result from this transaction. It is not expected that the
final allocation of the purchase price will produce materially different
results from those presented herein except for the possible incurrence of a
maximum of $2 million in contingent payments.

(h) BANK DEBT -- The adjustments represent additional borrowings
under the Company's existing credit facilities associated with the cash
consideration paid for the AlaTenn Acquisition and related financing costs.

(i) COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL -- The adjustments
reflect the issuance of 2,000,000 shares of Midcoast's Common Stock at a
price to the public of $16 per share. The estimated net proceeds of $29.6
million will be used to reduce the debt incurred for the AlaTenn
Acquisition.

<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with "Selected
Historical Consolidated Financial Data," the "Consolidated Financial
Statements" and the notes thereto, included elsewhere herein.

GENERAL

Since its formation, the Company has grown significantly as a result of the
construction and acquisition of new pipeline facilities. The Company's principal
business strategy is to increase its earnings and cash flow by acquiring or
constructing pipeline systems, aggressively pursuing end-user customers,
increasing utilization of its existing pipeline systems and processing plants in
order to enhance the Company's profitability and improving cost efficiencies.
Since 1994, the Company acquired or constructed 32 pipelines for an aggregate
acquisition cost of over $50 million. See "Business and Properties -- Principal
Systems." All acquisitions were accounted for under the purchase method of
accounting for business combinations and accordingly, the results of operations
for such pipelines are included in the Company's financial statements only from
the applicable date of acquisition. As a result, the Company believes its
historical results of operations for the periods presented may not be directly
comparable. The Company believes the historical results of operations do not
fully reflect the operating efficiencies and improvements that are expected to
be achieved by integrating the acquired and newly constructed pipeline systems.

The Company's results of operations are determined primarily by the volumes
of gas transported, purchased and sold through its pipeline systems or processed
at its processing facility. Most of the Company's operating costs do not vary
directly with volume on existing systems, thus, increases or decreases in
transportation volumes on existing systems generally have a direct effect on net
income. Also, the addition of new pipeline systems typically results in a larger
percentage of revenues being added to operating income as fixed overhead
components are allocated over more systems. The Company derives its revenues
from three primary sources: (i) transportation fees from pipeline systems owned
by the Company, (ii) the processing and treating of natural gas and (iii) the
marketing of natural gas.

Transportation fees are received by the Company for transporting gas owned
by other parties through the Company's pipeline systems. Typically, the Company
incurs very little incremental operating or administrative overhead cost to
transport gas through its pipeline systems, thereby recognizing a substantial
portion of incremental transportation revenues as operating income.

The Company's natural gas processing revenues are realized from the
extraction and sale of natural gas liquids ("NGLs") as well as the sale of the
residual natural gas. Once extracted, the NGLs are further fractionated in the
Company's facilities into products such as ethane, propane, butanes, natural
gasoline and condensate, then sold to various wholesalers along with raw sulfur
from the Company's sulfur recovery plant. Typically, the Company enters into
agreements with natural gas producers wherein the Company and the producer share
in the revenue generated from the sale of NGLs extracted at the Company's
facilities. The Company's processing operations can be adversely affected by
declines in NGL prices, declines in gas throughput or increases in shrinkage or
fuel costs. The Company entered the processing business in October 1996 with its
purchase of the Harmony System.

The Company's gas marketing revenues are realized through the purchase and
resale of natural gas to the Company's customers. Generally, gas marketing
activities will generate higher revenues and correspondingly higher expenses
than revenues and expenses associated with transportation activities, given the
same volumes of gas. This relationship exists because, unlike revenues derived
from transportation activities, gas marketing revenues and associated expenses
include the full commodity price of the natural gas acquired. The operating
income the Company recognizes from its gas marketing efforts is the difference
between the price at which the gas was purchased and the price at which it was
resold to the Company's customers. The Company's strategy is to focus its
marketing activities where the Company has a fixed asset investment rather than
on third-party off-systems sales. The Company's marketing activities have
historically varied greatly in response to market fluctuations.

26
<PAGE>
The Company has had quarter-to-quarter fluctuations in its financial
results in the past due to the fact that the Company's natural gas sales and
pipeline throughputs can be affected by changes in demand for natural gas
primarily because of the weather. Although, historically, quarter-to-quarter
fluctuations resulting from weather variations have not been significant, the
acquisitions of the Magnolia System and the MIT System are expected to increase
the impact that weather conditions have on the Company's financial results. In
particular, demand on both the Magnolia System and the MIT System is expected to
fluctuate due to weather variations because of the large municipal and other
seasonal customers which are served by the respective systems. There can be no
assurances that the Company's efforts to minimize such effects will have any
impact on future quarter-to-quarter fluctuations due to changes in demand
resulting from variations in weather conditions. Furthermore, future results
could differ materially from historical results due to a number of factors
including but not limited to interruption or cancellation of existing contracts,
the impact of competitive products and services, pricing of and demand for such
products and services and the presence of competitors with greater financial
resources. See "Risk Factors -- Fluctuations in Demand Due to Weather."

The Company has also from time to time derived significant income by
capitalizing on opportunities in the industry to sell its pipeline systems on
favorable terms as the Company receives offers for such systems which are suited
to another company's pipeline network. Although no substantial divestitures are
currently under consideration, the Company will from time to time solicit bids
for selected properties which are no longer suited to its business strategy.

RESULTS OF OPERATIONS

The following discussion does not include results of operations acquired in
the AlaTenn Acquisition, which was completed in May 1997. See "Unaudited Pro
Forma Consolidated Financial Statements."

COMPARISON OF THREE MONTH PERIODS ENDED MARCH 31, 1997 AND 1996

OPERATING REVENUES. Operating revenues generated during the three months
ended March 31, 1997 totaled approximately $13.0 million as compared to $5.6
million for the three months ended March 31, 1996, which represents a 132%
increase in 1997. This increase is due primarily to the numerous pipeline
acquisitions made during the second half of 1996 as well as the introduction of
natural gas processing revenues in connection with the acquisition of the
Harmony System. Processing revenues totalled approximately $1.5 million during
the three months ended March 31, 1997.

OPERATING EXPENSES. Operating expenses for the three months ended March
31, 1997 totaled approximately $11.7 million, or 131% higher than the comparable
1996 period. The increase is primarily attributable to the numerous pipeline
acquisitions made during the second half of 1996 and the introduction of gas
processing costs.

Depreciation, depletion, and amortization expense was approximately $0.3
million in 1997, as compared to approximately $0.2 million in 1996. The increase
in 1997 is primarily attributable to the pipeline acquisitions in 1996.

General and administrative expenses incurred for the three months ended
March 31, 1997 were approximately $0.4 million or 88% higher than for the same
period in 1996. The Company continued to control its general and administrative
expenses in 1997, despite the Company's growth, by effectively assimilating and
managing new business using existing resources.

Interest expense for the first quarter declined approximately 21% as
compared to the same period in 1996. The Company was servicing an average of
approximately $4.5 million in debt during the first quarter of 1997 as compared
to an average of $4.7 million in debt during the first quarter of 1996. The
decline in interest expense is primarily attributable to lower interest rates
paid by the Company under the Credit Agreement negotiated in August 1996.

EARNINGS. The Company recognized operating income and net income of $1.3
million and $1.1 million, respectively, for the three months ended March 31,
1997 as compared to operating income and net income of $0.5 million and $0.4
million for the three months ended March 31, 1996. Operating income and net
income increased 143% and 215%, respectively, over 1996, primarily due to the
pipeline acquisitions

27
<PAGE>
discussed above, including the gas processing income generated from the
acquisition of the Harmony System.

COMPARISON OF YEARS ENDED DECEMBER 31, 1996 AND 1995

OPERATING REVENUES. Operating revenues generated during the twelve months
ended December 31, 1996 totaled approximately $29.4 million as compared to $15.6
million in 1995, an 88% increase over 1995. The $13.8 million increase was
primarily attributable to a 131% increase in sales of natural gas and
transportation fees as well as the introduction of natural gas processing
revenues in 1996. These factors were mitigated by a 95% decrease in revenue
derived from sales of pipelines during 1995.

Natural gas marketing revenues increased 127% from approximately $7.5
million to $17.0 million for the years ended December 31, 1995 and 1996,
respectively, primarily due to increased marketing opportunities on
Company-owned pipelines. The 131% increase in sales of natural gas and
transportation fees also represents the effect of constructing or acquiring 26
pipelines in 1996, and the purchase of the Magnolia System in September 1995.

The Company's acquisition of the Harmony System in October 1996 marked the
Company's entrance into the natural gas processing business. During its first
partial year of ownership in 1996, the Harmony System contributed approximately
$2.5 million in processing revenues.

Revenue from the sale of pipelines decreased from approximately $4.1
million in 1995 to $0.2 million in 1996, due to the sale of Five Flags Pipeline
Company ("Five Flags") in 1995, compared to the sale of only three small
pipelines during 1996. The Company elected to focus its efforts on consummating
construction and acquisition opportunities in 1996 as opposed to divestiture
opportunities.

OPERATING EXPENSES. Operating expenses for the year ended December 31,
1996 totaled approximately $26.8 million, a 106% increase over the year ended
December 31, 1995. The increase in operating expenses in 1996 was primarily due
to the increased gas marketing activity and the introduction of natural gas
processing costs, which were offset in part by a decline in the cost of
pipelines sold.

Depreciation, depletion, and amortization expense was approximately $0.8
million in 1996, as compared to $0.5 million in 1995. The increase was due to
the addition of 26 pipelines in 1996.

General and administrative expenses during 1996 were approximately $1.2
million compared with $0.8 million in 1995. The $0.4 million increase was due
primarily to personnel additions in connection with the Company's 1996
acquisitions.

Interest expense totaled approximately $0.4 million and $0.3 million for
1996 and 1995, respectively. The Company had an average of approximately $4.4
million in debt during 1996 as compared to an average of approximately $3.3
million in debt during 1995. The increased debt service in 1996 was attributable
to the acquisition of the Magnolia System in September 1995, and various other
acquisitions during 1996, mitigated by the repayment of all the Company's
outstanding debt in August 1996, except for the debt of the Company's joint
ventures, Pan Grande Pipeline L.L.C. ("Pan Grande") and Starr County Gathering
System ("Starr County"), with proceeds from the Company's 1996 Common Stock
offering. However, during the fourth quarter of 1996, the Company added $3.5
million in long-term bank debt primarily in connection with the acquisition of
the Harmony System. See "Business and Properties -- Principal Systems."

EARNINGS. The Company recognized operating income and net income
applicable to common shareholders of $2.6 million and $1.9 million,
respectively, for the year ended December 31, 1996, as compared to operating
income of $2.6 million and net income applicable to common shareholders of $2.1
million for the year ended December 31, 1995. However, excluding income
generated from the sale of pipelines, operating income in 1996 rose to $2.5
million from $0.4 million in 1995, and net income applicable to common
stockholders was $1.8 million in 1996 as compared to a net loss applicable to
common shareholders of $0.1 million in 1995. The Company achieved these
increases in 1996 through marketing and transportation revenues generated from
numerous pipeline additions, capitalizing on operating efficiencies and
assimilating new pipeline additions with limited increases to operating and
personnel costs.

28
<PAGE>
COMPARISON OF YEARS ENDED DECEMBER 31, 1995 AND 1994

OPERATING REVENUES. Operating revenues generated during the twelve months
ended December 31, 1995 totaled approximately $15.6 million as compared to $15.0
million in 1994, a 4% increase over 1994. The slight increase was primarily
attributable to a $4.0 million increase in revenues derived from the sale of
pipelines mitigated by a 23% decrease in sales of natural gas and transportation
fees during 1995.

In September 1995, the Company and an affiliate owned by a former officer
and director of the Company jointly acquired 100% of the outstanding capital
stock of Five Flags. Total cash consideration of approximately $2.1 million was
paid on September 13, 1995 of which the Company's share was $1.9 million for
91.3% of Five Flags' capital stock. The acquisition of Five Flags stock was made
as an investment to be resold and in October 1995, the Company and the affiliate
jointly sold 100% of the capital stock of Five Flags for cash consideration of
which the Company's share was $4.1 million.

The decrease in sales of natural gas and transportation fees in 1995 was
primarily attributable to a decline in gas marketing transactions in response to
declining profit margins and the Company's decision to focus its marketing
activities on servicing customer gas requirements where the Company has a fixed
asset investment, rather than on off-system transactions. Despite the decline in
sales of natural gas, the Company's operating income increased by $2.2 million
over 1994.

OPERATING EXPENSES. Operating expenses for the year ended December 31,
1995 totaled approximately $13.1 million, or 11% lower than the comparable 1994
period. The primary explanation for the decrease can be attributed to reduced
gas marketing transactions mitigated by an increase in the cost of pipelines
sold, in connection with the Five Flags sale.

Depreciation, depletion, and amortization expense was approximately $0.5
million in 1995, as compared to $0.3 million in 1994. The $0.2 million increase
in 1995 was primarily due to the acquisition of the Magnolia System in September
1995, the construction of two new pipelines during the fourth quarter of 1994
and the Company's investment in the Cook Inlet systems, which has been
depreciated since July 1994.

General and administrative expenses during 1995 were approximately $0.8
million, an 8% decrease from 1994. The reduction of general and administrative
expenses in 1995 was a result of the Company's ongoing effort to control
expenses and effectively assimilate new business utilizing existing resources.

Interest expense totaled approximately $0.3 million and $0.2 million for
1995 and 1994, respectively. The Company serviced an average of approximately
$3.3 million in debt during 1995 as compared to an average of $2.1 million in
debt during 1994. The increased debt service in 1995 was attributable to the
construction of two new pipelines during the fourth quarter of 1994, investing
in the Cook Inlet systems during the second quarter of 1994 and the acquisition
of the Magnolia System in September 1995. Additionally, interest rates on the
Company's debt are adjusted for changes to the prime rate, and therefore, the
increase in interest rates during 1994 and 1995 adversely affected the Company's
interest costs.

EARNINGS. The Company recognized operating income and net income of
approximately $2.6 million and $2.1 million, respectively, for the year ended
December 31, 1995 as compared to operating income of $0.3 million and a net loss
of approximately $32,000 for the year ended December 31, 1994. Despite a 74%
increase in depreciation, depletion and amortization expense and a 23% decrease
in sales of natural gas in 1995, operating income increased by $2.2 million over
1994. The decrease in natural gas sales did not have a significant impact on
operating earnings because gas marketing activities are characterized by large
dollar sales but small earnings margins. Furthermore, 1994 earnings had been
adversely affected by a non-recurring charge of $0.1 million, when the Company
changed the method of accounting for its transportation and exchange gas
imbalances. The primary factors which contributed to the increase in operating
earnings in 1995 were the revenue generated by the Company's investment in the
Cook Inlet systems, five months of revenue from the Magnolia System and a $2.2
million gain on the sale of Five Flags.

CAPITAL RESOURCES AND LIQUIDITY

Prior to its public offering of Common Stock in August 1996, the Company
had historically funded its capital requirements through cash flow from
operations and borrowings from affiliates and various commercial lenders. In
August 1996, the Company repaid approximately $5.0 million in outstanding bank

29
<PAGE>
and related party indebtedness with proceeds from the Company's 1996 public
offering of Common Stock. At the same time, the Company also established the
Credit Agreement with Bank One. Amounts available under the Credit Agreement
were increased to $46.5 million in May 1997 in conjunction with the AlaTenn
Acquisition. See "Business and Properties -- Principal Systems" and Note 13 to
the "Consolidated Financial Statements." The revised Credit Agreement provides
borrowing availability as follows: (i) a $13.0 million Working Capital Facility,
of which $3.0 million can be used for working capital needs and $10.0 million of
which is available for issuance of letters of credit, with an initial commitment
expiring in August 1999, (ii) a $38.5 million Reducing Revolver which reduces
monthly and expires in August 1999, of which the $7.0 million Equity Bridge
matures in August 1997 and (iii) a $5.0 million MIT Revolver expiring in August
1999. Available credit under the Reducing Revolver and the MIT Revolver will be
reduced by a total of approximately $362,667 per month from July 1, 1997 to
August 31, 1997 at such time a balloon payment of $7.0 million is due and
payable under the Reducing Revolver, and the available credit will then be
reduced by $304,167 per month thereafter. At June 3, 1997, the Company had
approximately $3.0 million of available credit under the Working Capital
Facility, $0.6 million under the Reducing Revolver and no available credit under
the MIT Revolver. The borrowing availability under each line is subject to
revision, on a monthly basis for the Working Capital Facility and a semi-annual
basis for the Reducing Revolver and the MIT Revolver (or otherwise at the
discretion of Bank One), based on the performance of the Company's existing
assets and any asset dispositions or additions from new construction or
acquisitions. The Credit Agreement contains a number of covenants that, among
other things, require the Company to maintain certain financial ratios, and
limit the Company's ability to incur additional indebtedness, transfer or sell
assets, create liens, or enter into a merger or consolidation.

With respect to the Reducing Revolver and the MIT Revolver, when borrowings
under the Credit Agreement are less than 50% of available credit, at the
Company's option, interest will accrue at the London Interbank Offering Rate
plus 2.5% per annum or the Bank One base rate (8.25% at December 31, 1996 and
8.50% at May 30, 1997) plus .25% per annum. When borrowings are greater than 50%
of available credit, an additional .25% will be added to the above interest
rates. With respect to the Working Capital Facility, the per annum interest
accrues at the Bank One base rate plus .50%. In addition, the Company is subject
to a non-recurring 1% facility fee as funds are borrowed, as well as a .375%
commitment fee payable quarterly on the unused portion of borrowing
availability. The Credit Agreement is secured by all accounts receivable,
contracts, the pledge of the stock of Midcoast Interstate Transmission, Inc.
(f/k/a Alabama-Tennessee Natural Gas Company) ("MIT"), the pledge of the stock
of Magnolia Pipeline Corporation and a first lien security interest in the
Company's pipeline systems, other than those owned by Pan Grande and Starr
County.

The only outstanding indebtedness other than the indebtedness under the
Credit Agreement, are the notes payable to banks associated with the acquisition
of a gas gathering pipeline in Starr County (the "Starr County Note") and the
acquisition of six pipelines by Pan Grande (the "Pan Grande Note"). The Pan
Grande Note was entered into by Pan Grande in March 1996 to finance the
acquisition of the Guadalupe, Chapa, Guerra and Loma Novia pipeline systems. The
Pan Grande Note is secured by each respective system and all associated
transportation revenues with guarantees by each member of Pan Grande
proportionate to their ownership interest. The Pan Grande Note bears interest at
the prime rate plus 1% (9.25% at December 31, 1996). Upon maturity at March 15,
2001, the balance of principal plus accrued interest then outstanding is payable
in full. The Starr County Note was entered into by Starr County in January 1996
to finance the acquisition of the Flores gathering system. The Starr County Note
is secured by the Flores System and all transportation revenues pertaining to
the system, with guarantees by each partner of Starr County, proportionate to
their partnership interest. Accordingly, the Company has guaranteed 60% of the
loan value. The Starr County Note bears interest at the prime rate plus 1%
(9.25% at December 31, 1996). Upon maturity at January 15, 2000, the balance of
principal plus accrued interest then remaining outstanding is payable in full.

For the three months ended March 31, 1997, the Company generated cash flows
from operating activities of approximately $2.9 million. After the proceeds of
the Offering are used to reduce outstanding amounts due under the Credit
Agreement, the Company believes that its existing Credit Agreement and funds
provided by operations will be sufficient for it to meet its operating cash
needs for the foreseeable

30
<PAGE>
future. Excluding the cost of the AlaTenn Acquisition, the Company expects to
have $1.3 million of capital expenditures in 1997. If funds under the Credit
Agreement are not available to fund acquisition and construction projects, the
Company would seek to obtain such financing from the sale of equity securities
or other debt financing. There can be no assurances that any such financing will
be available on terms acceptable to the Company. Should sufficient capital not
be available, the Company will not be able to implement its acquisition
strategy.

As of December 31, 1996, the Company had NOL carryforwards of approximately
$11.0 million expiring in various amounts from 1999 through 2008. These NOL
carryforwards were generated by the Company's predecessor. The ability of the
Company to utilize the carryforwards is dependent upon the Company generating
sufficient taxable income and could be affected by annual limitations on the use
of such carryforwards due to a change in stockholder control under the Code. The
Offering will trigger such a limitation which will be calculated in the future
based on certain factors set forth in applicable federal tax laws. The Company
believes, however, that such a limitation would not materially impact the
Company's ability to utilize the NOL carryforwards prior to their expiration.

RECENT ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board ("FASB") issued SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed of" effective for fiscal years beginning after December 15,
1995. SFAS No. 121 specifies certain events and circumstances which indicate the
cost of an asset or assets may be impaired, the method by which the evaluation
should be performed, and the method by which writedowns, if any, of the asset or
assets are to be determined and recognized. The adoption of this pronouncement
in 1996 did not have a material impact on the Company's financial condition or
operating results.

The FASB also issued SFAS No. 123, "Accounting for Stock Based
Compensation," effective for fiscal years beginning after December 15, 1995.
This statement allows companies to choose to adopt the statement's new rules for
accounting for employee stock based compensation plans. For those companies who
choose not to adopt the new rules, the statement requires disclosures as to what
earnings per share would have been if the new rules had been adopted. Management
will adopt the disclosure requirements of this statement in 1997 for the stock
based compensation granted during the year.

MIT has chosen to continue to account for stock-based compensation using
the intrinsic value method prescribed in APB Opinion No. 25. Had compensation
cost for MIT's 1995 and 1996 grants of stock-based compensation been recorded
consistent with SFAS 123, the effects would not have been material to MIT's net
income or net income per share.

MIT is subject to the provisions of SFAS No. 71, "Accounting for the
Effects of Certain Types of Regulation." Regulatory assets represent probable
future revenue to MIT associated with certain costs which will be recovered from
customers through the regulatory, or the rate making process. The MIT System had
no material regulatory assets or liabilities on its books as of December 31,
1996.

The FASB also issued Statement of Financial Accounting Standards No. 128,
entitled "Earnings Per Share," during February 1997. The new statement, which
is effective for financial statements issued after December 31, 1997, including
interim periods, establishes standards for computing and presenting earnings per
share. The new statement requires retroactive restatement of all prior-period
earnings per share data presented. The Company does not believe the new
statement will have a material impact upon previously presented earnings per
share information.

31
<PAGE>
BUSINESS AND PROPERTIES

The Company's principal assets are located in two core geographic areas:
Alabama/Mississippi and Texas. The Company's key operations include (i) the
AlaTenn Systems, a 288-mile interstate pipeline and a 38-mile and two end-user
pipelines in northern Alabama, (ii) the Magnolia System in the Black Warrior
Basin of central Alabama which consists of over 111 miles of natural gas
transmission and gathering pipelines and a 4,000 horsepower system compressor
station, (iii) the Harmony System in Mississippi which includes a sour gas
processing plant and over 150 miles of natural gas gathering pipelines and (iv)
the Company's Texas pipeline systems which consist of over 162 miles of gas
gathering and bypass pipelines.

Since the first quarter of 1994, the Company has grown significantly by
acquiring or constructing 32 pipeline systems at an aggregate cost of over $50
million, and increasing its average daily throughput by over twelve-fold to 280
Mmcf/d for the first quarter of 1997 after giving effect to the AlaTenn
Acquisition. Primarily as a result of these acquisitions, the Company's EBITDA
(as defined in the Glossary) increased to $12.7 million on a pro forma basis in
1996 for the Harmony Acquisition and the AlaTenn Acquisition, from $0.6 million
on a historical basis in 1994. See "Unaudited Pro Forma Consolidated Financial
Statements."

BUSINESS STRATEGY

The Company's principal business strategy is to increase its earnings and
cash flow by acquiring or constructing pipeline systems, aggressively pursuing
end-user customers, increase the utilization of its existing pipeline systems
and processing plants in order to enhance the Company's profitability and
improving cost efficiencies.

The Company implements this strategy through the following steps:

o ACQUISITION OR CONSTRUCTION OF PIPELINE AND PROCESSING SYSTEMS. The
Company seeks to acquire or construct natural gas transmission,
end-user gathering and processing pipeline systems which offer the
opportunity for increased utilization and expansion of the system due
to their proximity to geographic areas where municipal and industrial
demand for natural gas is growing or where drilling activity is
expected to increase. The Company seeks to acquire or construct
additional transmission and gathering systems or processing facilities
in its core geographic areas of operation when the Company believes
such additional systems will enhance the overall profitability of the
area of operation.

32
<PAGE>
excess natural gas throughput capacity that provide the Company with
opportunities to pursue additional gas volumes with little incremental
capital cost and to provide high-margin "swing" sales during periods
of increased gas demand.

OPERATIONS

Substantially all of the Company's revenues are derived from transportation
fees from pipeline systems owned by the Company, the processing and treating of
natural gas and the marketing of natural gas. The Company's various operations
involve the following activities:

MAINLINE TRANSMISSION. The Company's transmission pipelines primarily
receive and deliver natural gas to and from other pipelines, but often also
involve some end-user or gathering functions. Transportation fees are received
by the Company for transporting gas owned by other parties through the Company's
pipeline systems. Typically, very little incremental operating or administrative
overhead costs are incurred by the Company to transport gas through its pipeline
systems and a substantial portion of incremental transportation revenues can be
recognized as operating income by the Company. The Company has greatly expanded
its transmission pipeline activities with the August 1995 acquisition of the
Magnolia System and the May 1997 acquisition of the AlaTenn Systems. The Company
seeks to further expand its activities in this area through the acquisition or
construction of natural gas transmission pipelines in its core geographic areas
of operation where operational synergies and market opportunities exist or in
new geographic regions where there is increasing demand for gas by municipal and
industrial users. The Company owns one interstate and two intrastate
transmission pipelines.

END-USER TRANSMISSION. The Company also contracts with industrial
end-users, municipalities or electrical generating facilities to provide natural
gas and natural gas transportation services to their facilities through
interconnect gas pipelines constructed or acquired by the Company. These
pipelines provide a supply of natural gas to new industrial facilities or to
existing facilities as an alternative energy source. The Company intends to
continue to actively pursue direct sales to these end-users who have more
flexibility in recent years to negotiate their gas purchase and transportation
contracts as a result of industry deregulation. Frequently, the Company is able
to offer its end-user customers rates lower than the customer's current energy
supplier. The Company's contracts with end-user customers typically provide for
the payment of a transportation fee by the customer based on the volume of
natural gas transported through the Company's pipeline. The Company also offers
its end-user customers natural gas marketing services enabling them to purchase
their gas supply from the Company, but without any obligation to do so. These
marketing contracts typically provide for gas prices to be determined at
prevailing market rates, although certain of the Company's agreements with
municipalities provide for fixed prices. The Company strives to structure the
terms and transportation fees for its end-user systems in such a way as to
provide an acceptable rate of return regardless of any natural gas marketing
revenues. The Company owns 18 end-user pipelines.

GATHERING. The Company's gathering systems typically consist of a network
of small diameter pipelines which collect natural gas or crude oil from points
near producing wells and transport it to larger pipelines for further
transmission. Gathering systems may include meters, separators, dehydration
facilities and other treating equipment owned by the Company or others. The
Company derives revenues from gathering systems by transporting natural gas or
crude oil owned by others through its pipelines for a transportation fee, by
purchasing natural gas and utilizing its pipelines to transport the natural gas
to a customer in another location where the natural gas is resold or, in certain
instances, by purchasing natural gas and arranging for the delivery and resale
of an equivalent quantity of natural gas to a customer not directly served by
the Company's pipelines. Transactions with customers not directly served by the

33
<PAGE>
Company's pipelines are typically accomplished by entering into agreements
whereby the Company exchanges natural gas in its pipelines for natural gas in
the pipelines of other transmission companies. The Company intends to pursue the
construction of additional gas gathering systems in or near its core geographic
operating areas and where drilling activity is expected to provide opportunities
for expansion of gathering or processing facilities. The Company currently owns
an interest in and operates 25 gathering systems.

NATURAL GAS PROCESSING. The Company's natural gas processing revenues are
realized from the extraction and sale of NGLs as well as the sale of the
residual natural gas. Once extracted the NGLs are further fractionated in the
Company's facilities into products such as ethane, propane, butanes, natural
gasoline and condensate and then sold to various wholesalers along with raw
sulphur from the Company's sulphur recovery plant. The Company, in most
instances, enters into agreements with natural gas producers wherein the Company
and the producer share in the revenue generated from the sale of the NGLs and
natural gas extracted at the Company's facilities. The Company entered the
natural gas processing business in October 1996 with its purchase of the Harmony
System, a 150-mile gathering system and gas processing plant in central
Mississippi. The Company intends to pursue expansion of the Harmony System
through the construction of additional interconnections with wells in the area.
See " -- Principal Systems."

GAS MARKETING. Historically, the Company's gas marketing activities have
been focused on the Company's systems and customers served by such systems with
a strategic focus to provide quality and consistent service to its customers
connected to the Company's pipeline network. As a result of the AlaTenn
Acquisition, the Company has greatly expanded its natural gas marketing
activities in the Alabama/Mississippi area. The Company's marketing activities
include providing natural gas supply and sales services to some of its end-user
customers by purchasing the natural gas supply from other marketers or pipeline
affiliates and reselling the natural gas to the end-user. The Company also
purchases natural gas directly from well operators on many of the Company's
gathering systems and resells the natural gas to other marketers or pipeline
affiliates. Many of the contracts pertaining to the Company's gas marketing
activities are month-to-month spot market transactions with numerous gas
suppliers or producers in the industry. The Company also offers to customers of
its AlaTenn Systems other gas services, such as management of capacity release,
storage service and gas balancing. The Company intends to further enhance its
increased natural gas marketing presence in its core geographic areas of
operation through an aggressive marketing program focused on end-users' need for
additional throughput.

Typically, the Company purchases natural gas at a price determined by
prevailing market conditions. Simultaneous with the purchase of natural gas by
the Company, the Company generally resells natural gas at a higher price under a
sales contract which is comparable in its terms to the purchase contract,
including any price escalation provisions. In most instances, natural gas
marketing is characterized by small margins since there are numerous companies
of greatly varying size and financial capacity who compete with the Company in
the marketing of natural gas. Accordingly, historical operating income
associated with this revenue stream has varied depending on market conditions.
The Company believes the marketing of natural gas is an important complement to
its transportation services.

PRINCIPAL SYSTEMS

Since 1994, the Company has acquired ownership of or interests in 32
pipelines, three of which were transmission lines, nine of which were end-user
pipelines and 20 of which were gathering systems. During this time, the Company
has expanded into the interstate pipeline and natural gas processing markets
with the MIT System and Harmony System acquisitions. The Company's principal
pipeline systems and processing operations are as follows:

ALATENN SYSTEMS. The Company owns and operates the MIT System consisting
of a 288-mile interstate pipeline and two compressor stations with approximately
3,500 horsepower that runs from Selmer, Tennessee to Huntsville, Alabama. The
MIT System serves an eight-county area in northern Alabama, northern Mississippi
and southern Tennessee and has connections with three major interstate
pipelines. The MIT System transports natural gas to 17 municipal and eight
industrial customers and is certificated by the FERC to deliver approximately
133,000 Mcf/d of firm transportation. The Company also

34
<PAGE>
owns the Champion System consisting of a 38-mile intrastate pipeline which is
parallel to the MIT System and extends from Barton, Alabama to Courtland,
Alabama, and the Monsanto System consisting of a one-mile intrastate pipeline
system in Morgan County, Alabama. These systems service two large industrial
plant customers, Champion International Corporation ("Champion") and the
Monsanto Corporation. The Company also maintains a regional office in Muscle
Shoals, Alabama that includes administrative, operations and gas marketing
personnel. See "-- Major Customers" and "-- Office Facilities."

The Company completed the AlaTenn Acquisition in May 1997 for a total
purchase price of $39.4 million cash, subject to certain post-closing
adjustments based on a review of the net book value of the acquired companies on
the closing date. In addition, during the eight-year period beginning in 1998,
the Company has agreed to pay additional contingent annual payments, which will
be treated as deferred purchase price, not to exceed $250,000 per year. The
amount each year is dependent upon revenues received by the Company from certain
gas transportation contracts. The acquisition agreement for the AlaTenn
Acquisition also limits the amount of damages recoverable by Midcoast if there
is a breach by Atrion of the representations and warranties to $10 million after
damages have exceeded $500,000, and requires Midcoast to assert any such claims
within 18 months of the closing.

The Company believes there are numerous opportunities for increasing the
utilization of the AlaTenn Systems through an aggressive marketing program aimed
at expanding its end-user customer base. The Company also intends to pursue new
construction and acquisition opportunities in this area such as gathering
systems, new end-user pipelines and additional transmission systems that
interconnect to or otherwise provide synergies with the AlaTenn Systems and the
Company's other systems in the area. The Company has instituted a cost reduction
program aimed at making these systems more cost efficient and intends to
emphasize its gas marketing efforts throughout the region.

MAGNOLIA SYSTEM. The Magnolia System consists of approximately 111 miles
of 6-inch to 24-inch gas pipelines and an approximately 4,000 horsepower
compressor station, located in central Alabama. The Magnolia System is primarily
a transmission pipeline with interconnections to one major interstate pipeline
and one major intrastate pipeline. The system also includes some gathering lines
that connect coal-seam gas production in the Black Warrior Basin with the
Magnolia System. The Company has pursued new transportation customers on the
Magnolia System, which offers an advantageous interconnection with Transco
Energy Corporation's interstate pipeline system. As a result, the Company has
been successful in increasing throughput 108% on the Magnolia System from 17,952
Mcf/d during the fourth quarter of 1995 to 37,423 Mcf/d during the comparable
period of 1996.

HARMONY SYSTEM. The Harmony System includes the only sour gas processing
facility in central Mississippi and gathers natural gas from producing fields
through over 150 miles of high and low pressure pipeline with 4,620 horsepower
of compression. The processing plant is a refrigerated propane natural gas
liquid extraction plant with a designed capacity of over 20 Mmcf/d. The plant
has full fractionation and sulphur extraction facilities, and produces and sells
ethane, propane, butanes, natural gasoline, condensate and sulphur. The Company
acquired the Harmony System in October 1996 and has aggressively sought new
connections to producing wells in the area. Since its acquisition, the Company
has already added, or is in the process of adding, interconnections with six
wells to the Harmony System.

TEXAS OPERATIONS. The Company's Texas operations include eight end-user
and ten gathering systems covering 162 miles and which collectively have had an
average daily throughput during 1996 of 28,791 Mcf/d. The Company's Texas
gathering systems serve numerous producers with over 70 wells, while the
end-user customers include a municipal natural gas distribution system, an
electric generating facility, a Texas Department of Corrections prison, three
pump stations for a NGL pipeline company, a sulphur mine and an enhanced oil
recovery project. Since 1994, the Company has acquired 13 of its 18 systems in
Texas as part of its strategy to identify selected geographic areas and make key
asset acquisitions within those areas. As a result, the Company has been able to
capitalize on the proximity of these systems to each other and has integrated
the operations of its Texas pipelines where possible to maximize cost savings
and synergies among the various systems. The Company plans to continue
evaluating strategic additions of undervalued or underutilized pipelines to its
Texas operations.

35
<PAGE>
PIPELINE SYSTEMS

The Company owns an interest in and operates one interstate transmission
pipeline and forty-five intrastate natural gas transmission, end-user and
gathering systems the majority of which are situated strategically in the
Company's two core geographic areas: Alabama/Mississippi and Texas. Certain
information concerning the Company's pipelines is summarized in the following
table:

<TABLE>
<CAPTION>
DATE OF AVERAGE DAILY
ACQUISITION DAILY VOLUME
OR INITIAL LENGTH VOLUME(2) CAPACITY(2)
PIPELINE SYSTEM(1) OPERATIONS LOCATION IN MILES (MCF/D) (MCF/D)
- ------------------------------------- ---------------- ------------------------------ --------- ---------- ------------
<S> <C> <C> <C> <C> <C>
INTERSTATE TRANSMISSION:
MIT................................ May 1997 Selmer, TN to Huntsville, AL 288.0 97,463 140,000
INTRASTATE TRANSMISSION:
Magnolia........................... September 1995 Central AL 111.0 28,691 120,000
Moores Bridge...................... May 1996 Tuscaloosa Co., AL 4.5 0 4,000
END-USER:
Burnet............................. December 1989 Burnet Co., TX 1.3 712 3,000
Conway............................. December 1989 Rice Co., KS --(3) 9,123 14,000
Turkey Creek....................... January 1991 Fort Bend Co., TX 15.6 992 5,000
OC/Kansas.......................... June 1991 Wyandotte Co., KS 1.0 2,549 6,500
Clemens Dome....................... February 1992 Brazoria Co., TX --(3) 191 3,000
Augusta............................ July 1993 Butler Co., KS 0.5 145 5,000
Westlake........................... November 1993 Calcasieu Parish, LA 1.3 9,268 50,000
Quindaro........................... November 1994 Wyandotte Co., KS 3.1 505 60,000
OC/Albany.......................... December 1994 Albany Co., NY 0.5 1,354 3,000
Guadalupe (4)...................... February 1996 Culberson & Loving Cos., TX 9.1 320 10,000
Power Paper........................ August 1996 Roane Co., TN 2.1 1,698 5,000
South Fulton (5)................... September 1996 Obion Co., TN 0.6 NAV 1,200
Salt Creek (4)..................... September 1996 Kent & Scurry Cos., TX 39.1 4,321 20,000
Cuero.............................. October 1996 DeWitt Co., TX 5.4 100 2,000
STEC............................... October 1996 Victoria Co., TX 4.0 0 10,000
Falfurrias......................... January 1997 Brooks Co., TX --(3) 387 8,000
Monsanto........................... May 1997 Morgan Co., AL 1.0 3,124(6) 20,000
Champion........................... May 1997 Lawrence & Colbert Cos., AL 38.0 26,480 50,000
GATHERING:
Fitzsimmons........................ April 1993 Duval Co., TX --(3) 98 3,000
Zmeskal............................ June 1994 Victoria Co., TX --(3) 311 3,000
Cook Inlet Gas (5)................. July 1994 Cook Inlet, AK 2.7 131(7) 15,000
Cook Inlet Oil (5)................. July 1994 Cook Inlet, AK 2.7 2,902(8) 20,000(8)
Foss............................... December 1994 Custer Co., OK 4.1 344 5,000
Flores (9)......................... January 1996 Starr Co., TX 9.9 1,499 5,000
Chapa (4).......................... February 1996 Live Oak Co., TX 24.7 4,200 50,000
Guerra (4)......................... February 1996 Webb & Duval Cos., TX 18.8 5,877 50,000
Loma Novia (4)..................... February 1996 Duval & McMullen Cos., TX 15.2 9,648 25,000
Detroit............................ May 1996 Lamar Co., AL 16.5 66 3,000
Fayette............................ May 1996 Fayette Co., AL 62.8 1,220 10,000
Greenwood Springs.................. May 1996 Monroe Co., MS 7.9 148 5,000
Happy Hill......................... May 1996 Fayette Co., AL 5.5 87 3,000
Heidelberg-Koch.................... May 1996 Jasper Co., MS 1.0 155 3,000
Heidelberg-TGP..................... May 1996 Jasper Co., MS 3.5 767 2,500
Millbrook.......................... May 1996 Wilkinson Co., MS 8.9 287 5,000
Sizemore........................... May 1996 Lamar Co., AL 1.0 15 3,000
</TABLE>
(TABLE CONTINUED ON FOLLOWING PAGE)

36
<PAGE>
<TABLE>
<CAPTION>
DATE OF AVERAGE DAILY
ACQUISITION DAILY VOLUME
OR INITIAL LENGTH VOLUME(2) CAPACITY(2)
PIPELINE SYSTEM(1) OPERATIONS LOCATION IN MILES (MCF/D) (MCF/D)
- ------------------------------------- ---------------- ------------------------------ --------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Lake Rosemound..................... September 1996 Wilkinson Co., MS 18.4 3,019 10,000
Chaparral.......................... October 1996 Monroe Co., MS 9.6 128 3,000
Harmony............................ October 1996 Central MS 150.4 5,431 20,000
Minnie Bock........................ November 1996 Nueces Co., TX 14.0 2,361 10,000
Minnie Bock East................... November 1996 Nueces Co., TX 2.5 529 5,000
Port............................... November 1996 Nueces Co., TX 1.5 1,023 5,000
Rowden............................. November 1996 Duval Co., TX 1.0 189 3,000
Raymond............................ March 1997 Central KS 120.0 NAV 5,000
--------- ---------- ------------
Totals......................... 1028.7(10) 221,832 791,200(10)
========= ========== ============
</TABLE>
- ------------

(1) Unless otherwise indicated, all systems are 100% owned and operated by the
Company.

(2) All volume and capacity information is approximate. Average daily volumes
are based on total volumes transported during the twelve-month period ended
March 31, 1997, for all systems acquired prior to March 31, 1996, the MIT
and Champion Systems. All other average daily volumes are based on total
volumes transported from the date of acquisition or initial operation
through March 31, 1997. NAV means the pipeline has not been placed in
service.

(3) This system is less than a quarter-mile in length.

(4) This system is owned by Pan Grande, in which the Company owns a 50%
interest, and is operated by the Company.

(5) These systems are owned and operated by third-parties and the Company
receives throughput charges from these systems.

(6) The Monsanto System's average daily volume is included as part of the MIT
System totals, and is not included in the totals.

(7) Average usage since the line was placed in service in December 1996.

(8) Volume is reflected in barrels of oil production per day, and are not
included in totals.

(9) This system is owned by Starr County, a joint venture in which the Company
owns a 60% interest, and is operated by the Company.

(10) This total excludes four inactive systems owned by the Company.

MAJOR CUSTOMERS

The Company's principal customers are primarily industrial end-users,
municipalities and producers of natural gas. The Company typically enters into
one to five year transportation agreements which may also include provisions
regarding guaranteed minimum volumes and price reductions after the customer
meets certain transportation commitments. With regard to the MIT System, the
Company enters into transportation contracts regarding firm and interruptible
transportation using the tariff rates approved by FERC, which contracts
typically provide for a one to five year term. In certain situations, the
Company has offered discounts from its tariffs in response to specific market
situations. The Company also enters into marketing agreements with many of its
customers related to gas supply and other services.

Key customers under these contracts, representing in excess of 10% of the
Company's gross margin, on a pro forma basis for the AlaTenn Acquisition include
Champion, Reynolds Metal Company, Amoco Chemical and the cities of Huntsville,
Decatur, and Florence, Alabama. Gross margin represents transportation revenues
earned in transmission contracts and the difference between the contract price
of the gas purchased and the contract price of the gas sold. The agreement with
Champion, which expires in 2004, provides for 28 Mmcf/d of firm transportation
and a rate reduction of 41% in the event that Champion meets a minimum
transportation volume, which is expected to occur in 2001 based on Champion's
current usage. Contracts covering a majority of the gas volumes delivered to the
cities of Huntsville and Decatur, Alabama expire in 1997 and 1998. See
"-- Competition."

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<PAGE>
COMPETITION

The natural gas transportation, gathering, processing and marketing
industries are highly competitive. In marketing natural gas, the Company has
numerous competitors, including marketing affiliates of interstate pipelines,
major integrated oil companies, and local and national natural gas gatherers,
brokers and marketers of widely varying sizes, financial resources and
experience. Local utilities and distributors of natural gas are, in some cases,
engaged directly, and through affiliates, in marketing activities that compete
with the Company. Many of the Company's contracts are month-to-month
arrangements and as such, these agreements are affected by existing competition
in the natural gas markets at the time of sale as well as competition for the
cost of natural gas supplies.

The Company competes against other companies in the transmission, gathering
and marketing businesses for supplies of natural gas and for sales customers.
Competition for natural gas supplies is primarily based on efficiency,
reliability, availability of transportation and the ability to offer a
competitive price for natural gas. Competition for customers is primarily based
upon reliability and price of deliverable natural gas. For customers that have
the capability of using alternative fuels, such as oil and coal, the Company
also competes against companies capable of providing these alternative fuels at
a competitive price.

Southern, a large interstate pipeline subsidiary of Sonat, announced plans
in 1995 to construct a new natural gas pipeline to serve the Huntsville and
Decatur, Alabama areas. Southern has filed an application with the FERC to build
a 110-mile pipeline from Tuscaloosa, Alabama, to northern Alabama to provide
such service to the cities of Huntsville and Decatur beginning in or after the
fourth quarter of 1997. The cities of Decatur and Huntsville, which accounted
for approximately 47% of the MIT System's total contracted demand in 1996, have
entered into 20-year contracts with Southern to provide substantially all of the
cities' firm natural gas transportation requirements. Service by Southern under
the contracts is dependent upon the construction of this pipeline, and Southern
has announced that it is planning for the new pipeline to be placed in service
by late 1997. Approximately 93% of Decatur's contract volume with the MIT System
expires on November 1, 1998 and 86% of Huntsville's contract volume expires on
April 1, 1999. The balance of Decatur's and Huntsville's contract volumes expire
on November 1, 2000. In 1996, Huntsville and Decatur accounted for approximately
23%, or $3.0 million, of the AlaTenn Subsidiaries gross margin.

If Southern's proposed pipeline is constructed and Southern begins
providing service to the cities of Decatur and Huntsville, the Company may at
some point in the future lose the transported volumes related to these
customers. In an effort to mitigate the anticipated loss of sales to Decatur and
Huntsville, these customers have been notified that the contracts scheduled to
expire on November 1, 1998 and April 1, 1999 will not be renewed and the
capacity related to those contracts has been posted for third-party bidding. In
the meantime, the Company continues to maintain firm transportation contracts
with both cities. Unless the Company is able to renew the contracts or obtain
new customers who contract for the transportation volumes taken by these
customers, the completion of this pipeline may have a material adverse effect on
the financial condition, results of operations and business of the Company.

NATURAL GAS SUPPLY

The Company's end-user pipelines have connections with major interstate and
intrastate pipelines which management believes have ample supplies of natural
gas in excess of the volumes required for these systems. In connection with the
construction and acquisition of its gathering systems, evaluations were made of
well and reservoir data furnished by producers to determine the availability of
natural gas supply for the systems. Based on those evaluations, it is
management's belief that there should be adequate natural gas supply for the
Company to recoup its investment with an adequate rate of return. As such,
management does not routinely obtain independent evaluation of reserves
dedicated to its systems due to the cost of such evaluations. Accordingly, the
Company does not have estimates of total reserves dedicated to its systems or
the anticipated life of such producing reserves.

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<PAGE>
OIL AND GAS PROPERTIES

The Company owns several non-operated working interests in producing and
non-producing oil and gas properties. For the three-month period ended March 31,
1997, revenues from the Company's oil and gas properties were less than 1% of
its total revenues, and for the same period the Company's oil and gas properties
represented less than 7% of its total assets. The Company owns working interests
in 3,560 gross acres of oil and gas leases and interests in 12 producing wells.
Although it is not expected to become a major line of business for the Company,
management expects that acquisition and ownership of non-operated oil and gas
interests will remain a facet of the Company's business for the foreseeable
future.

TITLE TO PROPERTIES

The Company, as part of its pipeline construction process, must obtain
certain right-of-way agreements from landowners whose property the proposed
pipeline will cross. The terms and cost of these agreements can vary greatly due
to a number of factors. In addition, as part of its acquisition process, the
Company will typically evaluate the underlying right-of-way agreements for the
particular pipeline to be acquired to determine that the pipeline owner has met
all terms and conditions of the underlying right-of-way agreement and that the
agreement is still in full force and effect.

The Company typically relies upon outside service organizations to review
the right-of-way agreements and to make suggestions to the seller as to any
curative work required before closing. The Company typically does not receive a
title opinion or title policy as to these right-of-way agreements due to the
complexity of the records and attendant expense. Occasionally, the Company may
seek to initiate condemnation proceedings where permitted under state law to
obtain a right-of-way necessary for pipeline construction projects. The Company
believes that this process is consistent with standards in the pipeline industry
and that it holds good title to its pipeline systems, subject only to defects
which the Company believes are not material to the ownership of its properties
or results of operations. Substantially all of the Company's pipeline systems
are pledged to secure borrowings under the Credit Agreement. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Capital Resources and Liquidity."

RATE AND REGULATORY MATTERS

Various aspects of the transportation of natural gas are subject to or
affected by extensive federal regulation under the Natural Gas Act ("NGA"),
the Natural Gas Policy Act of 1978 ("NGPA"), the Natural Gas Wellhead
Decontrol Act of 1989 ("Decontrol Act") and regulations promulgated by the
FERC.

NATURAL GAS TRANSMISSION INDUSTRY. Historically, interstate pipeline
companies acted as wholesale merchants by purchasing natural gas from producers,
transporting that natural gas from the fields to their markets, and reselling
the natural gas to LDCs and large end-users. Prior to the enactment of the NGPA
in 1978 and the Decontrol Act of 1989, all sales of natural gas for resale in
interstate commerce, including sales by producers, were subject to the rates and
service jurisdiction of the FERC under the NGA and NGPA. However, as a result of
the NGPA and the Decontrol Act, all so-called "first sales" of natural gas
were federally deregulated, thus allowing all types of non-pipeline and
non-local distribution sellers to market their natural gas free from federal
controls. Moreover, pursuant to Section 311 ("Section 311") of the NGPA, the
FERC promulgated regulations by which wholly-intrastate natural gas pipeline
companies could engage in interstate transactions without becoming subject to
the FERC's full rates and service jurisdiction under the NGA. At the same time,
however, the FERC has retained its traditional jurisdiction over the activities
of interstate pipelines. Thus, under the NGA and NGPA, the transportation and
resale of natural gas by interstate pipeline companies have been subject to
extensive regulation, and the construction of new facilities, the extension of
existing facilities, and the commencement and cessation of sales, resales or
transportation services by pipeline companies generally have required prior FERC
authorization.

Commencing in 1985 with the promulgation of Order No. 436, the FERC adopted
regulatory changes that have significantly altered the transportation, sale and
marketing of natural gas. These changes were

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<PAGE>
intended to foster competition in the natural gas industry by, among other
things, transforming the role of the interstate pipeline companies from
wholesale marketers of natural gas to primarily natural gas transporters, and
mandating that interstate pipeline companies provide open and nondiscriminatory
transportation services to all producers, distributors, marketers and other
shippers that seek such services (so-called "open access" requirements). As an
incentive to cause the interstate pipeline companies to revamp their services,
the FERC also sought to expedite the certification process for new services,
facilities, and operations of those pipeline companies providing "open access"
services. Throughout the early years of this process, the FERC's actions in
these areas were subject to extensive judicial review and generated significant
industry comment and proposals for modification to existing regulations.

In April 1992, the FERC issued its most comprehensive restructuring ruling,
Order 636, a complex regulation that has had a major impact on natural gas
pipeline operations, services and rates. Among other things, Order 636 generally
required each interstate pipeline company to "unbundle" its traditional
wholesale services and make available on an open and nondiscriminatory basis
numerous constituent services (such as gathering services, storage services, and
firm and interruptible transportation services) and to adopt a new rate making
methodology to determine appropriate rates for those services. To the extent the
pipeline company or its sales affiliate makes natural gas sales as a merchant in
the future, it will do so pursuant to a blanket sales certificate that puts
those entities in direct competition with all other sellers pursuant to private
contracts, however, pipeline companies were not required by Order 636 to remain
merchants of natural gas, and several of the interstate pipeline companies have
elected to become transporters only. The FERC required that each pipeline
company develop the specific terms of service in individual pipeline
restructuring proceedings by means of a compliance filing that set forth the
pipeline company's new, detailed procedures. In subsequent orders, the FERC
largely affirmed the significant features of Order 636 and denied requests for
stay of the implementation of the new rules pending judicial review. In July
1996, the United States Court of Appeals for the District of Columbia Circuit
(the "D.C. Circuit") largely upheld Order 636, but did remand certain aspects
of Order 636 to the FERC for further explanation including, INTER ALIA, the
right of first refusal mechanism and the eligibility of customers to receive
no-notice transportation service. On February 27, 1997, the FERC issued Order
No. 636-C, its order on remand from the D.C. Circuit. Order No. 636-C is
currently pending on rehearing before the FERC. Orders approving the individual
pipeline restructuring proceedings, however, are the subject of numerous appeals
to the United States Court of Appeals. The outcome of such proceedings and the
ultimate impact that they may have on the Company's business is uncertain.

In late 1996 and early 1997, the FERC issued a series of orders
incorporating certain business practice standards of interstate pipelines which
was intended to establish a more efficient and integrated pipeline grid which
will reduce the variations in pipeline business practices and allow customers to
obtain and transport gas from all potential sources of supply more easily and
efficiently. Certain aspects of these orders are currently pending on appeal
before the D.C. Circuit.

INTERSTATE PIPELINE REGULATION. The MIT System's operations constitute the
operations of a "natural gas company," as defined in the NGA. As such, it is
subject to the jurisdiction of FERC. The interstate pipeline operations of the
MIT System are operated pursuant to certificates of public convenience and
necessity and other authorization issued under the NGA and pursuant to the NGPA.
FERC regulates the interstate transportation and certain sales of natural gas,
including among other things, rates and charges allowed natural gas companies,
extensions and abandonment of facilities and service, rates of depreciation and
amortization and the accounting system utilized by the MIT System.

The interstate pipeline operations of MIT System are subject to regulation
by FERC under the NGA which requires, among other things, that pipeline rates be
just and reasonable and not unduly discriminatory. Pipeline rates must be filed
with FERC, and, in general, such rates are required to be cost-based to be
deemed to be just and reasonable. FERC may suspend for up to five months the
effectiveness of rate changes filed by the pipeline, and thereafter permit the
changed rate to go into effect subject to refund. FERC may require the pipeline
to refund, with interest, all or any portion of any increased amount that it

40
<PAGE>
finds not to be just and reasonable. FERC also may investigate, either on its
own motion or pursuant to protests by third parties, the lawfulness of pipeline
rates that are on file.

On April 1, 1993, the MIT System increased its jurisdictional rates from
rates that had been in effect since April 1990. This rate increase was agreed to
in an uncontested settlement with the MIT System's customers which the FERC
approved on December 30, 1993. That agreement was amended in September 1996 to
eliminate the requirement that the MIT System file a new rate case in September
1996. As part of that agreement, the MIT System reduced its rates by 6%
effective September 1, 1996.

INTRASTATE PIPELINE REGULATION. The Company's intrastate pipeline
operations, other than the Magnolia System, are generally not subject to
regulation by the FERC. The Company's intrastate operations are subject to
regulation by various agencies of the states in which the Company operates such
as the Company's principal operations in the Alabama/Mississippi area and in
Texas, which are subject to the jurisdiction of these states' respective
regulatory commissions or with regard to operational, environmental, and safety
considerations. The Magnolia System is subject to the jurisdiction of the FERC
with respect to the transportation rates under Section 311(a)(2) of the NGPA.
Under Section 311, an intrastate pipeline can provide transportation service
"on behalf of" any interstate pipeline or local distribution company without
prior FERC authorization. Specifically, the FERC adopted a so-called transport
or title standard requiring that for purposes of interstate transportation under
Section 311, the on behalf of entity must either (1) have physical custody of or
(2) hold title to the gas at some point during the transaction. Section 311
service must be provided without undue discrimination or preference and is
subject to certain FERC filing and reporting requirements. The Champion and
Monsanto Systems are regulated by the Alabama Public Service Commission
("APSC"). The rates to transportation customers on these two systems are
determined by negotiated contracts which are approved by the APSC. The Company's
operations in Texas are subject to the Texas Gas Utility Regulatory Act, as
implemented by the Texas Railroad Commission (the "TRC"). Generally, the TRC
is vested with authority to ensure that rates charged for natural gas sales and
transportation services are just and reasonable. The Company must also make
filings with the TRC for all new and increased rates. As in the case of
potential federal regulatory changes, there can be no assurances that state
regulatory measures will not adversely affect the Company's business and
financial condition. In such events, the states' regulatory authorities could
temporarily suspend or hinder operations in a particular state, depending on the
authority's view of its jurisdiction. Although, regulators at the state level
have generally followed the FERC's lead by allowing increased competition behind
LDCs, there can be no assurance that every state will follow this practice
without the pressure of litigation. See "Risk Factors."

GATHERING OPERATIONS REGULATION. The NGA exempts gas gathering facilities
from the direct jurisdiction of the FERC. Interstate transmission facilities, on
the other hand, remain subject to FERC jurisdiction. The FERC has historically
distinguished between these two types of facilities on a fact-specific basis.
The Company believes that its gathering facilities and operations meet the
current tests that the FERC uses to grant nonjurisdictional gathering facility
status. Some of the recent cases applying these tests in a manner favorable to
the determination of the Company's nonjurisdictional status are, however, still
subject to rehearing and appeal. In addition, the FERC's articulation and
application of the tests used to distinguish between jurisdictional pipelines
and nonjurisdictional gathering facilities have varied over time. While the
Company believes the current definitions create nonjurisdictional status for the
Company's gathering facilities, no assurance is available that such facilities
will not, in the future, be classified as regulated transmission facilities and
thus, the rates, terms, and conditions of the services rendered by those
facilities would become subject to regulation by the FERC.

The Company's natural gas gathering activities, including fees, are not
regulated by the FERC and no state in which the Company operates currently
regulates such fees. Although the Company is not aware that any state in which
it operates a natural gas gathering system is likely to begin regulation of the
Company's natural gas gathering activities and fees, new or increased state
regulation has been adopted or proposed in other natural gas producing states
and there can be no assurance that such regulation will not be proposed or
adopted in states where the Company conducts natural gas-related activities or
that the Company will not expand into or acquire operations in a state where
such regulations could be imposed.

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<PAGE>
ENVIRONMENTAL AND SAFETY MATTERS. The Company's activities in connection
with the operation and construction of pipelines and other facilities for
transporting, processing, treating, or storing natural gas and other products
are subject to environmental and safety regulation by numerous federal, state
and local authorities. This can include ongoing oversight regulation as well as
requirements for construction or other permits and clearances which must be
granted in connection with new projects or expansions. On the federal level,
regulatory agencies can include the Environmental Protection Agency ("EPA"),
the Occupational Safety and Health Administration, the U.S. Army Corp of
Engineers, the U.S. Fish and Wildlife Service and others. State regulatory
agencies or boards can include various air and water quality control boards,
historical and cultural resources offices, fish and game services and others.
Regulatory requirements can increase the cost of planning, designing, initial
installation and operation of such facilities. Sanctions for violation of these
requirements include a variety of civil and criminal enforcement measures
including monetary penalties, assessment and remediation requirements and
injunctions as to future compliance. The following is a discussion of certain
environmental and safety concerns related to the Company. It is not intended to
constitute a complete discussion of the various federal, state and local
statutes, rules, regulations, or orders to which the Companys operations may be
subject.

In most instances, the regulatory requirements of, including, without
limitation, those state agencies mentioned above and the EPA, relate to the
release of substances into the environment and include measures to control water
and air pollution. Moreover, the Company, without regard to fault, could incur
liability under the Comprehensive Environmental Response, Compensation, and
Liability Act of 1980, as amended, or state counterparts, in connection with the
disposal or other releases of hazardous substances, including those arising out
of historical operations conducted by the Company's predecessors. Further, the
recent trend in environmental legislation and regulations is toward stricter
standards, and this will likely continue in the future.

Environmental laws and regulations may also require the acquisition of a
permit before certain activities may be conducted by the Company. Further, these
laws and regulations may limit or prohibit activities on certain lands lying
within wilderness areas, wetlands, areas providing habitat for certain species
or other protected areas. The Company is also subject to other federal, state
and local laws covering the handling, storage or discharge of materials used by
the Company, or otherwise relating to protection of the environment, safety and
health. As an employer, the Company is required to maintain a workplace free of
recognized hazards likely to cause death or serious injury and to comply with
specific safety standards.

Management believes, based on its current knowledge, that the Company has
obtained and is in current compliance with all necessary and material permits
and that the Company is in substantial compliance with applicable material
environmental and safety regulations. Further, the Company maintains insurance
coverages that it believes are customary in the industry, although it is not
fully insured against all environmental and safety risks. The Company is not
aware of any existing environmental or safety claims that would have a material
impact upon its financial position or results of operations. See
" -- Insurance."

INSURANCE

The Company maintains insurance coverage of its operations and properties
considered to be customary in the industry. There can be no assurance, though,
that the Company's insurance coverage will be available or adequate for any
particular risk or loss. Although, management believes that the Company's assets
are adequately covered by insurance, a substantial uninsured loss could have a
materially adverse impact on the Company and its financial position.

LEGAL PROCEEDINGS

In addition to opposing Southern's application with the FERC, on February
9, 1996, MIT filed a lawsuit in the Circuit Court of Jefferson County ("Circuit
Court"), Alabama against Southern and the City of Huntsville asserting that the
firm transportation contract between Southern and Huntsville violates Alabama's
competitive bid law and requesting that the contract be declared void. The
Circuit Court entered summary judgment for Southern and Huntsville on August 20,
1996. The MIT System's appeal of that ruling is pending in the Supreme Court of
Alabama. See " -- Competition."

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<PAGE>
On September 13, 1996, an involuntary petition for relief under Chapter 11
of the United States Bankruptcy Code was filed against Stewart Petroleum Company
("Stewart") in the United States Bankruptcy Court for the District of Alaska
(the "Court") by certain working interest owners in the West McArthur River
Unit ("WMRU") Production Facility, operated by Stewart. Stewart consented to
an order for relief on January 24, 1997 and Stewart subsequently filed a
Disclosure Statement and Plan of Reorganization, as amended (the "Stewart
Plan"). The payment of the Company's throughput fees since August 1996 have
been suspended by the Court, and only those claims deemed to be necessary to
avoid immediate and irreparable harm to the Stewart estate have been paid. The
Court has approved the Disclosure Statement and scheduled a Confirmation Hearing
on the Stewart Plan for June 1997. The Stewart Plan provides for the payment of
the Company's claim and the Company believes it is adequately protected, but
there can be no assurance that the Stewart Plan will be confirmed or that the
Company's claim will be paid. As such, the Company is continuing to accrue
revenue for the throughput fees from August 1996 to May 1997, which amounts to
approximately $143,000.

The Company is currently involved in certain other litigation. Management
believes that all such other litigation arose in the ordinary course of business
and that costs of settlements or judgments arising from such suits will not have
a material adverse effect on the Company's consolidated financial position or
results of operations.

OFFICE FACILITIES

The Company leases its principal executive offices in Houston, Texas. The
Company also owns an 11,212 square foot, two-story office building in Muscle
Shoals, Alabama and maintains other regional offices in Corpus Christi, Texas,
Pachuta, Mississippi, Topeka, Kansas and Tuscaloosa, Alabama.

EMPLOYEES AND CONTRACT SERVICE ORGANIZATIONS

The Company has 61 full-time employees. The Company has arrangements with
other unaffiliated independent pipeline operating companies who service and
operate the Company's extensive field operations and provide for emergency
response measures. The Company is not party to any collective bargaining
agreements. There have been no significant labor disputes in the past.

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<PAGE>
MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

The following table sets forth certain information concerning the directors
and executive officers of the Company. Each director holds office until the
first annual meeting of stockholders is held after his election or until his
successor is elected or appointed and qualified.

OFFICER OR
DIRECTOR
NAME AGE POSITION SINCE
- ---------------------- ----------------------------------------- ----------
Dan C. Tutcher........ 48 Chairman of the Board, President and 1992
Chief Executive Officer
I. J. Berthelot, II... 37 Vice President of Operations, Chief 1995
Engineer and Director
Richard A. Robert..... 31 Chief Financial Officer and Treasurer 1996
Duane S. Herbst....... 33 Vice President of Corporate Affairs 1992
and Secretary
Richard N. Richards... 50 Director 1996
Bruce M. Withers, Jr.. 70 Director (designee) 1997

DAN C. TUTCHER has served as Chairman of the Board, President and Chief
Executive Officer since the Company's incorporation in 1992 and Treasurer from
1995 to 1996. Since 1989, Mr. Tutcher has also been President and Chief
Executive Officer of Magic Gas Corp. Prior to its merger into the Company in
1992, Mr. Tutcher served as a director of Nugget Oil Corporation ("Nugget"),
from 1990 to 1992. He also has held various positions in companies which
constructed pipelines and marketed gas, such as Gulf Gas Utilities, Inc. and
Wildhorn Corporation, where he served as Vice President from 1987 through 1989
and as President from 1984 through 1993, respectively. Mr. Tutcher holds a
Bachelors of Business Administration degree in General Business from Washburn
University.

I. J. (CHIP) BERTHELOT, II has served as Vice President of Operations since
1995, Chief Engineer since 1992 and director since 1996. From 1991 to 1992, Mr.
Berthelot was a gas contracts representative with Mitchell Energy & Development
Co. ("Mitchell Energy"). Prior to 1991, Mr. Berthelot was with Texline Gas
Company ("Texline") as a gas contracts representative and engineer for the
period from 1990 to 1991. He is a Professional Engineer, licensed in Texas and
holds a Bachelors of Science degree in Petroleum and Natural Gas Engineering
from Texas A&I University.

RICHARD A. ROBERT has served as Chief Financial Officer and Treasurer since
1996, and as Controller since the Company's incorporation in 1992. From 1988 to
1992, Mr. Robert was an audit associate in the energy audit division of Arthur
Andersen LLP. Mr. Robert is a certified public accountant and is a member of the
Texas Society of Certified Public Accountants. He holds a Bachelors of Business
Administration degree in Accounting from Southwest Texas State University.

DUANE S. HERBST has served as Vice President of Corporate Affairs since
1996 and as Secretary of the Company since its incorporation in 1992. From April
1992 until its merger with the Company in September 1992 he held the office of
President of Nugget. Since 1989, to the date hereof, he has been Vice President
of Rainbow Investments Company ("Rainbow"). Mr. Herbst has also held the
office of Secretary of Texline since 1993 and the office of Secretary and
director of Re-Claim Environmental Inc. since 1995. He holds a Masters of
Business Administration from the University of Texas and a Bachelors of Science
degree in Finance from Trinity University. Mr. Herbst is the son of Stevens G.
Herbst, a principal stockholder of the Company. See "Principal Stockholders."

RICHARD (DICK) N. RICHARDS has served as a director since 1996. Mr.
Richards has been with NASA since 1980. Mr. Richards was an astronaut with NASA
until 1995 and flew one mission as pilot and commanded three missions of the
space shuttles Discovery and Columbia. Mr. Richards is currently the Manager of
Space Shuttle Program Integration. He recently completed an assignment as
Mission Director of the third Hubble Space Telescope Servicing Space Shuttle
Mission and Mission Manager for the second Tethered Satellite System Space
Shuttle Mission. He holds a Bachelors of Science degree in Chemical

44
<PAGE>
Engineering from the University of Missouri and a Masters of Science in
Aeronautical Systems from the University of West Florida.

BRUCE M. WITHERS, JR. has agreed to become a director after the closing of
the Offering. From August 1991 to October 1996, Mr. Withers served as Chairman
and Chief Executive Officer of Trident NGL, Inc. and Vice Chairman of NGC
Corporation ("NGC"). NGC is a leading North American aggregator, processor,
transporter and marketer of energy products and services. Prior to joining NGC,
Mr. Withers served as the President of the Transmission and Processing Division
of Mitchell Energy for 17 years. Mitchell Energy is engaged through its
subsidiaries in the exploration for and production of oil and gas, in natural
gas processing and gas gathering and transmission and in real estate
development. He also served as President and Chief Operating Officer of Liquid
Energy Corp. and Southwestern Gas Pipeline, two affiliates of Mitchell Energy.
Mr. Withers holds a Bachelors of Science degree in Petroleum and Natural Gas
Engineering from Texas A&I University.

EXECUTIVE COMPENSATION

The following table reflects all forms of compensation for services to the
Company for the years ended December 31, 1996, 1995 and 1994 for the Chief
Executive Officer, the Vice President of Operations and the Chief Financial
Officer of the Company. During 1995 and 1994, no other executive officers
received compensation, including bonuses, which exceeded $100,000.

<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
-------------------------------------- -------------
OTHER ANNUAL RESTRICTED ALL OTHER
NAME AND POSITION YEAR SALARY BONUS COMPENSATION STOCK AWARDS COMPENSATION(1)
- ------------------------------------- --------- ---------- --------- -------------- ------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Dan C. Tutcher....................... 1996 $ 125,000 -- -- -- $ 12,400
President and 1995 $ 125,000 -- -- -- $ 6,675
Chief Executive Officer 1994 $ 125,000 -- -- -- $ 6,675
I. J. Berthelot, II.................. 1996 $ 59,110 -- $ 5,586(2) $91,383 $ 1,518
Vice President of 1995(3) $ 64,206 $ 1,200 $ 16,170(2) $ 4,200 --
Operations and 1994 $ 66,486 -- -- $ 3,000 --
Chief Engineer
Richard A. Robert.................... 1996(3) $ 65,125 -- $ 5,586(2) $25,383 $ 8,228
Chief Financial Officer 1995 $ 50,654 $ 1,200 -- $ 4,200 $ 4,800
and Treasurer 1994 $ 47,109 $ 5,000 -- $ 3,000 $ 3,200
</TABLE>
- ------------

(1) Represents the Company's matching contributions to the Midcoast Energy
Resources, Inc. Profit Sharing Plan and Trust ("401(k) Plan") and certain
personal benefits including car allowances.

(2) Includes amounts paid by the Company as reimbursement for taxes incurred on
appreciation of shares of stock issued as consideration for executing
employment agreements.

(3) Mr. Berthelot and Mr. Robert became executive officers in 1995 and 1996,
respectively.

Pursuant to separate shareholders agreements dated April 30, 1994 by and
between the Company and I. J. Berthelot, II, Richard A. Robert and Duane S.
Herbst, each officer was respectively, issued 11,152, 11,152, and 6,691 shares,
respectively, of the Company's Common Stock as additional consideration for
their services to the Company.

EXECUTIVE EMPLOYMENT CONTRACTS

Dan C. Tutcher, the Chief Executive Officer and President of the Company,
has an employment agreement with the Company which, as amended, terminates in
December 2001 pursuant to which he receives a base annual salary of $95,000 in
1997, $125,000 in 1998 and 1999 and $150,000 in 2000 and 2001 and may
participate in any such executive level bonuses or salary increases as the Board
may approve. Mr. Tutcher is also entitled to reimbursement for reasonable
automobile expenses not to exceed $500 each

45
<PAGE>
month and is eligible for participation in the Company's group insurance plans.
Mr. Tutcher is required to devote his full business time and attention to the
Company.

I. J. Berthelot, II, Vice President of Operations and Chief Engineer,
entered into an four-year employment agreement with the Company commencing April
1995. Pursuant to the employment agreement Mr. Berthelot is to receive an annual
base salary of $55,200, increased a minimum of 10% annually, beginning on April
17, 1995. Mr. Berthelot was also awarded 57,991 shares of the Company's Common
Stock as consideration for executing the agreement. Mr. Berthelot is required to
devote his full business time and attention to the Company.

Richard A. Robert, Chief Financial Officer and Treasurer, entered into a
five-year employment agreement with the Company commencing April 1994. Pursuant
to the employment agreement, Mr. Robert is to receive an annual base salary of
$69,000 to be increased a minimum of 10% annually, beginning on April 8, 1997.
Mr. Robert was also awarded 8,921 shares of the Company's Common Stock as
consideration for executing the agreement. Mr. Robert is required to devote his
full business time and attention to the Company.

DIRECTOR COMPENSATION AND BOARD COMMITTEES

During the year ended December 31, 1996, the Board met 14 times. Each
director attended all Board meetings either in person or by telephonic
conference. Employee directors do not receive additional compensation for
service on the Board or its committees. The Company currently pays each
non-employee director a cash fee of $1,000 at the end of each calendar quarter
of service, $1,000 for each regular and special meeting of the Board attended
and $300 for each committee meeting attended plus any travel expenses. Under the
1997 Non-Employee Director Stock Option Plan (the "Director Plan"), pursuant
to an annual election by the director, these cash fees may be converted into
shares of the Company's Common Stock at the market price (as defined in the
Director Plan) on the last day of the quarter in which the fees are paid. See
" -- 1997 Non-Employee Director Stock Option Plan." In July 1996, the
Company's two outside directors, Mr. E. P. Marinos and Mr. Richards, were issued
a stock grant of 2,007 shares of the Company's Common Stock in consideration for
their future services as directors. Mr. Marinos became President of MIT in May
1997 and did not stand for re-election as a director of the Company at its 1997
Annual Stockholders' Meeting.

The Director Plan entitles each newly-elected director who is neither (i)
an employee of the Company nor (ii) a director as a result of an acquisition or
financing transactions (a "New Director") to receive options to purchase up to
15,000 shares of Common Stock on their initial election. The Director Plan
entitles each existing non-employee director (the "Existing Directors") to
receive an option to purchase 5,000 shares of Common Stock. Further, the
Director Plan entitles each Existing Director and each New Director to receive
an option to purchase 5,000 shares on each date he is re-elected to serve as a
member of the Company's Board. Mr. Richards was issued an option to purchase
5,000 shares pursuant to the Director Plan upon his re-election as a director in
1997. See " -- 1997 Non-Employee Director Stock Option Plan." Employee
directors are eligible to participate in the Company's Incentive Plan. See
" -- 1996 Incentive Stock Plan."

AUDIT COMMITTEE. The Board's Audit Committee was established in May 1996.
The Committee's functions include reviewing internal controls and recommending
to the Board the engagement of the Company's independent certified public
accountants, reviewing with such accountants a plan for and results of their
examination of the financial statements, and determining the independence of
such accountants. The Audit Committee was comprised of Messrs. Marinos and
Richards through May 1997 and will consist of Messrs. Withers and Richards upon
completion of the Offering.

EXECUTIVE COMMITTEE. The Board's Executive Committee was established in
May 1996. The Executive Committee is authorized to exercise, to the extent
permitted by law, the power of the full Board when a meeting of the full Board
is not practicable or necessary. The Executive Committee consists of Messrs.
Tutcher and Berthelot and did not meet during 1996.

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<PAGE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. The Board's
Compensation Committee was established in May 1996. The Compensation Committee
administers the Incentive Plan and the Director Plan. In this capacity, the
Compensation Committee recommends all option grants or awards to Company
officers, executives, employees and consultants. The Compensation Committee also
recommends the establishment of policies dealing with various compensation,
including compensation of executive officers, the Company's 401(k) Plan, and any
pension and profit sharing plans which may be created. The Compensation
Committee was comprised of Messrs. Marinos and Richards through May 1997 and
will consist of Messrs. Withers and Richards upon completion of the Offering.

1996 INCENTIVE STOCK PLAN

The stockholders approved the Incentive Plan in May 1996. The purpose of
the Incentive Plan is to (i) align the personal financial incentives of the
employees and consultants of the Company ("Consultants") and its subsidiaries
(collectively, the "Participants") with the long-term growth of the Company
and the interests of the Company's stockholders through the ownership and
performance of the Company's Common Stock and (ii) enhance the ability of the
Company and its subsidiaries to attract and retain employees and Consultants who
share primary responsibility for the Company's management and growth. All
Participants, including officers (whether or not directors) of the Company and
its subsidiaries are currently eligible to participate in the Incentive Plan.
Persons who are not in an employment or consulting relationship with the Company
or any of its subsidiaries, including non-employee directors, are not eligible
to participate in the Incentive Plan.

The Incentive Plan provides for the grant of (i) stock options, including
incentive stock options and non-qualified stock options, (ii) shares of
restricted stock, (iii) performance awards payable in cash or Common Stock, (iv)
shares of phantom stock, (v) stock bonuses, and (vi) cash bonuses (collectively,
the "Incentive Awards"). Under the Incentive Plan, the Company may grant
Incentive Awards with respect to a number of shares of Common Stock of up to
230,000 shares. All employees, including officers (whether or not they are
directors), of the Company and its subsidiaries are eligible to participate in
the Incentive Plan. As of May 15, 1997, 160,000 stock options had been granted
under the Incentive Plan. See Note 12 to the Company's "Consolidated Financial
Statements."

The Incentive Plan is administered by the Compensation Committee of the
Board, whose members will consist of Messrs. Withers and Richards upon the
completion of the Offering. The Compensation Committee determines which
Participants receive grants of Incentive Awards, the type of Incentive Awards
and bonuses granted and the number of shares subject to each Incentive Award;
provided, however, that the maximum number of shares of Common Stock subject to
Incentive Awards that can be issued to any one individual during any calendar
year is 50,000 shares.

The Incentive Plan provides for proportionate adjustments in the number of
shares of Common Stock available for grants thereunder, and the number of shares
and exercise prices of outstanding options for subdivisions or a consolidations
of, or stock dividends on, Common Stock effected by the Company without the
receipt of consideration. Subject to the terms of the Incentive Plan, the
Compensation Committee also determines the prices, expiration dates and other
material features of the Incentive Awards granted under the Incentive Plan. The
Compensation Committee has the authority to interpret and construe any provision
of the Incentive Plan and to adopt such rules and regulations for administering
the Incentive Plan as it deems necessary. All decisions and determinations of
the Compensation Committee are final and binding on all parties. The Company
indemnifies each member of the Compensation Committee against any cost, expenses
or liability arising out of any action, omission or determination relating to
the Incentive Plan, unless such action, omission or determination was taken or
made in bad faith and without reasonable belief that it was in the best interest
of the Company.

The exercise price of each stock option (singularly, "Option" and
collectively, "Options") granted under the Incentive Plan is determined by the
Compensation Committee, but such price may not be less than the fair market
value (as defined) of a share of Common Stock of the Company on the date on
which such Option is granted. Each Option is exercisable for a period not to
exceed ten years and no Option is

47
<PAGE>
exercisable until six months after the date of grant. For each Option, the
Compensation Committee establishes (i) the term of each Option and (ii) the time
or period of time in which the Option will vest. The exercise price will be paid
in cash or, subject to the approval of the Compensation Committee, (i) in shares
of Common Stock valued at their fair market value (as defined) on the date of
exercise, (ii) through a cashless exercise (as defined), or (iii) in a
combination of the foregoing.

A grant of shares of restricted stock represents the promise of the Company
to issue shares of Common Stock of the Company on a predetermined date (the
"Issue Date") to a Participant, provided the Participant is continuously
employed by the Company until the Issue Date. Vesting of the shares occurs on a
second predetermined date (the "Vesting Date"), if the Participant has been
continuously employed by the Company until that date. Prior to the Vesting Date,
the shares are not transferable by the Participant and are subject to a
substantial risk of forfeiture. The Compensation Committee may, at the time
shares of restricted stock are granted, impose additional conditions to the
vesting of the shares, such as, for example, the achievement of specified
performance goals. Vesting of some portion, or all, of the shares of restricted
stock may occur on the termination of the employment of a Participant, other
than for cause (as defined), prior to the Vesting Date. If vesting does not
occur, shares of restricted stock are forfeited.

A performance award is an award granted to a Participant contingent upon
the future performance of the Company or any subsidiary, division or department
thereof over a specified performance period. The Compensation Committee will
establish the relevant performance criteria, subject to adjustment to reflect
unforeseen events or changes. Each performance award will be subject to a
maximum value at the time of grant of such award.

A share of phantom stock represents the right to receive the economic
equivalent of a grant of restricted stock. Shares of phantom stock are subject
to the same vesting requirements as are shares of restricted stock. On vesting
of a share of phantom stock, the holder is entitled to receive cash in an amount
equal to the sum of (i) the fair market value (as defined) of a share of Common
Stock as determined on the vesting date and (ii) the aggregate amount of cash
dividends paid in respect of a share of Common Stock during the period
commencing on the date of grant and ending on the vesting date.

Bonuses payable in stock may be granted by the Compensation Committee and
may be payable at such times and subject to such conditions as the Compensation
Committee determines.

1997 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN

The Director Plan provides for the grant to non-employee: (i) Existing
Directors (as defined) on the Effective Date (as defined) to purchase 5,000
shares of Common Stock and (ii) New Directors (as defined) on their initial
election of a non-qualified stock option ("NQO") to purchase 15,000 shares of
Common Stock on the Effective Date (as defined) at an exercise price equal to
the fair market value of the Common Stock on the date of grant. The Director
Plan also entitles each non-employee director to receive an NQO to purchase
5,000 shares of Common Stock on each date he is reelected to the Company's
Board. As of May 15, 1997, 5,000 NQOs had been awarded under the Director Plan.

The Compensation Committee has no discretion as to the selection of the
non-employee directors to whom NQOs are to be granted or Cash Fee Awards (as
defined) paid, the number of shares subject to any NQO granted, the exercise
price of any NQO granted or the ten-year maximum term of any NQO granted
thereunder. The Compensation Committee has the authority to interpret and
construe any provision of the Director Plan and to adopt such rules and
regulations for administering the Director Plan as it deems necessary. All
decisions and determinations of the Compensation Committee are final and binding
on all parties. The Company has agreed to indemnify each member of the
Compensation Committee against any cost, expense or liability arising out of any
action, omission or determination relating to the Director Plan, unless such
action, omission or determination relating to the Director Plan, unless such
action, omission or determination was taken or made in bad faith and without
reasonable belief that it was in the nest interest of the Company.

48
<PAGE>
outstanding shares of Common Stock and any merger, consolidation,
recapitalization of the Company or other similar event which affects the issued
and outstanding shares of Common Stock.

CERTAIN TRANSACTIONS

The Company has obtained financing from certain former officers and
directors and affiliates of the Company for the acquisition and construction of
pipelines. This financing enabled the Company to take advantage of pipeline
acquisition opportunities that would have otherwise been unavailable to the
Company because no other source or no less costly source of financing may have
been available to the Company at the time such opportunities arose. It is
management's belief that under such circumstances these transactions with
affiliates were fair and equitable to the Company. Prior to the Company's Common
Stock offering in August 1996, all indebtedness to non-affiliated third parties
had been personally guaranteed by Dan C. Tutcher, Stevens G. Herbst, and Kenneth
B. Holmes, Jr., the Company's three largest stockholders. The Company does not
presently intend to obtain financing, security or guarantees for financing from
affiliates in the future. No future transaction will be entered into between the
Company and members of management or affiliates without the approval of the
disinterested outside members of the Board. Set forth below are descriptions of
such transactions:

COOK INLET PIPELINE. In April 1994, Texline, a Texas corporation owned by
two former officers and directors of the Company and Rainbow, provided
approximately $1,000,000 in certificates of deposit and U. S. Treasury Bills as
security for obtaining the long-term bank financing for the Company's investment
in the Cook Inlet systems (the "Alaska Loan"). This collateral was outstanding
for a period of approximately eight months at which point the Company replaced
the Alaska Loan with another commercial lender and the collateral was released.
In consideration for providing such security, the Company assigned a 3% and a 2%
net revenue interest to Texline and Rainbow, respectively, on the net income
derived from the Company's investment in the Cook Inlet systems in Alaska.
However, the net revenue interest applies only after all costs associated with
the investment have been recouped by the Company. As a result, no amounts have
been paid under the assignment of the net revenue interests.

PROJECT REFINANCING. In December 1994, Texline provided a $275,000
unsecured loan (as amended, the "Texline Note") to the Company, which bore
interest at the Mercantile Bank, N.A. -- Corpus Christi prime rate plus 1.5%.
Interest was payable monthly and principal and remaining accrued interest were
due in full at maturity on April 1, 1997. The proceeds of the loan were used for
general corporate purposes including the repayment of other indebtedness.
Principal of $75,000 was repaid in November 1995 with the remaining $200,000
repaid in August 1996 with proceeds from the Common Stock offering. Cash
payments totaling $39,106 were made for interest during the term of the loan.

EXXON PRODUCTION ACQUISITION. In May 1995, Texline provided a $173,822
loan to partially finance the acquisition of a 23% working interest in oil and
gas production from two leases located in Starr County, Texas. The loan, as
amended in March 1996, bore interest at the Mercantile Bank N.A. -- Corpus
Christi prime rate plus 1% and matured on April 1, 1997. However, the loan was
repaid in full in July 1996 with cash generated from operations. Cash payments
of interest amounting to $3,346 and $18,124 were made during 1995 and 1996,
respectively. No collateral was required to obtain this loan, although, as
additional consideration for obtaining the loan, Texline was assigned a .5%
working interest in the oil and gas properties.

FIVE FLAGS SYSTEM. In September 1995, the Company and Rainbow jointly
acquired 100% of the outstanding capital stock of Five Flags from Five Flags
Holding Company. Total cash consideration of $2,052,000 was paid for the stock,
of which the Company's share was $1,872,450 representing 91.25% of Five Flags'
capital stock and Rainbow's share was $179,550 for 8.75% of Five Flags' capital
stock. This transaction was financed by Stevens G. Herbst, a former officer and
director of the Company. A promissory note in the amount of $1,872,450 was
issued by the Company in favor of Mr. Herbst (the "Herbst Note") which
provided for monthly payments of interest beginning April 1, 1996 through
December 31, 1996, at which time both principal and all accrued interest would
be due in full. Interest on the Herbst Note accrued at the prime rate plus 2%.
Shortly after acquiring Five Flags' capital stock, the Company and Rainbow sold
100% of the capital stock of Five Flags to Koch Gateway Pipeline Company for
$4,664,865. A portion of the proceeds from the sale were used to repay the
Herbst Note in October 1995 including accrued interest of

49
<PAGE>
approximately $10,500, with the remainder of the proceeds used to repay certain
other notes associated with the acquisition of the Magnolia System.

MAGNOLIA SYSTEM PIPELINE ACQUISITION. In connection with the acquisition
of the Magnolia System in October 1995, the Company borrowed $1,200,000 from
Rainbow (the "Rainbow Note"). These funds were used in conjunction with the
remainder of the sale proceeds of Five Flags to fully retire a $500,000
debenture and a $2,700,000 note due to the seller of the Magnolia System. The
Rainbow Note called for interest to be accrued at the prime rate plus 5% and was
due monthly beginning April 1, 1996. The Rainbow Note provided for a maturity
date of January 31, 1997, however, upon the entry into a new bank credit
facility by the Company in December 1995, the Rainbow Note plus accrued interest
of $35,260 was repaid in full.

As additional consideration for extending the Rainbow Note, Midcoast
granted Rainbow a 5% net revenue interest in the Magnolia System's earnings
before interest, income taxes and depreciation to be paid on a monthly basis.
The net revenue interest, as amended in May 1996, applied only after the
Magnolia System's acquisition cost had been recouped by the Company. No amounts
related to the Magnolia System's earnings were paid under the assignment of the
net revenue interest. The Company had the right to repurchase this net revenue
interest for a cash payment of $25,000, with such amount increased an additional
$25,000 on November 1, 1995 and each following month up to a maximum of
$500,000. In July 1996, the Company exercised it's right to repurchase the net
revenue interest for cash consideration of $250,000.

ADDITIONAL WORKING CAPITAL. Rainbow also loaned the Company a total of
$660,000 in December 1995 for general corporate purposes pursuant to an
unsecured promissory note accruing interest at the prime rate plus 5%. All
amounts under this note were due and payable on January 1, 1997. On January 12,
1996 the Company repaid all principal amounts due under the note to Rainbow as
well as accrued interest in the amount of $4,039. The proceeds of such
indebtedness were used by the Company for general corporate purposes including
the repayment of indebtedness.

SEAHAWK ACQUISITION. In connection with the acquisition of certain
pipeline systems in March 1996, the Company borrowed $100,000 from Rainbow for
its equity contribution to Pan Grande pursuant to a promissory note between the
Company and Rainbow (as amended, the "Seahawk Note"). The Seahawk Note bore
interest at the prime rate plus 2.5% and was payable in 59 monthly installments
of $1,667 plus accrued interest and a final installment at March 15, 2001 in the
amount of the remaining principal and accrued interest. The Seahawk Note was
secured by the Company's interest in Pan Grande. Rainbow also committed to lend
up to an additional $75,000 in the event an additional system was purchased by
Pan Grande. In consideration for the financing of the equity contribution and
the commitment for additional financing, the Company issued Rainbow 4,460 shares
of the Company's Common Stock. The Seahawk Note plus accrued interest of $4,896
was repaid in full in August 1996 with proceeds from the Company's Common Stock
offering.

REDEMPTION OF 5% CUMULATIVE PREFERRED STOCK. In May 1996, the Board
approved the redemption of the 5% cumulative preferred stock ("5% Preferred")
for $118,366 held by Magic (Dan Tutcher is the beneficial owner of such shares),
Stevens G. Herbst and Kenneth B. Holmes, Jr. The shares were redeemed for 10% of
the stated liquidation value ($1,183,665). As a result of the redemption of the
5% Preferred by the Company, Magic, Mr. Herbst and Mr. Holmes were paid $59,182,
$29,592, and $29,592 for the redemption of 100,000, 50,000 and 50,000 shares,
respectively.

50
<PAGE>
PRINCIPAL STOCKHOLDERS

The following table sets forth information based upon the records of the
Company and filings with the SEC as of April 16, 1997 (including shares that may
be acquired pursuant to outstanding stock options within 60 days of such date),
with respect to (i) each person known to be the beneficial owner of more than 5%
of the Company's Common Stock, (ii) each executive officer and director of the
Company, and (iii) all directors and executive officers as a group, and (iv) the
Selling Stockholder.

<TABLE>
<CAPTION>
PERCENTAGE OF
OUTSTANDING OWNED (1)
AMOUNT AND NATURE OF ---------------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER (2) BENEFICIAL OWNERSHIP (3) BEFORE OFFERING AFTER OFFERING
- ---------------------------------------- ------------------------ --------------- --------------
<S> <C> <C> <C>
Magic Gas Corp.(4)...................... 611,240 24.5% 13.6%
Stevens G. Herbst (5)(6)................ 285,902 11.4% 6.4%
710 Buffalo, Suite 800
Corpus Christi, Texas 78401
Kenneth B. Holmes, Jr. (5)(7)........... 283,195 11.3% 4.1%
710 Buffalo, Suite 800
Corpus Christi, Texas 78401
Wellington Management Co., LLP (8)...... 219,100 8.8% 4.9%
75 State Street
Boston, Massachusetts 02109
Kennedy Capital Management, Inc......... 161,950 6.5% 3.6%
10829 Olive Blvd.
St. Louis, Missouri 63141
Dan C. Tutcher (9)...................... 611,440 24.5% 13.6%
I. J. Berthelot, II (10)................ 78,066 3.1% 1.7%
Richard A. Robert (11).................. 22,304 * *
Duane S. Herbst (12).................... 11,152 * *
710 Buffalo, Suite 800
Corpus Christi, Texas 78401
Richard N. Richards (13)................ 2,507 * *
All Directors and Executive
Officers as a group (5 persons)....... 725,469 29.0% 16.1%
</TABLE>
- ------------

* Denotes less than 1%.

(1) Assumes no exercise of Underwriters' over-allotment option.

(2) Unless otherwise indicated, the address of each person listed below is 1100
Louisiana, Suite 2950, Houston, Texas 77002.

(3) Except as otherwise noted, shares beneficially owned by each person as of
the record date were owned of record and each person had sole voting and
investment power with respect to all shares beneficially held by such
person.

(4) All of the outstanding stock of Magic is owned by Dan C. Tutcher, his wife
and a trust established for the benefit of their children.

(5) Stevens G. Herbst and Kenneth B. Holmes, Jr. are parties to an irrevocable
five-year voting proxy agreement dated August 5, 1996 pursuant to which all
voting power of such shares owned of record and beneficially by Messrs.
Herbst and Holmes will be voted by the trust department of a banking
institution. See " -- Voting Proxy Agreement."

(6) Includes 4,460 shares held of record by Rainbow which is controlled by
Stevens G. Herbst.

(7) See "Selling Stockholder."

(8) On January 24, 1997, Wellington Management Company LLP filed a Schedule 13G
on behalf of itself and Wellington Trust Company, NA ("Wellington
Trust"), a wholly-owned subsidiary, denoting beneficial ownership of the
shares shown above. On January 27, 1997, Wellington Trust filed a Schedule
13G denoting beneficial ownership of 144,100 shares of the Company's Common
Stock.

(FOOTNOTES CONTINUED ON FOLLOWING PAGE)

51
<PAGE>
(9) Includes 611,240 shares of Common Stock held of record by Magic, an
affiliate of Mr. Tutcher, and 200 shares held as custodian for minor
children under the Uniform Gift to Minors Act.

(10) Includes 4,461 shares subject to certain vesting requirements and 1,338
shares which Mr. Berthelot holds as custodian for minor children under the
Uniform Gift to Minors Act.

(11) Includes 10,409 shares subject to certain vesting requirements.

(12) Includes 2,676 shares subject to certain vesting requirements.

(13) Mr. Richards was issued a stock grant of 2,007 shares on July 1, 1996. See
"Management -- Directors Compensation and Board Committees."

VOTING PROXY AGREEMENT

In July 1996, Stevens G. Herbst, Kenneth B. Holmes, Jr. and the Company
entered into an irrevocable five-year voting proxy agreement. Pursuant to the
voting proxy agreement, all shares owned of record and beneficially by Messrs.
Herbst and Holmes will be voted by the trust department of a banking
institution. Pursuant to this agreement, the appointed proxy holder is empowered
and authorized to represent Messrs. Herbst and Holmes and to vote their shares
in the same proportion as all other shares of Common Stock are voted which are
held of record and beneficially by stockholders who are not officers, directors,
or Affiliates (as defined) of the Company. Messrs. Herbst and Holmes have
retained the power to receive dividends and sell their shares.

SELLING STOCKHOLDER

The following table sets forth certain information concerning the
beneficial ownership of Common Stock by the Selling Stockholder as of May 15,
1997 and as adjusted to reflect the sale of 100,000 shares of Common Stock by
the Selling Stockholder.

<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP
BEFORE THE OFFERING (1) AFTER THE OFFERING (2)
----------------------- SHARES OF -----------------------
SHARES OF COMMON STOCK SHARES OF
NAME AND ADDRESS COMMON STOCK PERCENT TO BE SOLD COMMON STOCK PERCENT
- ---------------------------------------- ------------ ------- ------------ ------------ -------
<S> <C> <C> <C> <C> <C>
Kenneth B. Holmes, Jr.(1)............... 283,195 11.3% 100,000 183,195 4.1%
710 Buffalo, Suite 800
Corpus Christi, Texas 78401
</TABLE>
- ------------

(1) Mr. Holmes was Vice President and director of the Company since its
incorporation in 1992 until 1996 and Treasurer from the same period until
1995. In 1985, Mr. Holmes formed Texline jointly with Mr. Stevens G. Herbst
where he currently serves as Vice President. See "Management -- Certain
Transactions."

(2) Assumes no exercise of Underwriters' over-allotment option.

52
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of the Offering, the Company will have 4,500,000 shares of
Common Stock outstanding (4,815,000 shares if the Underwriters' over-allotment
option is exercised in full). The 2,100,000 shares sold in this Offering
(2,415,000 shares if the Underwriters' over-allotment option is exercised in
full) will be freely transferable without restriction or registration under the
Securities Act, unless purchased by persons deemed to be "affiliates" of the
Company (as that term is defined under the Securities Act). Substantially all of
the remaining 2,500,000 shares of Common Stock outstanding immediately following
the Offering will be transferable without restriction or registration under the
Securities Act, except for approximately 1,200,000 shares persons deemed to be
affiliates of the Company (as that term is defined under the Securities Act)
which will be subject to the volume restrictions under Rule 144. No shares of
Common Stock are subject to registration rights in connection with the Offering.
The Company has previously granted to certain holders of Common Stock demand
registration rights under the Securities Act with respect to the 100,000 shares
of Common Stock underlying the Warrants.

In general, under Rule 144, as recently amended, a person (or persons whose
shares are aggregated) including an affiliate, who has beneficially owned his
shares for one year, may sell in the open market within any three-month period a
number of shares that does not exceed the greater of (i) 1% of the then
outstanding shares of the Company's Common Stock (approximately 45,000 shares
immediately after this Offering, or 48,150 if the Underwriters' over-allotment
option is exercised in full) or (ii) the average weekly trading volume in the
Common Stock on the AMEX during the four calendar weeks preceding such sale.
Sales under Rule 144 are also subject to certain limitations on the manner of
sale, notice requirements and availability of current public information about
the Company. A person (or persons whose shares are aggregated) who is deemed not
to have been an "affiliate" of the Company at any time during the 90 days
preceding a sale by such person and who has beneficially owned his shares for at
least two years, will be able to sell such shares in the public market under
Rule 144(k) without regard to the volume limitations, manner of sale provisions,
notice requirements or availability of current information referred to above.
Restricted shares properly sold in reliance upon Rule 144 are thereafter freely
tradeable without restrictions or registration under the Securities Act, unless
thereafter held by an "affiliate" of the Company.

The Company has reserved an aggregate of 280,000 shares of Common Stock for
issuance pursuant to the Incentive Plan and the Director Plan. Options to
purchase 160,000 shares of Common Stock, which are not exercisable until August
1997, have been issued under the Incentive Plan at exercise prices ranging from
$10.50 to $11.55 per share, the fair market value on the date of grant as
determined by the Company's Board. The Company intends to register eligible
shares of Common Stock issuable upon the exercise of options under the Incentive
Plan and the Director Plan pursuant to a Registration Statement on Form S-8
following the Offering. Subject to restrictions imposed pursuant to the
Incentive Plan and the Director Plan, such eligible shares of Common Stock
issued pursuant to the Incentive Plan and the Director Plan after the effective
date of such Registration Statement on Form S-8 will be available for sale in
the public market without restriction to the extent they are held by persons who
are not affiliates of the Company, and by affiliates pursuant to Rule 144. See
"Management -- 1996 Incentive Stock Plan" and "Management -- 1997
Non-Employee Director Plan."

The Company, the Selling Stockholder, the Company's executive officers and
directors and certain stockholders of the Company who collectively own an
aggregate of 1,382,606 shares of Common Stock have agreed that they will not,
directly or indirectly, offer, sell, contract to sell, make a short sale, pledge
or otherwise dispose of any shares of Common Stock (or any securities
convertible into or exchangeable or exercisable for any other rights to purchase
or acquire Common Stock) for a period of 180 days after the date of this
Prospectus, without the prior written consent of the Representatives, other than
(i) in the case of the Company and the Selling Stockholder, for sales of Common
Stock to the Underwriters pursuant to the Underwriting Agreement and (ii) in the
case of the Company, for (a) the issuance of shares of Common Stock upon the
exercise of options granted pursuant to the Incentive Plan or Director Plan
prior to the date hereof, (b) subject to certain limitations, the grant of
options, restricted shares, performance awards payable in Common Stock or stock
bonuses issued or granted pursuant to the Incentive Plan or Director Plan, (c)
the issuance of shares upon the exercise of warrants described in this
Prospectus and (d) acquisitions of businesses; provided, the Company shall
obtain the agreement from persons receiving shares pursuant to (a), (b) and (d)
that such persons will not, for a period of 180 days following the date of this
Prospectus, make any such disposition without the prior written consent of the
Representatives.

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<PAGE>
In addition, the Company has agreed that for a period of 180 days following the
date of this Prospectus it will not, without the prior written consent of the
Representatives, register with the Commission any shares of Common Stock or any
other equity securities of the Company except for the shares of Common Stock
offered hereby, the issuance of shares of Common Stock upon exercise of stock
options previously authorized by the Company under the Incentive Plan and
Director Plan or shares to be issued in connection with an acquisition of a
business, which shares shall be restricted in the manner set forth above.

After the 180 day period, the shares of Common Stock subject to the sale
restriction will be eligible for sale in the public market pursuant to Rule 144
under the Securities Act, subject to the volume limitations and other
restrictions contained in Rule 144. The 2,100,000 shares of Common Stock sold in
the Offering (2,415,000 shares if the Underwriters' over-allotment option is
exercised in full) will be freely transferable without restriction or
registration under the Securities Act, unless purchased by persons deemed to be
affiliates of the Company (as that term is defined under the Securities Act).

DESCRIPTION OF CAPITAL STOCK

GENERAL

The authorized capital stock of the Company consists of 10,000,000 shares
of Common Stock, $.01 par value. As of May 15, 1997, the Company had outstanding
2,500,000 shares of Common Stock. The following summary description of the
Company's capital stock is not intended to be complete and is subject to, and is
qualified in its entirety by reference to, the Company's Articles of
Incorporation (the "Articles"), as amended, and the Company's bylaws
("Bylaws"), copies of which are filed as exhibits to the Registration
Statement of which this Prospectus forms a part.

COMMON STOCK

Holders of Common Stock are entitled to one vote per share on all matters
submitted to a vote of the stockholders of the Company. Except as may be
required by applicable law, holders of Common Stock will not vote separately as
a class, but will vote together with the holders of outstanding shares of other
classes of capital stock. A majority of the issued and outstanding Common Stock
constitutes a quorum at any meeting of stockholders and the vote by the holders
of a majority of the outstanding shares is required to effect certain
fundamental corporate changes such as liquidation, merger or amendment of the
Articles.

Holders of shares of Common Stock are entitled to receive dividends, if,
as, and when declared by the Board out of funds legally available therefore.
Upon liquidation of the Company, holders of shares of Common Stock are entitled
to share ratably in all assets of the Company remaining after payment of
liabilities. Holders of shares of Common Stock have no preemptive rights or
other rights to subscribe for unissued or treasury shares or securities
convertible into shares. The outstanding shares of Common Stock are fully paid
and nonassessable.

OUTSTANDING WARRANTS

WARRANTS. The Company issued the Triumph Warrant to purchase 34,349 shares
of Common Stock at $7.85 per share that expire in February 1999 in consideration
for services which have been and will continue to be provided by a consultant in
connection with the conventional, commercial financing or sale/leaseback of
certain Magnolia System assets. The Triumph Warrants are the subject of 18 month
lockup agreement commencing August 1996, and have certain piggyback registration
rights and standard antidilution protections.

Warrants to acquire 100,000 shares of Common Stock at a price of $14.20 per
share commencing in August 1998 were also outstanding at May 15, 1997. These
Warrants expire in August 2001. The Warrants were issued in the Company's 1996
public offering and are registered under the Securities Act, however, the shares
of Common Stock underlying such warrants have not been registered under the
Securities Act. In connection with the issuance of the Warrants, the warrant
holders were granted certain demand and piggyback registration rights and have
standard antidilution protection.

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<PAGE>
CERTAIN CORPORATE GOVERNANCE PROVISIONS

LIMITATION ON DIRECTOR LIABILITY. As permitted by Private Corporations
Section 78.037 of the General Corporation Law of Nevada (the "NGCL"), the
Company's Articles eliminate the personal liability of its directors and
officers to the Company and its stockholders for damages for breach of fiduciary
duty, except for (i) acts or omissions which involve intentional misconduct,
fraud of a knowing violation of law, or (ii) the payment of dividends in
violation of the NGCL. To the extent that this provision limits the remedies of
the Company and its stockholders to equitable remedies it might reduce the
likelihood of derivative litigation and discourage the Company's management or
stockholders from initiating litigation against its directors or officers for
breach of their fiduciary duties. Additionally, equitable remedies may not be
effective in many situations. If a stockholder's only remedy is to enjoin the
completion of an action, such remedy would be ineffective if the stockholder
does not become aware of a transaction or event until after it has been
completed. In such a situation, it is possible that the Company and its
stockholders would have no effective remedy against the directors and officers.

INDEMNIFICATION. To the maximum extent permitted by law, the Articles
provide for mandatory indemnification of directors and officers of the Company
against all expenses, liabilities and losses to which they may become subject or
which they may incur as a result of being or having been a director or officer
of the Company. The Company may also indemnify any employee or agent of the
Company to the fullest extent permitted by law. In addition, the Company must
advance or reimburse directors and officers and may advance or reimburse
employees and agents for expenses incurred by them in connection with
indemnifiable claims. Under such provisions, any director or officer, who in his
capacity as such, is made or threatened to be made, a party to any suit or
proceeding, may be indemnified if the Board determines such director or officer
acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interest of the Company. The Company's Articles and Bylaws,
and the NGCL, further provide that such indemnification is not exclusive of any
other rights to which such individuals may be entitled under the Articles,
Bylaws, any agreement, vote of stockholders or disinterested directors or
otherwise.

Pursuant to certain indemnity agreements executed by each current director
and executive officer, the Company also must indemnify, defend and hold harmless
its directors and officers from and against any loss, liability or claim arising
out of or relating to their capacities as such. There is in effect for the
Company an insurance policy providing directors and officers with
indemnification, subject to certain exclusions and to the extent not otherwise
indemnified by the Company, against loss (including expenses incurred in the
defense of actions, suits or proceedings in connection therewith) arising from
any negligent act, error, omission or breach of duty while acting in their
capacity as directors and officers of the Company. The policy also reimburses
the Company for liability incurred in the indemnification of its directors and
officers.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the Company's Common Stock is American
Stock Transfer & Trust Company, which is also the transfer agent, registrar and
dividend disbursing agent for the Common Stock.

55
<PAGE>
UNDERWRITING

Subject to the terms and conditions set forth in the underwriting agreement
(the "Underwriting Agreement") by and among the Company, the Selling
Stockholder, and each of the underwriters named below (the "Underwriters"),
the Company and the Selling Stockholder have agreed to sell to each of the
Underwriters, and each of the Underwriters, for whom Oppenheimer & Co., Inc.,
A.G. Edwards & Sons, Inc. and Coleman and Company Securities, Inc. are acting as
representatives (the "Representatives") have severally agreed to purchase from
the Company and the Selling Stockholder, the aggregate number of shares of the
Company's Common Stock set forth opposite their respective names below:

NUMBER OF
UNDERWRITERS SHARES
- ---------------------------------------- ---------
Oppenheimer & Co., Inc. ................ 725,000
A.G. Edwards & Sons, Inc. .............. 725,000
Coleman and Company Securities, Inc. ... 150,000
George K. Baum & Company................ 50,000
Donald & Co. Securities, Inc............ 50,000
Jefferies & Company..................... 50,000
Mesirow Financial, Inc.................. 50,000
Nolan Securities Corp................... 50,000
Petrie Parkman & Co..................... 50,000
Rauscher Pierce Refsnes, Inc............ 50,000
Raymond James & Associates, Inc......... 50,000
Stephens Inc............................ 50,000
Van Kasper & Company.................... 50,000
---------
Total.............................. 2,100,000
=========

The Underwriting Agreement provides that the obligations of the several
Underwriters thereunder are subject to approval of certain legal matters by
counsel and to various other conditions. The nature of the Underwriters'
obligations is such that they are committed to purchase all of the above shares
of Common Stock if any are purchased.

The Underwriters propose to offer the shares of Common Stock directly to
the public initially at the public offering price set forth on the cover page of
this Prospectus and to certain dealers at such price less a concession not in
excess of $.52 per share of Common Stock. The Underwriters may allow, and such
dealers may reallow, a concession not in excess of $.10 per share of Common
Stock on sales to certain other dealers. After the Offering, the public offering
price, concession and other selling terms may be changed by the Representatives.

The Company has granted to the Underwriter a 30-day over-allotment option
to purchase up to an aggregate of 315,000 additional shares of Common Stock,
exercisable at the public offering price, less the underwriting discount. If the
Underwriters exercise such over-allotment option, each of the Underwriters will
have a firm commitment, subject to certain conditions, to purchase approximately
the same percentage thereof as the number of shares of Common Stock to be
purchased by it as shown in the above table bears to the shares of Common Stock
offered hereby. The Company will be obligated, pursuant to the over-allotment
option, to sell such shares to the Underwriters to the extent such
over-allotment is exercised. The Underwriters may exercise such option only to
cover over-allotments made in connection with the sale of the shares of Common
Stock offered hereby.

The Representatives, on behalf of the Underwriters, may engage in
over-allotment, stabilizing transactions, syndicate covering transactions and
penalty bids in accordance with Regulation M under the Exchange Act.
Over-allotment involves syndicate sales in excess of the offering size, which
creates a syndicate short position. Stabilizing transactions permit bids to
purchase the underlying security so long as the stabilizing bids do not exceed a
specified maximum. Syndicate covering transactions involve purchases of the
Common Stock in the open market after the distribution has been completed in
order to cover syndicate short positions. Penalty bids permit the
Representatives to reclaim a selling concession from a syndicate member when the
Common Stock originally sold by such syndicate member is purchased in a
syndicate covering transaction to cover syndicate short positions. Such
stabilizing transactions, syndicate covering transactions, penalty bids and
passive market making may cause the price of the Common Stock to be higher than
it would otherwise be in the absence of such transactions. These transactions
may be effected on the AMEX or otherwise and, if commenced, may be discontinued
at any time.

56
<PAGE>
The Company, the Selling Stockholder, the Company's directors and executive
officers and certain stockholders of the Company who collectively own an
aggregate of approximately 1,284,000 shares of Common Stock have agreed that
they will not, directly or indirectly, offer, sell, contract to sell, make a
short sale, pledge or otherwise dispose of any shares of Common Stock (or any
securities convertible into or exchangeable or exercisable for any other rights
to purchase or acquire Common Stock) for a period of 180 days following the date
of this Prospectus, without the prior written consent of the Representatives,
other than (i) in the case of the Company and the Selling Stockholder, for sales
of Common Stock to the Underwriters pursuant to the Underwriting Agreement and
(ii) in the case of the Company, for (a) the issuance of shares of Common Stock
upon the exercise of options granted pursuant to the Incentive Plan or Director
Plan prior to the date hereof, (b) subject to certain limitations, the grant of
options, restricted shares, performance awards payable in Common Stock or stock
bonuses issued or granted pursuant to the Incentive Plan or Director Plan, (c)
the issuance of shares upon the exercise of warrants described in this
Prospectus and (d) acquisitions of businesses; provided, the Company shall
obtain the agreement from persons receiving shares pursuant to (a), (b) and (d)
that such persons will not, for a period of 180 days following the date of this
Prospectus, make any such disposition without the prior written consent of the
Representatives. In addition, the Company has agreed that for a period of 180
days following the date of this Prospectus it will not, without the prior
written consent of the Representatives, register with the Commission any shares
of Common Stock or any other equity securities of the Company except for the
shares of Common Stock offered hereby, the issuance of shares of Common Stock
upon exercise of stock options previously authorized by the Company under the
Incentive Plan and Director Plan or shares to be issued in connection with an
acquisition of a business, which shares shall be restricted in the manner set
forth above.

The Company and the Selling Stockholder have agreed to indemnify the
Underwriters against certain liabilities, losses and expenses, including
liabilities under the Securities Act, or to contribute to payments that the
Underwriters may be required to make in respect thereof. The Company has agreed
in turn to indemnify the Selling Stockholder against certain of these same
liabilities.

In connection with the Company's offering in August 1996, the Company
agreed to permit Coleman and Company Securities, Inc. ("Coleman") to have an
observer attend the meetings of the Company's Board for a period of three years
from August 1996 and agreed to pay the representative of Coleman up to a maximum
of $18,966 for such services during such three-year period, payable at the rate
of $1,583 per meeting with a limit of payment for four meetings per year. In
connection with the Company's offering in August 1996, the Company also entered
into an arrangement with Coleman pursuant to which Coleman was entitled to
receive an investment banking advisory fee of $3,000 per month for 24 months. In
May 1997, the Company paid the representative of Coleman and Coleman $14,217 and
$45,000, respectively, as satisfaction for the release of the Company's and
Coleman's obligations.

LEGAL MATTERS

The validity of the issuance of the Common Stock offered hereby has been
passed on for the Company by Porter & Hedges, L.L.P., Houston, Texas. Certain
legal matters related to this Offering will be passed on for the Underwriters by
Andrews & Kurth L.L.P., Houston, Texas.

EXPERTS

The consolidated financial statements of the Company as of December 31,
1996 and 1995 and for each of the three years in the period ended December 31,
1996 included in this Prospectus, have been audited by Hein + Associates LLP,
certified public accountants, as set forth in their report and is included
herein in reliance upon the authority of said firm as experts in accounting and
auditing.

The combined financial statements of the AlaTenn Subsidiaries as of
December 31, 1996 and 1995 and for the three years in the period ended December
31, 1996, included in this Prospectus, have been audited by Hein + Associates
LLP, certified public accountants, as set forth in their report and is included
herein in reliance upon the authority of said firm as experts in accounting and
auditing.

The historical summary of revenue and direct operating expenses of the KOCH
Hydrocarbons Company -- Harmony Gas Processing Plant for the year ended December
31, 1995, included in this Prospectus, has been audited by Hein + Associates
LLP, certified public accountants, as set forth in their report and is included
herein in reliance upon the authority of said firm as experts in accounting and
auditing.

57
<PAGE>
GLOSSARY

Certain terms used in this Prospectus have the meanings set forth below:

"AMEX" means the American Stock Exchange, Inc.

"BARREL OR BBL" means one stock tank barrel, or 42 U.S. gallons liquid
volume, and represents the basis unit for measuring crude oil or other liquid
hydrocarbons.

"BYPASS PIPELINE" means a pipeline built to provide an end-user of
quantities of natural gas, typically a chemical or manufacturing plant, an
alternative natural gas supply source to that offered by the local distribution
company or "LDC" by connecting the end-user to major pipelines, thus by
passing the LDC.

"EBITDA" represents the net income of the Company before income taxes,
net interest expense, depreciation, depletion and amortization and other noncash
items reducing net income. EBITDA is not a measure of financial performance
under GAAP and may not be comparable to other similarly titled measures by other
companies. Accordingly, it does not represent net income or cash flows from
operations as defined by GAAP and does not necessarily indicate that cash flows
will be sufficient to fund cash needs. As a result, EBITDA should not be
considered an alternative to net income as an indicator of operating performance
or to cash flows as a measure of liquidity. The Company incurs significant
capital expenditures and incurs debt, primarily related to acquisitions, which
are not reflected in EBITDA. As such, the Company has provided above cash flows
from operating, investing and financing activities, and capital expenditures
which reflect these transactions. The Company has included information
concerning EBITDA as it understands that it is used by certain investors as one
measure of an issuer's historical ability to service its debt.

"GROSS ACRE" means an acre in which a working interest is owned.

"MCF" means thousand cubic feet of natural gas expressed, where gas sales
contracts are in effect, in terms of contractual temperature and pressure bases
and, where contracts are nonexistent, at 60 degrees Fahrenheit and 14.65 pounds
per square inch absolute. Where applicable, all Mmbtu amounts have been
converted to Mcf on a 1 Mmbtu to 1 Mcf basis.

"MCF/D" means thousand cubic feet per day.

"MMCF/D" means million cubic feet per day.

"NET" when used in connection with the transportation of a quantity of
natural gas, means the total amount of gas transported multiplied by the
Companys interest in the joint venture or other entity that owns the gathering
and transportation system.

"OIL" means crude oil and condensate.

"SOUR GAS" means natural gas containing chemical impurities, notably
hydrogen sulfide (H2S) or other sulfur compounds that make it extremely harmful
to breathe even small amounts.

"SPOT" means purchase or sale arrangements which are "best efforts" or
"interruptible" in nature and are typically for 30 days or less.

"THROUGHPUT" means the volume of gas transported or passing through a
pipeline or other facility.

"VOLUMES" as used herein means the amount of gas sold or transported by
the Company, unless otherwise stated. All volumes of natural gas referred to in
this Prospectus are stated at a pressure base of 14.65 pounds per square inch
and a 60 degrees Fahrenheit and in most instances are rounded to the nearest
major multiple.

"WORKING INTEREST" means the operating interest under an oil and gas
lease which gives the owner the right to drill, produce and conduct operating
activities on the property and a share of production, subject to all royalties,
overriding royalties and other burdens and to all costs of exploration,
development and operations and all risks in connection therewith.

58
<PAGE>
MIDCOAST ENERGY RESOURCES, INC.

INDEX TO FINANCIAL STATEMENTS

Page
----
MIDCOAST ENERGY RESOURCES, INC ...........................................
Consolidated Financial Statements:
Independent Auditor's Report ........................................ F-2
Consolidated Balance Sheets, December 31, 1995, 1996 and
unaudited as of March 31, 1997 ..................................... F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1994, 1995, 1996 and unaudited for the three months
ended March 31, 1996 and 1997 ...................................... F-4
Consolidated Statements of Shareholders' Equity for the Years
Ended December 31, 1994, 1995, 1996 and unaudited for the three
months ended March 31, 1997 ........................................ F-5
Consolidated Statements of Cash Flows for the Years Ended December
31, 1994, 1995, 1996 and unaudited for the three months ended March
31, 1996 and 1997 .................................................. F-6
Notes to Consolidated Financial Statements .......................... F-7

ALATENN SUBSIDIARIES
Combined Financial Statements:
Independent Auditor's Report ........................................ F-20
Combined Balance Sheets, December 31, 1995, 1996 and unaudited as of
March 31, 1997 ..................................................... F-21
Combined Statements of Operations for the Years Ended December 31,
1994, 1995, 1996 and unaudited for the three months ended March 31,
1996 and 1997 ...................................................... F-22
Combined Statements of Retained Earnings for the Years Ended
December 31, 1994, 1995, 1996 and unaudited for the three months
ended March 31, 1997 ............................................... F-23
Combined Statements of Cash Flows for the Years Ended December 31,
1994, 1995, 1996 and unaudited for the three months ended March 31,
1996 and 1997 ...................................................... F-24
Notes to Combined Financial Statements .............................. F-25

KOCH HYDROCARBONS COMPANY -- HARMONY GAS PROCESSING PLANT
Historical Summary of Revenue and Direct Operating Expenses:
Independent Auditor's Report ........................................ F-31
Historical Summary of Revenue and Direct Operating Expenses for the
year ended December 31, 1995 and unaudited for the six months ended
June 30, 1995 and 1996 ............................................. F-32
Notes to Historical Summary of Revenue and Direct Operating
Expenses ........................................................... F-33

F-1
<PAGE>
INDEPENDENT AUDITOR'S REPORT

Board of Directors and Shareholders
Midcoast Energy Resources, Inc.
Houston, Texas

We have audited the accompanying consolidated balance sheets of Midcoast
Energy Resources, Inc. and subsidiaries as of December 31, 1995 and 1996, and
the related consolidated statements of operations, shareholders' equity and cash
flows for each of the years in the three year period ended December 31, 1996.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Midcoast
Energy Resources, Inc., and subsidiaries as of December 31, 1995 and 1996, and
the results of their operations and their cash flows for each of the years in
the three year period ended December 31, 1996, in conformity with generally
accepted accounting principles.

HEIN + ASSOCIATES LLP
Houston, Texas
March 27, 1997

F-2
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, MARCH 31,
1995 1996 1997
------------ ------------ -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........... $ 106,152 $1,167,825 $ 3,041,418
Accounts receivable, no allowance
for doubtful accounts............. 2,319,667 8,891,808 5,021,126
Asset held for resale............... 210,447 -- --
------------ ------------ -----------
Total current assets........... 2,636,266 10,059,633 8,062,544
------------ ------------ -----------
PROPERTY, PLANT AND EQUIPMENT, at cost:
Natural gas transmission
facilities........................ 7,365,421 11,939,173 12,141,699
Investment in transmission
facilities........................ 1,284,609 1,302,303 1,325,407
Natural gas processing facilities... -- 3,735,262 3,789,447
Oil and gas properties, using the
full-cost method of accounting.... 302,293 1,274,436 1,307,800
Other property and equipment........ 85,819 264,842 315,950
------------ ------------ -----------
9,038,142 18,516,016 18,880,303
ACCUMULATED DEPRECIATION, DEPLETION, AND
AMORTIZATION.......................... (831,981) (1,550,670) (1,732,437)
------------ ------------ -----------
8,206,161 16,965,346 17,147,866
OTHER ASSETS, net of amortization....... 246,081 278,235 2,442,954
------------ ------------ -----------
Total assets................... $11,088,508 $27,303,214 $27,653,364
============ ============ ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued
liabilities....................... $2,086,138 $8,464,395 $ 6,060,779
Current portion of deferred
income............................ 83,000 83,000 83,000
Short-term borrowing from bank...... 25,000 180,000 --
Current portion of long-term debt
payable to banks.................. 540,998 196,831 196,831
------------ ------------ -----------
Total current liabilities...... 2,735,136 8,924,226 6,340,610
------------ ------------ -----------
LONG-TERM DEBT PAYABLE TO:
Banks............................... 2,926,947 4,015,146 5,942,861
Shareholders and affiliates......... 1,033,822 -- --
------------ ------------ -----------
Total long-term debt........... 3,960,769 4,015,146 5,942,861
------------ ------------ -----------
DEFERRED INCOME......................... 235,167 152,167 131,417
MINORITY INTEREST IN CONSOLIDATED
SUBSIDIARIES.......................... -- 618,591 654,985
COMMITMENTS AND CONTINGENCIES (Note7)
SHAREHOLDERS' EQUITY (Note 8):
5% cumulative preferred stock, $1
par value, 1 million shares
authorized and 200,000 shares
issued and outstanding at December
31, 1995 with a liquidation
preference of $1,183,665.......... 200,000 -- --
Common stock, $.01 par value,
10,000,000 shares authorized,
1,465,680 shares issued and
outstanding at December 31, 1995;
2,499,999 at December 31, 1996 and
March 31, 1997.................... 14,657 25,000 25,000
Paid-in capital..................... 18,824,681 26,941,660 26,941,660
Accumulated deficit................. (14,775,102) (13,283,876) (12,351,969)
Unearned compensation............... (106,800) (89,700) (31,200)
------------ ------------ -----------
Total shareholders' equity..... 4,157,436 13,593,084 14,583,491
------------ ------------ -----------
Total liabilities and
shareholders' equity......... $11,088,508 $27,303,214 $27,653,364
============ ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.

F-3
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
THREE MONTHS ENDED
FOR THE YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------------- ------------------------
1994 1995 1996 1996 1997
------------ ------------ ------------ ---------- ----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING REVENUES:
Sale of natural gas and
transportation fees............... $ 14,901,222 $ 11,469,394 $ 26,495,975 $5,510,278 $11,416,814
Natural gas processing revenue..... -- -- 2,459,683 -- 1,470,120
Sale of pipelines.................. 60,586 4,092,850 211,888 22,500 --
Oil and gas revenue................ 6,902 60,046 247,787 50,769 77,320
------------ ------------ ------------ ---------- ----------
Total operating revenues......... 14,968,710 15,622,290 29,415,333 5,583,547 12,964,254
------------ ------------ ------------ ---------- ----------
OPERATING EXPENSES:
Cost of natural gas and
transportation charges............ 13,459,465 9,895,793 23,169,573 4,675,938 10,298,512
Natural gas processing costs....... -- -- 1,442,681 -- 726,290
Cost of pipelines sold............. 48,606 1,909,624 131,055 2,153 --
Production of oil and gas.......... 2,783 11,544 58,472 22,288 11,556
Depreciation, depletion and
amortization...................... 259,440 451,551 817,807 150,759 255,016
General and administrative......... 849,002 784,653 1,222,531 198,970 374,068
------------ ------------ ------------ ---------- ----------
Total operating expenses......... 14,619,296 13,053,165 26,842,119 5,050,108 11,665,442
------------ ------------ ------------ ---------- ----------
Operating income................. 349,414 2,569,125 2,573,214 533,439 1,298,812
NON-OPERATING ITEMS:
Interest expense................... (188,623) (339,324) (412,629) (119,879) (95,282)
Minority interest in consolidated
subsidiaries...................... -- -- (197,731) (20,633) (59,754)
Other expense, net................. (13,066) (36,400) (48,765) (19,245) (11,869)
------------ ------------ ------------ ---------- ----------
INCOME BEFORE INCOME TAXES AND
CUMULATIVE EFFECT OF A CHANGE IN
ACCOUNTING PRINCIPLE.............. 147,725 2,193,401 1,914,089 373,682 1,131,907
PROVISION FOR INCOME TAXES (Note
9)................................ -- -- -- -- --
CUMULATIVE EFFECT OF A CHANGE IN
ACCOUNTING PRINCIPLE.............. (120,936) -- -- -- --
------------ ------------ ------------ ---------- ----------
Net income....................... 26,789 2,193,401 1,914,089 373,682 1,131,907
5% CUMULATIVE PREFERRED STOCK
DIVIDENDS......................... (59,183) (59,183) (22,863) (14,755) --
------------ ------------ ------------ ---------- ----------
NET INCOME (LOSS) APPLICABLE TO
COMMON SHAREHOLDERS............... $ (32,394) $ 2,134,218 $ 1,891,226 $ 358,927 $1,131,907
============ ============ ============ ========== ==========
NET INCOME (LOSS) PER COMMON SHARE
Operations......................... $ 0.07 $ 1.48 $ 1.00 $ 0.24 $ 0.45
Accounting principle change........ (0.09) -- -- -- --
------------ ------------ ------------ ---------- ----------
$ (0.02) $ 1.48 $ 1.00 $ 0.24 $ 0.45
============ ============ ============ ========== ==========
PRO FORMA AMOUNTS ASSUMING THE CHANGE
IN ACCOUNTING PRINCIPLE IS APPLIED
RETROACTIVELY
Net income......................... $ 147,725
Net income to common
shareholders...................... $ 88,542
Net income per common share........ $ 0.06
============
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING................ 1,390,553 1,439,606 1,885,596 1,465,827 2,499,999
============ ============ ============ ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.

F-4
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
AND THREE MONTHS ENDED MARCH 31, 1997

<TABLE>
<CAPTION>
5%
CUMULATIVE TOTAL
PREFERRED COMMON PAID-IN ACCUMULATED UNEARNED SHAREHOLDERS'
STOCK STOCK CAPITAL DEFICIT COMPENSATION EQUITY
---------- ------- ----------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1993.............. $200,000 $13,662 $18,692,073 $(16,876,926) $ -- $ 2,028,809
Shares issued or vested under various
stock-based compensation
arrangements.......................... -- 361 48,179 -- (38,400) 10,140
Net income.............................. -- -- -- 26,789 -- 26,789
5% cumulative preferred stock
dividends............................. -- -- -- (59,183) -- (59,183)
---------- ------- ----------- ------------ ------------ -------------
BALANCE, December 31, 1994.............. $200,000 $14,023 $18,740,252 $(16,909,320) $ (38,400) $ 2,006,555
Shares issued or vested under various
stock-based compensation
arrangements.......................... -- 634 84,429 -- (68,400) 16,663
Net income.............................. -- -- -- 2,193,401 -- 2,193,401
5% cumulative preferred stock
dividends............................. -- -- -- (59,183) -- (59,183)
---------- ------- ----------- ------------ ------------ -------------
BALANCE, December 31, 1995.............. $200,000 $14,657 $18,824,681 $(14,775,102) $ (106,800) $ 4,157,436
Shares issued in conjunction with a
financing agreement with an
affiliate............................. -- 45 5,955 -- -- 6,000
Shares issued or vested under various
stock-based compensation
arrangements.......................... -- 298 38,401 -- 17,100 55,799
Redemption of 200,000 shares of 5%
cumulative preferred stock............ (200,000) -- 81,634 -- -- (118,366)
Sale of 1,000,000 shares of common
stock................................. -- 10,000 7,990,989 -- -- 8,000,989
Net income.............................. -- -- -- 1,914,089 -- 1,914,089
5% cumulative preferred stock
dividends............................. -- -- -- (22,863) -- (22,863)
Common stock dividends,
$.08 per share........................ -- -- -- (400,000) -- (400,000)
---------- ------- ----------- ------------ ------------ -------------
BALANCE, December 31, 1996.............. $ -- $25,000 $26,941,660 $(13,283,876) $ (89,700) $ 13,593,084
Shares issued or vested under various
stock-based compensation arrangements
(Unaudited)........................... -- -- -- -- 58,500 58,500
Net income (Unaudited).................. -- -- -- 1,131,907 -- 1,131,907
Common stock dividends,
$.08 per share (Unaudited)............ -- -- -- (200,000) -- (200,000)
---------- ------- ----------- ------------ ------------ -------------
BALANCE, March 31, 1997 (Unaudited)..... $ -- $25,000 $26,941,660 $(12,351,969) $ (31,200) $ 14,583,491
========== ======= =========== ============ ============ =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.

F-5
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH
FOR THE YEARS ENDED DECEMBER 31, 31,
---------------------------------------- ------------------------
1994 1995 1996 1996 1997
------------ ------------ ------------ ---------- ----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) applicable to
common shareholders............... $ (32,394) $ 2,134,218 $ 1,891,226 $ 358,927 $1,131,907
Adjustments to arrive at net cash
provided (used) in operating
activities --
Depreciation, depletion and
amortization.................... 259,440 451,551 817,807 150,759 255,016
Gain on sale of operating
pipelines....................... (11,980) -- (80,833) (20,347) --
Recognition of deferred income... 401,167 (83,000) (83,000) (20,750) (20,750)
Increase in deferred tax asset... -- (43,868) (40,000) -- --
Cumulative effect of a change in
accounting principle............ 120,936 -- -- -- --
Income from partnership
investments..................... (5,575) -- -- -- --
Minority interest in consolidated
subsidiaries.................... -- -- 197,731 20,633 59,754
Issuance of common stock to
employees....................... 10,140 16,663 48,486 -- 17,875
Changes in working capital
accounts --
(Increase) decrease in accounts
receivable.................... 339,787 (321,155) (6,574,566) (57,909) 3,870,682
Increase (decrease) in accounts
payable and accrued
liabilities................... (1,596,036) 206,455 6,387,125 874,929 (2,366,449)
------------ ------------ ------------ ---------- ----------
Net cash provided (used) in
operating activities....... (514,515) 2,360,864 2,563,976 1,306,242 2,948,035
------------ ------------ ------------ ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures............... (1,088,117) (3,885,282) (9,390,966) (1,285,652) (425,026)
Acquisition escrow deposit (Note
4)................................ -- -- -- -- (2,000,000)
Investment in transmission
facilities........................ (1,284,609) -- -- -- --
Sale of operating pipelines........ -- -- 211,888 -- --
Other.............................. (5,917) (40,655) 216,873 71,268 (197,131)
------------ ------------ ------------ ---------- ----------
Net cash used in investing
activities................. (2,378,643) (3,925,937) (8,962,205) (1,214,384) (2,622,157)
------------ ------------ ------------ ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Bank debt borrowings............... 5,448,000 5,857,505 9,288,000 2,628,000 2,110,000
Bank debt repayments............... (3,836,317) (5,011,023) (8,388,968) (1,284,507) (362,285)
Proceeds from notes payable to
shareholders and affiliates....... 591,250 3,906,272 100,000 100,000 --
Repayments on notes payable to
shareholders and affiliates....... (316,250) (3,147,450) (1,133,822) (660,000) --
Proceeds from notes payable........ -- 3,200,000 -- -- --
Repayments on notes payable........ -- (3,200,000) -- -- --
Redemption of 5% cumulative
preferred stock................... -- -- (118,366) -- --
Net proceeds from common stock
offering.......................... -- -- 8,113,058 -- --
Dividends on common stock.......... -- -- (400,000) -- (200,000)
------------ ------------ ------------ ---------- ----------
Net cash provided in
financing activities....... 1,886,683 1,605,304 7,459,902 783,493 1,547,715
------------ ------------ ------------ ---------- ----------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS.................. (1,006,475) 40,231 1,061,673 875,351 1,873,593
------------ ------------ ------------ ---------- ----------
CASH AND CASH EQUIVALENTS, beginning
of period......................... 1,072,396 65,921 106,152 106,152 1,167,825
------------ ------------ ------------ ---------- ----------
CASH AND CASH EQUIVALENTS, end of
period............................ $ 65,921 $ 106,152 $ 1,167,825 $ 981,503 $3,041,418
============ ============ ============ ========== ==========
CASH PAID FOR INTEREST............... $ 177,355 $ 323,376 $ 410,897 $ 142,932 $ 95,282
============ ============ ============ ========== ==========
CASH PAID FOR INCOME TAXES........... $ -- $ -- $ 40,000 $ -- $ 51,476
============ ============ ============ ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.

F-6
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION SUBSEQUENT TO DECEMBER 31, 1996 IS UNAUDITED)

1. BACKGROUND AND INFORMATION:

Midcoast Energy Resources, Inc. ("Midcoast" or "the Company") was
formed on May 11, 1992, as a Nevada corporation and, in September 1992, became
the successor to Nugget Oil Corporation. The merger was accounted for as a
pooling of interests.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

BASIS OF PRESENTATION

The accompanying consolidated financial statements include the accounts of
the Company, all of its wholly-owned subsidiaries and those subsidiaries in
which the Company owns a controlling interest or is in a control position. As of
March 31, 1997, the Company's wholly-owned subsidiaries include Magnolia
Pipeline Corporation ("Magnolia"), Magnolia Resources, Inc., Magnolia
Gathering, Inc., H&W Pipeline Corporation, Midcoast Holdings No. One, Inc.,
Midcoast Marketing, Inc., Midcoast Gas Pipeline, Inc. and Nugget Drilling
Corporation. The consolidated subsidiaries in which the Company owns a
controlling interest or is in a control position are Starr County Gathering
System, a Joint Venture ("Starr County"), Pan Grande Pipeline, L.L.C., a Texas
limited liability company ("Pan Grande") and Arcadia/Midcoast Pipeline of New
York, L.L.C., a New York limited liability company. All significant intercompany
transactions and balances have been eliminated. Certain reclassification entries
were made with regard to Consolidated Financial Statements for the three months
ended March 31, 1996 so that the presentation of the information is consistent
with reporting for the Consolidated Financial Statements for the three months
ended March 31, 1997.

INCOME TAXES

Midcoast and its subsidiaries file a consolidated federal income tax
return. Midcoast accounts for income taxes under the provisions of Statement of
Financial Accounting Standards (SFAS) No. 109 -- "Accounting for Income
Taxes." Under SFAS 109, the Company recognizes deferred income taxes for the
differences between the financial and income tax bases of its assets and
liabilities.

PROPERTY, PLANT AND EQUIPMENT

Intrastate natural gas transmission, distribution and processing facilities
and other equipment are depreciated by the straight-line method at rates based
on the following estimated useful lives of the assets:

Intrastate natural gas transmission
facilities............................ 15 - 25 years
Pipeline right-of-ways.................. 17.5 years
Natural gas processing facilities....... 30 years
Other property and equipment............ 3 - 7 years

Repairs and maintenance are charged to expense as incurred; renewals and
betterments are capitalized.

The Company accounts for its oil and gas production activities using the
full cost method of accounting. Under this method of accounting, all costs,
including indirect costs related to exploration and development activities, are
capitalized as oil and gas property costs. No gains or losses are recognized on
the sale or disposition of oil and gas reserves, except for sales which include
a significant portion of the total remaining reserves.

CASH AND CASH EQUIVALENTS

For purposes of the statement of cash flows, the Company considers
short-term, highly liquid investments that have an original maturity of three
months or less to be cash equivalents.

F-7
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

ASSET HELD FOR RESALE

Assets for which the Company anticipates consummating a sales transaction
within one year of the balance sheet date are valued at the lower of cost or
market and classified as current assets.

TRANSPORTATION AND EXCHANGE IMBALANCES

Transportation and exchange gas imbalance volumes are accounted for using
the sales method of accounting. Transportation and exchange gas imbalances are
not material as of December 31, 1995 and 1996 and March 31, 1996 and 1997.

DEFERRED CONTRACT COSTS

Costs incurred to construct natural gas transmission facilities pursuant to
long-term natural gas sales or transportation contracts, which upon completion
of construction are assigned to the contracting party, are capitalized as
deferred contract costs and classified as "Other Assets" on the consolidated
balance sheet. These costs are amortized over the life of the initial contract
on a straight-line basis.

STOCK ISSUANCE COSTS

Direct costs incurred by the Company in connection with its offering of
securities (see Note 8) were applied as a reduction of the offering proceeds.

REVENUE RECOGNITION

Customers are invoiced and the related revenue is recorded as natural gas
deliveries are made. Pipeline sales are recognized upon closing the sale
transaction. Oil and gas revenue from the Company's interests in producing wells
is recognized as oil and gas is produced from those wells.

RECENT ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board ("FASB") issued SFAS No. 121
entitled "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" which is effective for fiscal years beginning after
December 15, 1995. SFAS No. 121 specifies certain events and circumstances which
indicate the cost of an asset or assets may be impaired, the method by which the
evaluation should be performed, and the method by which writedowns, if any, of
the asset or assets are to be determined and recognized. The adoption of this
pronouncement in 1996 did not have a material impact on the Company's financial
condition or operating results.

The FASB also issued Statement of Financial Accounting Standards No. 128,
entitled "Earnings Per Share", during February 1997. The new statement, which
is effective for financial statements issued after December 31, 1997, including
interim periods, establishes standards for computing and presenting earnings per
share. The new statement requires retroactive restatement of all prior-period
earnings per share data presented. The Company does not believe the new
statement will have a material impact upon previously presented earnings per
share information.

F-8
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

UNAUDITED INTERIM INFORMATION

The accompanying financial information as of March 31, 1997 and for the
three month periods ended March 31, 1996 and 1997 has been prepared by the
Company without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. The financial statements reflect all adjustments,
consisting of normal recurring accruals which are, in the opinion of management,
necessary to fairly present such information in accordance with generally
accepted accounting principals.

USE OF ESTIMATES

The preparation of the Company's consolidated financial statements in
conformity with generally accepted accounting principles requires the Company's
management to make estimates and assumptions that effect the amounts reported in
these financial statements and accompanying notes. Actual results could differ
from those estimates.

NET INCOME PER COMMON SHARE

Net income per common share was computed by dividing net income applicable
to common shareholders by the weighted average common shares outstanding. All
share and per share amounts in the accompanying consolidated financial
statements have been adjusted to reflect the approximate 4.46 to 1 stock split
authorized by the Board of Directors ("Board") in May 1996 (see Note 8).

3. PIPELINE ACQUISITION AND SUBSEQUENT SALE:

In September 1995, the Company and an affiliate owned by a former officer
and director of the Company jointly acquired 100% of the outstanding capital
stock of Five Flags Pipe Line Company ("Five Flags") from an unaffiliated
company. Total cash consideration of $2,052,000 was paid on September 13, 1995
of which Midcoast's share was $1,872,450 for 91.25% of Five Flags capital stock
and the affiliate's share was $179,550 for 8.75% of Five Flags capital stock.
The investment was financed by a former officer and director of the Company.

The acquisition of Five Flags' stock was made as an investment to be resold
to another unaffiliated company pursuant to an agreement for purchase and sale
of stock. On October 2, 1995, Midcoast and the affiliate jointly sold 100% of
the capital stock of Five Flags for cash consideration of which the Company's
share was $4,092,850. A portion of the proceeds from the sale was used to repay
a related party promissory note of $1,872,450 plus accrued interest. The
remainder of the proceeds was used to partially finance Midcoast's acquisition
of Magnolia.

4. PIPELINE CONSTRUCTION AND ACQUISITIONS:

In September 1995, Midcoast acquired 100% of the outstanding capital stock
of Magnolia, an Alabama corporation, from Williams Holdings of Delaware, Inc.
("Williams Holdings") an unaffiliated company. The acquisition was made
pursuant to the Agreement for Sale and Purchase of Stock dated July 27, 1995 and
had an effective date of August 1, 1995. The acquisition was accounted for under
the purchase method of accounting. The total purchase price of $3,200,000 was
allocated to property, plant, and equipment as the principal asset of Magnolia
consists of approximately 111 miles of natural gas pipeline located in central
Alabama. Initially, the acquisition was financed by Midcoast issuing a $500,000
subordinated debenture ("Debenture") and a $2,700,000 non-recourse promissory
note ("Note") to Williams Holdings. The Debenture accrued interest at 10% and
had a final maturity of September 15, 1996 but was redeemable at the option of
Midcoast. The Note was non-interest bearing and was due on October 9, 1995.
However, the Debenture and the Note were paid in full on October 2, 1995 using
the proceeds from the sale of Five Flags and borrowings of $1,200,000 from an
affiliate owned by a former officer and director of the Company. In December
1995, the $1,200,000 related party note was repaid using a new $1,500,000 credit
facility with a commercial lender which in turn was repaid in August 1996.

F-9
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In February 1996, the Company and Resource Energy Development Company,
L.L.C. ("Resource"), an unaffiliated third party, jointly formed Pan Grande
each owning a 50% interest. The companies joined together for the purpose of
acquiring, owning and operating pipelines. In March 1996, Pan Grande acquired
six pipeline systems consisting of approximately 77 miles of pipeline located in
Texas from an unaffiliated third party for cash consideration of $1,000,000. Pan
Grande financed $800,000 of the acquisition with a credit facility obtained from
a commercial lender (see Note 5). The remaining $200,000 of the purchase price
was obtained through equal $100,000 capital contributions from Midcoast and
Resource. Midcoast's $100,000 capital contribution was financed through a loan
from an affiliate owned by a former officer and director of the Company which
was repaid in August 1996. In August 1996, Resource sold its 50% interest to
four companies as follows: GMI Energy, Inc. (15%), Commercial Natural Gas, Inc.
(15%), Redcon, Inc. (10%) and Transtate Gas Systems, Inc. (10%). In September
1996, Pan Grande acquired the Salt Creek natural gas pipeline system ("Salt
Creek System") from an unaffiliated third party. Cash consideration of $650,000
was paid by Pan Grande of which Midcoast's share of $325,000 was funded from the
proceeds of the common stock offering described in Note 8. The Salt Creek System
consists of approximately 39 miles of pipeline in Texas and currently transports
gas for fuel use at the Salt Creek carbon dioxide injection plant and oil
lifting unit operated by Mobil Exploration and Producing. Also, in September
1996, Pan Grande sold two pipelines extending approximately 9 miles to two
unaffiliated third parties for cash consideration of approximately $189,000.
Midcoast acts as manager of Pan Grande and operates all the systems.

In October 1996, Midcoast consummated the acquisition of the Harmony gas
processing plant and gathering pipeline system ("Harmony System") from Koch
Hydrocarbons Company, a division of Koch Industries, Inc., for cash
consideration of approximately $3,640,000. The Harmony system gathers gas from
producing fields located in Mississippi. It consists of over 150 miles of high
and low pressure gas gathering pipeline with 4620 horsepower of field and inlet
compression. The processing plant is a refrigerated propane natural gas liquid
extraction plant with design capacity of over 20 MMcf/d. The plant has sulfur
extraction as well as full fractionation facilities and markets propane,
butanes, natural gasoline, condensate and sulfur. The acquisition was partially
funded with proceeds from the Company's sale of common stock described in Note 8
and the remainder was financed through the revolving line of credit with Bank
One, Texas N.A. discussed in Note 5. Midcoast's 1996 operating revenues, net
income applicable to common shareholders, and net income per share on an
unaudited pro forma basis assuming the purchase of the Harmony System had
occurred on January 1, 1996 are $33 million, $2.3 million, and $1.20,
respectively. These pro forma amounts were prepared using assumptions which are
based on estimates and subject to revision. The pro forma combined results are
not necessarily indicative of actual results that would have been achieved had
the acquisition occurred on January 1, 1996, or of future results. For further
information regarding the acquisition of the Harmony System, refer to the
Company's Form 8-K Report filed with the United States Securities and Exchange
Commission ("SEC") on October 7, 1996.

In October 1996, Midcoast acquired four natural gas gathering pipelines
from Esperanza Transmission Corporation ("Esperanza") for cash consideration
of $810,000. All four pipelines are located in southern Texas and collectively
include 19 miles of pipeline which gather natural gas from producing fields in
the area. A fifth pipeline, which provides natural gas supply to a municipal
distribution system, was acquired from Esperanza in January 1997 for $90,000.
The acquisition was financed using the new revolving line of credit with Bank
One, Texas N.A. discussed in Note 5.

In November 1996, Midcoast, in conjunction with a group of investors,
acquired overriding royalty interests ranging from 5.99% to 6.25% across three
oil and gas productive tracts in Howard County, Texas. These tracts are part of
the East Vealmoor Unit operated by Exxon Corporation and were purchased for cash
consideration of approximately $1,350,000 from unaffiliated third parties, of
which Midcoast's share was

F-10
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

$950,000 for 70.37% of the group's interest. As consideration for identifying
and negotiating the acquisition, Midcoast's interest is subject to a 25%
reversionary interest after it recoups its original investment to be assigned to
certain parties who developed the transaction.

In March 1997, the Company entered into a definitive purchase and sale
agreement (the "Agreement") to acquire the stock of three subsidiaries of
Atrion Corporation ("Atrion") for cash consideration of approximately $39.4
million subject to post closing adjustments and up to $2 million of deferred
contingent payments to be paid over an eight-year period. The Agreement contains
representations and warranties, indemnities and conditions to closing customary
to transactions of this type. The three subsidiaries include Alabama Tennessee
Natural Gas Company ("ATNG"), Tennessee River Intrastate Gas Company, Inc.
("TRIGAS") and AlaTenn Energy Marketing Company, Inc. ("ATEMCO")
(collectively the "AlaTenn Subsidiaries"). ATNG owns and operates a 288 mile
interstate pipeline, with two compressor stations, that runs from Selmer,
Tennessee to Huntsville, Alabama. TRIGAS owns and operates a 38 mile pipeline
extending from Barton, Alabama to Courtland, Alabama and a one mile pipeline in
Morgan County, Alabama, which transport gas to two industrial customers. ATEMCO
is a natural gas marketing company which primarily services the natural gas
needs of the customers on ATNG and TRIGAS. At March 31, 1997, the acquisition
had been approved by the board of directors of both the Company and Atrion,
however, the acquisition was subject to approval by Atrion's shareholders. In
conjunction with executing the purchase and sale agreement, Midcoast was
required to deposit $2.0 million in an escrow account maintained by the trust
department of a bank. In the event that Midcoast was unable or unwilling to
consummate the transaction after the necessary approvals had been received, the
escrowed money would be paid to Atrion as compensation for all damages. On the
other hand, the agreement also stipulated that if Atrion was unable or unwilling
to consummate the transaction, which included not receiving shareholder
approval, Midcoast would receive $2.0 million as cash compensation for all
damages. The transaction was consummated on May 30, 1997 with financing provided
by the Company's existing bank lender (see Note 13).

F-11
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. DEBT OBLIGATIONS:

At December 31, 1995 and 1996, and March 31, 1997, the Company had
outstanding debt obligations as follows (in thousands):

<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1996 MARCH 31, 1997
----------------- ----------------- --------------
<S> <C> <C> <C>
Notes payable to various financial
institutions, retired in 1996, at
rates ranging from prime plus 1% to
prime plus 1.5%....................... $ 3,493 $-- $--
Notes payable to various affiliates,
retired in 1996, at rates ranging from
prime plus 2% to prime plus 6%........ 1,034 -- --
Note payable by Starr County to a bank
under a term loan bearing interest at
the prime rate plus 1% (9.25% at
December 31, 1996), principal and
accrued interest are payable in 47
monthly installments of $4,408 with a X
final payment of the remaining unpaid
principal and interest due on January
15, 2000.............................. -- 135 100
Note payable by Pan Grande to a bank
under a term loan bearing interest at
the prime rate plus 1% (9.25% at
December 31, 1996), principal and
accrued interest are payable in 59
installments of $16,754 with a final
payment of the remaining unpaid
principal and interest due on March
15, 2001.............................. -- 577 540
Reducing revolving credit line with a
bank under a $40 million promissory
note which was amended in May 1997
(see following discussion)............ -- 3,500 5,500
Revolving credit line with a bank for
working capital needs under a $40
million promissory note which was
amended in May 1997 (see following
discussion)........................... -- 180 --
-------- -------- --------------
Total debt......................... 4,527 4,392 6,140
Less current portion............... (566) (377) (197)
-------- -------- --------------
Total long-term debt............... $ 3,961 $ 4,015 $5,943
======== ======== ==============
</TABLE>

In addition to the notes discussed below, the Company previously had
several credit facilities with banks and affiliates. In August 1996, the Company
repaid all its outstanding indebtedness, except for the debt of those
subsidiaries which are not wholly-owned as discussed below, with proceeds from
the common stock offering discussed in Note 8. Total principal repayments
amounted to approximately $4,973,000.

Additionally, in August 1996, the Company established a new $40 million
credit facility with Bank One, Texas N.A. The new credit facility provided a
three-year commitment with an initial borrowing availability of $10.5 million
comprised of a $1.5 million working capital line of credit and a $9.0 million
reducing revolving line of credit (collectively the "Credit Agreement").
Available credit under the revolving line was reduced by $107,150 per month
beginning October 1, 1996. The borrowing availability under each line is subject
to revision, on a semi-annual basis, based on the performance of the Company's
existing assets and any asset dispositions or additions from new construction or
acquisitions. In conjunction with acquiring the AlaTenn Subsidiaries, the Credit
Agreement was amended (see Note 13).

When borrowings under the Credit Agreement are less than 50% of available
credit, at the Company's option, interest on the reducing revolving line of
credit accrues at the London Interbank Offering Rate for

F-12
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

30, 60, or 90 day terms (approximately 5.69% at March 31, 1997) plus 2.5% or the
Bank One, Texas N.A. base rate (8.5% at March 31, 1997) plus .25%. When
borrowings are greater than 50% of available credit, an additional .25% will be
added to the above interest rates. Interest on the working capital line of
credit accrues at the Bank One, Texas N.A. base rate plus .5%. In addition, the
Company is subject to a non-recurring 1% facility fee as funds are borrowed, as
well as a .375% commitment fee payable quarterly on the unused portion of
borrowing availability. The facility is secured by all accounts receivable,
contracts, and a first lien security interest in all the Company's pipeline
systems. The Company is in compliance with various normal covenants and certain
financial ratios as required by the Credit Agreement.

In January 1996, Starr County, in which Midcoast owns a 60% interest and
acts as manager, obtained $175,000 from a bank lender to finance the acquisition
of a gas gathering pipeline. Principal and accrued interest are payable in 47
monthly installments of $4,408 with a final payment of the remaining principal
and interest due on January 15, 2000. The loan is secured by the pipeline and
related contracts. Furthermore, each member of Starr County has guaranteed the
loan in an amount equal to their respective ownership interest.

In March 1996, Pan Grande obtained $800,000 from a bank to partially
finance the acquisition of six pipelines (see Note 4). Principal and accrued
interest is payable in 59 monthly installments of $16,754 with a final payment
of the remaining unpaid principal and interest due on March 15, 2001. The loan
is secured by the pipelines and related contracts. Furthermore, each member of
Pan Grande has guaranteed the loan in an amount equal to their respective
ownership interest.

The aggregate maturities of long-term debt for the five years following
December 31, 1996 are:

FOR THE YEAR ENDING
DECEMBER 31, (IN THOUSANDS)
- ---------------------------------------- --------------
1997............................... $ 197
1998............................... 215
1999............................... 231
2000............................... 69
2001 and thereafter................ 3,500
--------------
Total.............................. $4,212
==============

6. RELATED PARTY TRANSACTIONS:

In April 1994, affiliates owned by former officers and directors of the
Company extended the collateral to obtain the long-term bank financing for the
Alaska investment. The collateral was outstanding for a period of approximately
eight months at which point the Company replaced the loan with another
commercial lender and the collateral was released. In consideration for
extending the collateral on the initial loan, the Company assigned a five
percent net revenue interest on the net income derived from the Company's
investment in the oil and natural gas gathering pipelines near Cook Inlet,
Alaska. However, the five percent net revenue interest applies only after all
costs associated with the investment have been recouped by the Company. As of
March 31, 1997, no amounts have been paid under the assignment of the net
revenue interest.

In December 1994, an affiliate owned by certain former officers and
directors of the Company provided a $275,000 loan which, as amended, bore
interest at the Mercantile Bank, Corpus Christi prime rate plus 1.5%. Interest
was payable monthly and principal and remaining accrued interest were due in
full at maturity on April 1, 1997. The proceeds of the loan were used for
general corporate purposes including the repayment of other indebtedness.
Principal of $75,000 was repaid in November 1995 with the remaining $200,000
repaid in August 1996 with proceeds from the common stock offering (see Note 8).
Cash payments of $39,106 were made for interest during the term of the loan.

F-13
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In May 1995, an affiliate owned by former officers and directors of the
Company provided a $173,822 loan to partially finance the acquisition of a 23%
working interest in oil and gas production from two leases located in Starr
County, Texas. The loan, as amended in March 1996, bore interest at the
Mercantile Bank, Corpus Christi prime rate plus 1% and matured on April 1, 1997.
However, the loan was repaid in full in August 1996 with proceeds from the
Company's common stock offering (see Note 8). Cash payments of interest
amounting to $3,346 and $18,124 were made during 1995 and 1996, respectively. No
collateral was required to obtain this loan, although, as additional
consideration for extending the loan, the affiliated company was assigned a
one-half percent working interest in the oil and gas properties.

The Five Flags acquisition discussed in Note 3 was financed by a former
officer and director of the Company. A promissory note in the amount of
$1,872,450 was executed by the Company which provided for monthly payments of
interest beginning April 1, 1996 until December 31, 1996 at which time both
principal and accrued interest would be due in full. Interest accrued at the
prime rate plus 2%. However, the note plus accrued interest of approximately
$10,500 was repaid in full in October 1995 using the proceeds from the sale of
the Five Flags investment.

In addition to the $660,000 general corporate purposes loan provided in
December 1995 and repaid in January 1996 (including accrued interest of $4,039)
as discussed in Note 5 herein, $1,200,000 was borrowed from an affiliate owned
by a former officer and director of the Company in October 1995. These funds
were used in conjunction with the remainder of the sales proceeds of Five Flags
to fully retire a $500,000 debenture and $2,700,000 note due the seller of
Magnolia. The loan agreement called for interest to be accrued at the prime rate
plus 5% and was due monthly beginning April 1, 1996. The loan was to mature on
January 31, 1997, however, upon consummation of the new $1,500,000 bank credit
facility in December 1995, the note plus accrued interest of $35,260 was repaid
in full.

As additional consideration for extending the $1,200,000 loan, Midcoast
granted the affiliate a 5% net revenue interest in Magnolia's earnings before
interest, income taxes and depreciation to be paid on a monthly basis. The net
revenue interest, as amended in May 1996, applied only after Magnolia's
acquisition cost has been recouped by the Company. No amounts related to
Magnolia's earnings were paid under the assignment of the net revenue interest.
Midcoast had the right to repurchase this net revenue interest from the
affiliate for a cash payment of $25,000. However, the repurchase amount was
increased an additional $25,000 on November 1, 1995 and each following month up
to a maximum of $500,000. In July 1996, the Company exercised its right to
repurchase the net revenue interest for cash consideration of $250,000.

In March 1996, the Company borrowed $100,000 from an affiliate owned by a
former officer and director of the Company for its equity contribution in Pan
Grande (see Note 4) pursuant to a promissory note. The note, as amended, bore
interest at the prime rate plus 2.5% and was payable in 59 monthly installments
of $1,667 plus accrued interest and a final installment at March 15, 2001 in the
amount of the remaining principal and accrued interest then outstanding and
unpaid. The note was secured by the Company's interest in Pan Grande. The
affiliate also committed to lend up to an additional $75,000 in the event an
additional system was purchased by Pan Grande. In consideration for the
financing of the equity contribution and the commitment for additional
financing, the Company issued the affiliate 4,460 shares of the Company's common
stock. The note plus accrued interest of $4,896 was repaid in full in August
1996 with proceeds from the Company's common stock offering (see Note 8).

7. COMMITMENTS AND CONTINGENCIES:

EMPLOYMENT CONTRACTS

The Chief Executive Officer and President of the Company (the
"President"), has an employment agreement with the Company, an amendment to
which was approved by the Compensation Committee in January 1997, which extended
the term to December 2001, and pursuant to which he will receive a base

F-14
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

annual salary of $95,000 in 1997, $125,000 in 1998 and 1999 and $150,000 in 2000
and 2001. He may further participate in any such executive level bonuses or
salary increases as the Board may approve, is entitled to reimbursement for
reasonable automobile expenses not to exceed $500 each month and is eligible for
participation in the Company's group insurance plans. In 1994 and 1995, two key
employees of the Company entered into three-year and four-year employment
agreements, respectively. In April 1996, the three-year employment agreement
referred to above was renegotiated to extend the term an additional two years.
These agreements may be terminated by mutual consent or at the option of the
Company for cause, death or disability. In the event termination is due to
death, disability or defined changes in the ownership of the Company, the full
amount of compensation remaining to be paid during the term of the agreement
will be paid to the employee or their estate, after discounting at 12% to
reflect the current value of unpaid amounts.

LEASES

In March 1996, Midcoast entered into a non-cancelable operating lease for
its office space in Houston, Texas. This lease, amended in March 1997 to include
additional space, expires on January, 1999. Midcoast's previous Houston lease
was also non-cancelable and expired in June 1995. The expired lease converted to
a month-to-month arrangement until Midcoast executed the current lease. In
October 1996, Midcoast assumed an office lease in Corpus Christi, Texas which
expires in August 1997.

The Company incurred rent expense of $50,500, $50,600, and $72,700 during
the years ended 1994, 1995 and 1996, respectively and $12,500 and $22,400 for
the three month periods ended March 31, 1996 and 1997, respectively under these
operating leases. As of March 31, 1997, future minimum lease payments due under
this lease are approximately $74,000 in 1997, $86,100 in 1998, and $7,200 in
1999.

INVESTMENT IN ALASKA

In September 1996, an involuntary petition for relief under Chapter 11 of
the United States Bankruptcy Code was filed against Stewart Petroleum Company
("Stewart")in the United States Bankruptcy Court for the District of Alaska
(the "Court") by certain working interest owners in the West McArthur River
("WMRU") production field operated by Stewart. The Company receives a
throughput fee for all oil and natural gas transported through the WMRU
pipeline. The payment of the Company's throughput fees since August 1996 have
been suspended by the Court, and only those claims deemed to be necessary to
avoid immediate and irreparable harm to the Stewart estate have been paid. In
January 1997, Stewart consented to an order for relief and Stewart subsequently
filed a Disclosure Statement and Plan of Reorganization, as amended (the
"Stewart Plan"). The Court has approved the Disclosure Statement and scheduled
a Confirmation Hearing on the Stewart Plan for June 1997. The Stewart Plan
provides for the payment of the Company's claim and the Company believes it is
adequately protected. As such, the Company is continuing to accrue revenue for
the throughput fees from August 1996 to March 1997, which amounts to $142,959.

8. CAPITAL STOCK:

At December 31, 1996, the Company had authorized 10,000,000 shares of
common stock, of which 2,499,999 shares were issued and outstanding. There are
23,195 shares issued and outstanding at March 31, 1997 which are subject to a
vesting schedule in connection with employee agreements entered into during 1994
and 1996 (see Note 12).

In May 1996, the Board approved the redemption of the 5% cumulative
preferred stock ("5% Preferred") for $118,366 held by a director and officer
and two former directors and officers of the Company. The shares were redeemed
for ten percent of the stated liquidation value ($1,183,665). Subsequently, no
shares of the Company's preferred stock remain outstanding. Following redemption
of the Company's 5% Preferred, the Company's articles of incorporation were
amended to reflect only one class of outstanding securities, the Company's
common stock.

F-15
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In July 1996, the Board and a majority of the Company's shareholders
authorized amending the Company's articles of incorporation to increase the
number of authorized common shares from 6,000,000 shares to 10,000,000 shares.
In addition, the Board authorized an approximate 4.46 for 1 stock split in
anticipation of the Company's common stock offering discussed below.

On August 9, 1996, the Company's Registration Statement on Form SB-2 was
declared effective by the SEC. On August 14, 1996, the Company sold 1,000,000
shares of its common stock at an offering price of $10.00 per share. The
Company's stock is listed on the American Stock Exchange under the symbol
"MRS." Under the terms of the underwriting agreement, the underwriters
received warrants to acquire 100,000 shares at 142% of the initial offering
price per share. The securities underlying these warrants are subject to
piggyback registration rights. After deducting underwriting commissions and
other underwriting expenses of the offering, proceeds of approximately
$8,841,000 were received by the Company from the underwriter. The proceeds were
used to repay indebtedness with the remainder applied to acquisitions of
pipelines and related assets.

The Company issued warrants to purchase 34,349 shares of the Company's
common stock at $7.85 per share. These warrants, which are subject to an
eighteen-month lock-up agreement and have certain piggyback registration rights,
were issued in connection with the Company's common stock offering.

9. INCOME TAXES:

The Company has net operating loss ("NOL") carryforwards of approximately
$11.0 million expiring in various amounts from 1999 through 2008. In addition,
the Company has an investment tax credit ("ITC") carryforward of approximately
$348,000 which expires primarily in 1997. These loss carryforwards were
generated by the Company's predecessor. The ability of the Company to utilize
the carryforwards is dependent upon the Company maintaining profitable
operations and staying in compliance with certain Internal Revenue Service
("IRS") code provisions and regulations associated with changes in shareholder
control. Failure to adhere to these IRS requirements could result in a
significant limitation of the Company's ability to utilize its NOL and ITC
carryforwards and could also result in a loss of utilization altogether.

The tax effect of significant temporary differences representing deferred
tax assets and liabilities at December 31, 1995 and 1996, are as follows (in
thousands):

DECEMBER 31,
--------------------
1995 1996
--------- ---------
Net operating and capital loss
carryforwards...................... $ 5,124 $ 3,723
Investment tax credit
carryforwards...................... 354 348
Alternative minimum tax credit....... 44 86
Financial basis of assets in excess
of tax basis....................... (644) (344)
Valuation allowance.................. (4,834) (3,727)
--------- ---------
Net deferred tax assets.............. $ 44 $ 86
========= =========

The valuation allowance declined $59,000 and $1,107,000 in the years ended
December 31, 1995 and 1996, respectively because of net operating loss
carryforwards utilized in 1995 and 1996 and capital loss carryforwards which
expired.

F-16
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A reconciliation of the 1994, 1995 and 1996 provision for income taxes to
the statutory United States tax rate is as follows (in thousands):

1994 1995 1996
--------- --------- ---------
Federal tax computed at statutory
rate.................................. $ 50 $ 771 $ 643
Utilization of net operating loss
carryforwards......................... (50) (771) (643)
--------- --------- ---------
Actual provision........................ $ -- $ -- $ --
========= ========= =========

10. MAJOR CUSTOMERS:

For the years ended December 31, 1994, 1995 and 1996, the Company derived
over 10% of its sales of natural gas and transportation fees from Mid-America
Pipeline Company and affiliates, and Westlake Petrochemicals Corporation. They
accounted for 42% and 21% during 1994; 40% and 14% during 1995, and 31% and 15%
during 1996, respectively.

11. CONCENTRATION OF CREDIT RISK:

The Company derives revenue from gas transmission and gathering services
for commercial companies located in Alabama, Alaska, Kansas, Louisiana, New
York, Oklahoma, Tennessee and Texas. Two of Midcoast's largest customers account
for 44% or approximately $4.0 million of the outstanding accounts receivable at
December 31, 1996. (At March 31, 1997 these amounted to $0.5 million or 10% of
the outstanding receivables.) These accounts receivable were subsequently
collected under normal credit terms and the Company believes that future
accounts receivable with these companies will continue to be collected under
normal credit terms based on previous experience. The Company performs ongoing
evaluations of its customers and generally does not require collateral. The
Company assesses its credit risk and provides an allowance for doubtful accounts
for any accounts which it deems doubtful of collection. At March 31, 1997, no
provision for doubtful accounts was provided.

The Company maintains deposits in banks which may exceed the amount of
federal deposit insurance available. Management periodically assesses the
financial condition of the institutions and believes that any possible deposit
loss is minimal.

12. EMPLOYEE BENEFITS:

The Company issued a total of 36,133, 63,343 and 26,007 common shares of
the Company's common stock to certain key employees in 1994, 1995 and 1996,
respectively. No shares were issued in the three month period ended March 31,
1997. Of the shares issued in 1994 and 1996, 35,687 and 8,921 respectively were
issued in connection with employment agreements with certain employees and vest
in equal amounts: the 35,687 over a five-year period and the 8,921 shares over a
three-year period. The shares were valued at the estimated fair market value on
the date of issuance. Compensation expense is being recognized ratably over the
vesting period.

In May 1996, the Board of the Company adopted the Midcoast Energy
Resources, Inc. 1996 Incentive Stock Plan (the "Incentive Plan"), which was
subsequently approved by the Company's shareholders in May 1997. All employees,
including officers (whether or not directors) and consultants of the Company and
its subsidiaries are currently eligible to participate in the Incentive Plan.
Persons who are not in an employment or consulting relationship with the Company
or any of its subsidiaries, including non-employee directors, are not eligible
to participate in the Incentive Plan. Under the Incentive Plan, the Compensation
Committee may grant incentive awards with respect to a number of shares of
common stock that in the aggregate do not exceed 230,000 shares of common stock,
subject to adjustment upon the occurrence of certain recapitalizations of the
Company.

F-17
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Incentive Plan provides for the grant of (i) options, both incentive
stock options and non-qualified options, (ii) shares of restricted stock, (iii)
performance awards payable in cash or common stock, (iv) shares of phantom
stock, and (v) stock bonuses (collectively, the "Incentive Awards"). In
addition, the Incentive Plan provides for the grant of cash bonuses payable when
a participant is required to recognize income for federal income tax purposes in
connection with the vesting of shares of restricted stock or the issuance of
shares of common stock upon the grant of a performance award or a stock bonus,
provided, that such cash bonus may not exceed the fair market value (as defined)
of the shares of common stock received on the grant or exercise, as the case may
be, of an Incentive Award. No Incentive Award may be granted under the Incentive
Plan after ten years from the Incentive Plan adoption date.

In December 1996, the Company established a defined contribution 401(k)
Profit Sharing Plan for its employees. The plan provides participants a
mechanism for making contributions for retirement savings. Each participant may
contribute certain amounts of eligible compensation. The Company makes a
matching contribution to the plan which amounted to approximately $16,000 in
1996 and $12,000 for the three month period ended March 31, 1997.

In February 1997, the Company's Compensation Committee approved the
granting of 160,000 incentive stock options to certain key employees. The
options were issued at an exercise price equal to the fair market value on the
date of grant which was $10.50. The options vest in equal amounts over a
five-year period and expire in ten years from the date of grant. However, those
options issued to employees who own 10% or more of the Company's common stock
were valued at 110% of fair market value on the date of grant ($11.55), vest in
equal amounts over a four and one-half year period, and expire five years from
the date of grant.

13. SUBSEQUENT EVENTS:

In May 1997, the Company acquired the stock of three subsidiaries of Atrion
for cash consideration of approximately $39.4 million subject to post closing
adjustments and up to $2 million of deferred contingent payments to be paid over
an eight-year period. The three subsidiaries include ATNG, TRIGAS, and ATEMCO.
For further discussion of the acquisition see Note 4. Financing for the
acquisition was provided by the Company's existing bank lender, as discussed
below. In May 1997, the Company amended its Credit Agreement and the Company's
new ATNG subsidiary executed a new credit agreement with its existing bank
lender, Bank One, Texas N.A. which increased the Company's total borrowing
availability to $46.5 million. Pursuant to the amendment of the Credit
Agreement, the borrowing availability under the reducing revolving line of
credit was increased to $38.5 million and the working capital line of credit
increased to $3 million. Furthermore, an additional $10.0 million of
availability was negotiated for the issuance of letters of credit. The new ATNG
credit agreement provides for a $5.0 million reducing revolving line of credit
and all other terms and conditions of the new agreement are the same in all
material respects as the Credit Agreement. Available credit under the reducing
revolving lines will be reduced by a total of approximately $362,667 per month
on July 1 and August 1, 1997 with a balloon payment of $7.0 million on August
31, 1997 at which time the available credit will be reduced by $304,167 per
month thereafter. In addition to the fees currently required under the Credit
Agreement, a $100,000 fee was paid upon consummation of the AlaTenn Subsidiaries
acquisition in consideration for extending the financing.

In April 1997, the Board of Directors, approved the adoption of the 1997
Non-Employee Director Stock Option Plan (the "Director Plan"), which was
subsequently approved by the Company's shareholders in May 1997. The Director
Plan provides for the grant to non-employee: (i) Existing Directors (as defined)
on the Effective Date (as defined), a non-qualified stock option ("NQO") to
purchase 5,000 shares of the Company's common stock and (ii) New Directors (as
defined) on their initial election, a NQO to purchase 15,000 shares of common
stock both at an exercise price equal to the fair market value of the

F-18
<PAGE>
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

common stock on the date of grant. The Director Plan also entitles each
non-employee director to receive a NQO to purchase 5,000 shares of common stock
on each date he is reelected to Company's Board.

The Compensation Committee of the Board has no discretion as to the
selection of the non-employee directors to whom NQOs are to be granted or Cash
Fee Awards (as defined) are paid, the number of shares subject to any NQO
granted, the exercise price of any NQO granted or the ten-year maximum term of
any NQO granted thereunder. The Compensation Committee has the authority to
interpret and construe any provision of the Director Plan and to adopt such
rules and regulations for administering the Director Plan as it seems necessary.
All decisions and determinations of the Compensation Committee are final and
binding on all parties. The Company has agreed to indemnify each member of the
Compensation Committee against any cost, expense or liability arising out of any
action omission or determination relating to Director Plan, unless such action,
omission or determination was taken or made in bad faith and without reasonable
belief that is was in the best interest of the Company.

The Director Plan provides for the adjustment of the number of shares
covered by an option awarded thereunder, and of the exercise price thereof, on
any stock dividend, any subdivision or combination of the outstanding shares of
common stock and any merger, consolidation, recapitalization of the Company or
other similar event which affects the issued and outstanding shares of common
stock.

Pursuant to the Director Plan, 5,000 NQOs were granted to the only Existing
Director in May 1997. The NQOs were issued at an exercise price equal to the
fair market value on the date of grant which was $15.125, and which expires ten
years from the date of grant.

F-19
<PAGE>
INDEPENDENT AUDITOR'S REPORT

To the Owner of the AlaTenn Subsidiaries

We have audited the accompanying combined balance sheets of the AlaTenn
Subsidiaries as of December 31, 1995 and 1996, and the related combined
statements of operations, retained earnings and cash flows for the years in the
three-year period ended December 31, 1996. These combined financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these combined financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of the AlaTenn
Subsidiaries as of December 31, 1995 and 1996, and the results of its operations
and its cash flows for the years in the three-year period ended December 31,
1996, in conformity with generally accepted accounting principles.

As discussed in Note 1, the Company has been a member of a group of
affiliated companies and, as disclosed in the financial statements, has
extensive transactions and relationships with members of the group. Because of
these relationships, the terms of some or all of these transactions may not be
the same as those that would result from transactions among wholly unrelated
parties. No evaluation to make such a determination was undertaken nor did we
become aware of such circumstances during our audits.

HEIN + ASSOCIATES LLP
Houston Texas
May 9, 1997

F-20
<PAGE>
ALATENN SUBSIDIARIES
COMBINED BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, MARCH 31,
1995 1996 1997
------------ ------------ -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Accounts receivable................ $ 12,309,210 $ 15,218,791 $ 7,961,289
Other current assets............... 690,293 904,531 858,548
------------ ------------ -----------
Total current assets.......... 12,999,503 16,123,322 8,819,837
------------ ------------ -----------
PROPERTY, PLANT AND EQUIPMENT........... 28,160,147 28,382,427 28,418,888
ACCUMULATED DEPRECIATION AND
AMORTIZATION.......................... (15,099,886) (15,667,504) (15,836,768)
------------ ------------ -----------
13,060,261 12,714,923 12,582,120
DEFERRED CONTRACT COSTS AND OTHER
ASSETS................................ 1,476,861 1,459,742 1,467,680
------------ ------------ -----------
Total assets.................. $ 27,536,625 $ 30,297,987 $22,869,637
============ ============ ===========

LIABILITIES AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued
liabilities...................... $ 10,470,122 $ 14,722,157 $ 6,770,122
Accrued income and other taxes..... 263,025 368,695 217,984
------------ ------------ -----------
Total current liabilities..... 10,733,147 15,090,852 6,988,106
------------ ------------ -----------
DEFERRED INCOME......................... 312,713 108,682 72,132
DEFERRED INCOME TAXES................... 1,385,199 1,507,520 1,533,520
UNAMORTIZED INVESTMENT TAX CREDITS...... 238,364 226,184 223,151
OTHER................................... 1,050,067 841,089 892,494
------------ ------------ -----------
2,986,343 2,683,475 2,721,297
------------ ------------ -----------
SHAREHOLDER'S EQUITY:
Common stock....................... 5,600 5,600 5,600
Paid-in capital.................... 11,276,400 11,276,400 11,276,400
Retained earnings.................. 2,535,135 1,241,660 1,878,234
------------ ------------ -----------
Total shareholder's equity.... 13,817,135 12,523,660 13,160,234
------------ ------------ -----------
Total liabilities and
shareholder's equity....... $ 27,536,625 $ 30,297,987 $22,869,637
============ ============ ===========
</TABLE>
The accompanying notes to combined financial statements are an integral part of
these statements.

F-21
<PAGE>
ALATENN SUBSIDIARIES
COMBINED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
FOR THE YEARS ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
----------------------------------------------- ------------------------------
1994 1995 1996 1996 1997
-------------- -------------- --------------- -------------- --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING REVENUES...................... $ 63,060,561 $ 68,557,243 $ 113,428,662 $ 38,119,207 $ 32,054,747
OPERATING EXPENSES:
Cost of natural gas and
transportation charges........... 52,536,706 58,709,495 102,157,152 34,103,919 29,249,589
General and administrative......... 3,744,302 3,876,651 3,960,694 1,126,018 872,560
Depreciation and amortization...... 554,750 576,987 584,121 145,979 147,064
-------------- -------------- --------------- -------------- --------------
Total operating expenses...... 56,835,758 63,163,133 106,701,967 35,375,916 30,269,213
-------------- -------------- --------------- -------------- --------------
Operating income.............. 6,224,803 5,394,110 6,726,695 2,743,291 1,785,534
RECOVERY OF ESTIMATED NONRECOVERABLE
TAKE-OR-PAY EXPENSE................... -- -- 472,888 -- --
NON-OPERATING ITEMS:
Interest expense................... (90,797) (26,435) (1,284) (6) --
Other income (expense), net........ 420,088 412,016 76,902 36,187 4,752
-------------- -------------- --------------- -------------- --------------
INCOME BEFORE INCOME TAXES.............. 6,554,094 5,779,691 7,275,201 2,779,472 1,790,286
INCOME TAXES............................ (2,395,214) (2,101,538) (2,641,747) (1,006,521) (647,966)
-------------- -------------- --------------- -------------- --------------
NET INCOME.............................. $ 4,158,880 $ 3,678,153 $ 4,633,454 $ 1,772,951 $ 1,142,320
============== ============== =============== ============== ==============
</TABLE>
The accompanying notes to combined financial statements are an integral part of
these statements.

F-22
<PAGE>
ALATENN SUBSIDIARIES
COMBINED STATEMENTS OF RETAINED EARNINGS

<TABLE>
<CAPTION>
THREE
MONTHS
FOR THE YEARS ENDED DECEMBER 31, ENDED
---------------------------------------------- MARCH 31,
1994 1995 1996 1997
-------------- -------------- -------------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Balance, beginning of period............ $ 5,388,306 $ 4,458,464 $ 2,535,135 $ 1,241,660
Net income.............................. 4,158,880 3,678,153 4,633,454 1,142,320
Dividends paid.......................... (1,443,840) (1,531,104) (1,970,763) --
Settlements with parent -- net.......... (3,644,882) (4,070,378) (3,956,166) (505,746)
-------------- -------------- -------------- -----------
Balance, end of period.................. $ 4,458,464 $ 2,535,135 $ 1,241,660 $ 1,878,234
============== ============== ============== ===========
</TABLE>
The accompanying notes to combined financial statements are an integral part of
these statements.

F-23
<PAGE>
ALATENN SUBSIDIARIES
COMBINED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
THREE MONTHS ENDED
FOR THE YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------------------- ------------------------------
1994 1995 1996 1996 1997
-------------- -------------- -------------- -------------- --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income......................... $ 4,158,880 $ 3,678,153 $ 4,633,454 $ 1,772,951 $ 1,142,320
Adjustments to arrive at net cash
provided by (used in) operating
activities:
Depreciation and amortization.... 554,750 576,987 584,121 145,979 147,064
Deferred income taxes............ (109,210) 182,390 122,321 9,264 26,000
Take-or-pay recoveries (net of
expenditures)................. 1,053,442 2,450,303 1,596,956 263,719 --
Take-or-pay reserve adjustment... 75,253 -- (472,888) -- --
Other............................ 454,966 638,364 62,819 267,760 26,084
Changes in working capital
accounts:
Accounts receivable.............. 4,354,620 (3,493,654) (4,412,777) (1,923,171) 7,257,502
Other current assets............. 327,601 (8,009) (214,238) (222,951) 45,983
Accounts payable and accrued
liabilities................... (4,720,261) 2,129,803 4,252,033 3,380,574 (7,952,035)
Accrued income and other taxes... (12,502) (55,786) 105,670 179,613 (150,711)
-------------- -------------- -------------- -------------- --------------
Net cash provided by operating
activities................. 6,137,539 6,098,551 6,257,471 3,873,738 542,207
-------------- -------------- -------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures............... (1,048,817) (497,069) (330,542) (184,493) (36,461)
-------------- -------------- -------------- -------------- --------------
Net cash used in investing
activities................. (1,048,817) (497,069) (330,542) (184,493) (36,461)
-------------- -------------- -------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Settlements with parent -- net..... (3,644,882) (4,070,378) (3,956,166) (3,689,245) (505,746)
Dividends on common stock.......... (1,443,840) (1,531,104) (1,970,763) -- --
-------------- -------------- -------------- -------------- --------------
Net cash used in investing
activities................. (5,088,722) (5,601,482) (5,926,929) (3,689,245) (505,746)
-------------- -------------- -------------- -------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS........................... -- -- -- -- --
-------------- -------------- -------------- -------------- --------------
CASH AND CASH EQUIVALENTS, beginning of
period................................ -- -- -- -- --
-------------- -------------- -------------- -------------- --------------
CASH AND CASH EQUIVALENTS, end of
period................................ $ -- $ -- $ -- $ -- $ --
============== ============== ============== ============== ==============
CASH PAID FOR INTEREST.................. $ -- $ -- $ -- $ -- $ --
============== ============== ============== ============== ==============
CASH PAID FOR INCOME
TAXES -- STATE........................ $ 250,000 $ 259,000 $ 203,000 $ 15,000 $ 39,000
============== ============== ============== ============== ==============
</TABLE>
The accompanying notes to combined financial statements are an integral part of
these statements.

F-24
<PAGE>
ALATENN SUBSIDIARIES
NOTES TO COMBINED FINANCIAL STATEMENTS

The accompanying financial information as of March 31, 1997 and for the
three months ended March 31, 1996 and 1997 has been prepared, without audit,
pursuant to the rules and regulations of the United States Securities and
Exchange Commission. The financial information reflects all adjustments,
consisting of normal recurring accruals, which are, in the opinion of
management, necessary to fairly present such information in accordance with
generally accepted accounting principles.

1. SUMMARY OF SIGNIFICIANT ACCOUNTING POLICIES:

The accompanying financial statements of the AlaTenn Subsidiaries represent
the predecessor operations of certain natural gas transportation and marketing
businesses owned by Atrion Corporation. These three subsidiaries include
Alabama-Tennessee Natural Gas Company, Inc. ("ATNG"), AlaTenn Energy Marketing
Company, Inc. ("ATEMCO") and Tennessee River Intrastate Gas Company, Inc.
("TRIGAS"), which are natural gas pipeline and marketing companies that
provide pipeline transportation and natural gas marketing services to the lower
Tennessee Valley area. Hereafter these combined predecessor operations of the
AlaTenn Subsidiaries are referred to as "the Company" solely for the purpose
of this presentation.

In March 1997, Atrion entered into a definitive purchase and sale agreement
(the "Agreement") to sell the stock of the AlaTenn Subsidiaries to Midcoast
Energy Resources, Inc. ("Midcoast") for cash consideration of approximately
$39.4 million subject to post closing adjustments and $2 million of deferred
contingent payments to be paid in equal amounts over an eight-year period. The
Agreement contains representations and warranties, indemnities and conditions to
closing customary to transactions of this type. At March 31, 1997, the
acquisition had been approved by the boards of directors of both Midcoast and
Atrion, however, the acquisition was subject to approval by Atrion's
shareholders. In conjunction with executing the purchase and sale agreement,
Midcoast was required to deposit $2.0 million in an escrow account maintained by
the trust department of a bank. In the event that Midcoast was unable or
unwilling to consummate the transaction after the necessary approvals had been
received, the escrowed money would be paid to Atrion as compensation for all
damages. On the other hand, the agreement also stipulated that if Atrion was
unable or unwilling to consummate the transaction, which included not receiving
shareholder approval, Midcoast would receive $2.0 million as cash compensation
for all damages. The transaction was consummated on May 30, 1997.

PRINCIPLES OF COMBINATION -- The combined financial statements include the
accounts of ATNG, ATEMCO and TRIGAS. All significant intercompany transactions
and balances between these three companies have been eliminated.

INTERIM FINANCIAL STATEMENTS -- The accompanying interim financial
statements have not been audited by independent accountants; however, in the
opinion of management, all necessary adjustments have been made to present
fairly the Company's financial position at March 31, 1997 and the results of its
operations and cash flows for the three month periods ended March 31, 1996 and
1997. The adjustments and allocations made for the interim financial statements
are only of a normal and recurring nature and are consistent with those made for
the audited annual statements. The results for the three-month period ended
March 31, 1997 are not necessarily indicative of future financial results.

TRANSACTIONS WITH PARENT -- Atrion provides financing and cash management
services through a centralized treasury system, with the associated transactions
being recorded in the group's system of intercompany accounts. The Company's net
cash settlements paid to Atrion (including settlements for income taxes) and
offsetting amounts for allocated costs are included in the Equity section of the
balance sheet for the purpose of this presentation.

F-25
<PAGE>
ALATENN SUBSIDIARIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

PROPERTY, PLANT AND EQUIPMENT -- Property, plant and equipment are stated
at original cost. The cost of additions to property, plant and equipment
includes direct labor and material, allocable overheads and, in the case of
natural gas pipeline plant, an allowance for the estimated cost of funds used
during construction ("AFUDC"). Such provisions for AFUDC are not reflected
separately in the accompanying combined statements of operations as the amounts
are not material. Maintenance and repairs, including the cost of renewals of
minor items of property, are charged principally to expense as incurred.
Replacements of property (exclusive of minor items of property) are charged to
the appropriate property accounts. Upon retirement of a natural gas pipeline
plant asset, its cost is charged to accumulated depreciation together with the
cost of removal, less salvage value. The following table represents a summary of
property, plant and equipment as of December 31, 1995 and 1996:

1995 1996
-------------- --------------
Pipelines and related facilities........ $ 26,726,511 $ 26,948,791
Land.................................... 77,358 77,358
Buildings............................... 1,356,278 1,356,278
-------------- --------------
Total................................... $ 28,160,147 $ 28,382,427
============== ==============

DEPRECIATION AND AMORTIZATION -- Depreciation on pipeline plant is
calculated using the composite rate method which approximated an average
depreciation rate of 2.0% in 1994, 2.1% in 1995 and 2.0% in 1996. Depreciation
on other facilities and equipment is calculated on a straight-line basis over
the useful lives of the assets which range from two to sixty-two years.

OPERATING REVENUE -- The Company recognizes revenue from natural gas sales
and transportation service in the period the service is provided. Provision is
made for possible refund of revenues collected which are subject to future rate
decisions.

INCOME TAXES -- The Company's deferred income taxes reflect the impact of
"temporary differences" between amounts of assets and liabilities for
financial reporting purposes and such amounts as measured by tax laws. These
temporary differences are determined in accordance with Statement of Financial
Accounting Standard No. 109 ("SFAS 109"), Accounting for Income Taxes.
Investment tax credits are deferred and amortized to income over the lives of
the related assets.

ESTIMATES -- The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amount of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

RECENT ACCOUNT PRONOUNCEMENTS -- The Financial Accounting Standards Board
("FASB") issued SFAS No. 121 entitled "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of" which is
effective for fiscal years beginning after December 15, 1995. SFAS No. 121
specifies certain events and circumstances which indicate the cost of an asset
or assets may be impaired, the method by which the evaluation should be
performed, and the method by which writedowns, if any, of the asset or assets
are to be determined and recognized. The adoption of this pronouncement in 1996
did not have a material impact on the Company's financial condition or operating
results.

2. REGULATORY AND RATE MATTERS:

The Company's interstate natural gas pipeline subsidiary, ATNG, is
regulated by the Federal Energy Regulatory Commission ("FERC"). The FERC
establishes the maximum and minimum transportation rates ATNG is permitted to
charge its customers. The Company's intrastate natural gas pipeline subsidiary,
TRIGAS, is regulated by the Alabama Public Service Commission ("APSC"). The
rates to TRIGAS' transportation customers are determined by negotiated contracts
which were approved by the APSC.

F-26
<PAGE>
ALATENN SUBSIDIARIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

On April 1, 1993, ATNG increased its jurisdictional rates from rates that
had been in effect since April 1990. This rate increase was agreed to in an
uncontested settlement with ATNG's customers which the FERC approved on December
30, 1993. That agreement was amended in September 1996 to eliminate the
requirement that ATNG file a new rate case in September 1996. As part of that
agreement ATNG reduced its rates by 6% effective September 1, 1996.

During the 1980s and early 1990s, many interstate natural gas pipelines
incurred significant take-or-pay liabilities owed to natural gas producers. ATNG
and the other subsidiaries of the Company did not incur any direct take-or-pay
obligations to natural gas suppliers or producers. However, through various
orders issued during the period from 1988 to 1992, the FERC allowed Tennessee
Gas Pipeline Company ("TGP") to pass on to its customers, including ATNG,
certain buyout and buydown costs. The portion of this take-or-pay obligation
which ATNG owed to TGP under various FERC approved orders, including interest,
totaled $23 million, all of which was paid by ATNG during the period from 1988
through 1995.

In 1991, ATNG reached a settlement with its customers which provided for
the recovery of a portion of the take-or-pay costs billed to it by TGP over a
five-year period. During 1996, ATNG recovered the final $1.8 million of
take-or-pay accounts receivable from its customers, and recognized a gain on the
reversal of estimated non-recoverable amounts originally recorded in 1989,
resulting in pre-tax income of $472,888.

3. INCOME TAXES:

The items comprising income tax expense are as follows (in thousands):

1994 1995 1996
--------- --------- ---------
Current:
Federal............................ $ 2,380 $ 1,932 $ 2,193
State.............................. 234 188 216
--------- --------- ---------
2,614 2,120 2,409
--------- --------- ---------
Deferred:
Federal............................ (190) (5) 225
State.............................. (16) -- 20
--------- --------- ---------
(206) (5) 245
--------- --------- ---------
Investment tax credits utilized......... (13) (13) (12)
--------- --------- ---------
Total income tax expense................ $ 2,395 $ 2,102 $ 2,642
========= ========= =========

The taxable income or loss of the Company is included in a consolidated
federal income tax return filed by Atrion Corporation. In accordance with income
tax allocation arrangements among certain companies, the Company makes
provisions for taxes as if the Company filed separately.

F-27
<PAGE>
ALATENN SUBSIDIARIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

Temporary differences and carryforwards which gave rise to a significant
portion of deferred tax assets and liabilities as of December 31, 1995 and 1996
are as follows (in thousands):

1995 1996
--------- ---------
Deferred tax assets:
Deferred investment tax
credits......................... $ 88 $ 82
Provisions for refunds.......... 120 130
Benefit plans................... 233 301
Other, net...................... 284 145
--------- ---------
Subtotal................... 725 658
Valuation allowance........ -- --
--------- ---------
Total deferred tax
assets..................... 725 658
--------- ---------
Deferred tax liabilities:
Depreciation and basis
differences..................... 1,931 2,004
Pensions........................ 138 142
Other, net...................... 41 20
--------- ---------
Total deferred tax
liabilities................ 2,110 2,166
--------- ---------
Net liability.............. $ 1,385 $ 1,508
========= =========

No valuation allowance is deemed necessary, as the Company anticipates
generating adequate future taxable income to realize the benefits of all
deferred tax assets on the balance sheet.

Total income tax expense differs from the amount which would be provided by
applying the statutory federal income tax rate to pretax earnings as illustrated
below (in thousands):

1994 1995 1996
--------- --------- ---------
Income tax expense at statutory
federal income tax rate............ $ 2,228 $ 1,965 $ 2,474
Increase (decrease) resulting from:
State income taxes.............. 205 180 175
Other, net...................... (38) (43) (7)
--------- --------- ---------
Total income tax expense........ $ 2,395 $ 2,102 $ 2,642
========= ========= =========

4. COMMON STOCK:

The following is a summary of common stock issued and outstanding for each
of the three subsidiaries as of December 31, 1995 and 1996 (in thousands):

ATNG.................................... $ 5,400
ATEMCO.................................. 100
TRIGAS.................................. 100
---------
Total.............................. $ 5,600
=========

5. REVENUES FROM MAJOR CUSTOMERS:

In 1994, approximately $23 million (36%) and $9 million (14%) of the
Company's operating revenues were attributable to two natural gas customers.

In 1995, approximately $20 million (29%) and $10 million (14%) of the
Company's operating revenues were attributable to the same two natural gas
customers.

In 1996, approximately $32 million (28%), $19 million (17%) and $16 million
(14%) of the Company's operating revenues were attributable to three natural gas
customers (the two largest are the same customers as 1994 and 1995).

F-28
<PAGE>
ALATENN SUBSIDIARIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

6. CONCENTRATION OF CREDIT RISK:

The Company derives revenue from gas transmission and marketing services in
the Tennessee Valley. Three of the Company's largest customers account for
approximately 55% or approximately $7.7 million ($2.1 million, $2.3 million and
$3.3 million, respectively) of the outstanding accounts receivable at December
31, 1996. These accounts receivable were subsequently collected under normal
credit terms and the Company believes that future accounts receivable with these
companies will continue to be collected under normal credit terms based on
previous experience. The Company performs ongoing evaluations of its customers
and generally does not require collateral. The Company assesses its credit risk
and provides an allowance for doubtful accounts for any accounts which it deems
doubtful of collection. At December 31, 1996, no provision for doubtful accounts
was provided.

7. EMPLOYEE RETIREMENT AND BENEFIT PLANS:

A noncontributory retirement plan is maintained for all regular employees
of the Company. The plan provides benefits based on years of service and other
factors. The Company's funding policy is to make the annual contributions
required by applicable regulations and recommended by its actuary.

Net pension income for 1994, 1995 and 1996 included the following
components (in thousands):

1994 1995 1996
--------- --------- ---------
Service cost......................... $ 139 $ 112 $ 151
Interest cost........................ 277 287 305
Actual return on assets.............. 66 (919) (633)
Net amortization and deferral........ (492) 509 168
--------- --------- ---------
Net periodic pension income.......... $ (10) $ (11) $ (9)
========= ========= =========

The following schedule sets forth the plan's funded status as of December
31, 1995 and 1996 and the amounts recognized on the Company's balance sheets for
those years (in thousands):

1995 1996
--------- ---------
Actuarial present value of benefit
obligation:
Vested.......................... $ 3,353 $ 3,485
Non-vested...................... 17 55
--------- ---------
Accumulated benefit obligation....... $ 3,370 $ 3,540
========= =========
Projected benefit obligation......... (4,123) (4,314)
Plan assets at fair value............ 5,263 5,583
--------- ---------
Plan assets in excess of projected
benefit obligation................. 1,140 1,269
Unrecognized net gain................ (156) (335)
Unrecognized net assets at date of
initial adoption................... (558) (498)
--------- ---------
Prepaid pension asset................ $ 426 $ 436
========= =========

The weighted average discount rate used in determining the actuarial
present value of the projected benefit obligation shown above was 7.25% in both
1995 and 1996. The rate of increase in future compensation levels used in
determining the actuarial present value of the projected benefit obligation
shown above was 6% in both 1995 and 1996. The expected long-term rate of return
on assets was 8% in both years. At December 31, 1996, plan assets were invested
approximately 40% in fixed income securities, 6% in cash and cash equivalents
and 54% in equity securities.

Effective July 1, 1992, the Company adopted a nonqualified Supplemental
Executive Retirement Plan ("SERP") which provides additional pension benefits
to certain executive officers of the Company. Expense recognized in connection
with the SERP in 1994, 1995 and 1996 was $50,000, $69,000 and $78,000,
respectively.

F-29
<PAGE>
ALATENN SUBSIDIARIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

The Company also sponsors defined contribution plans for its employees.
These plans provide participants a mechanism for making contributions for
retirement savings. Each participant may contribute up to 12% of eligible
compensation. The Company makes a 100% matching contribution for up to 6% to the
plans. The Company's contribution under these plans was $97,000 in 1994,
$116,000 in 1995 and $114,000 in 1996.

The Company also provides certain contributory postretirement health care
and life insurance benefits to full-time employees of ATNG. The Company's
commitment towards the cost of these postretirement health care benefits in the
year 2000 and later is capped based on the levels provided in 1999.

The Company adopted FASB Statement No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions" effective as of January 1, 1993.
ATNG has established a VEBA trust to fund these expenses. The expected long-term
rate of return on plan assets was 8.0% as of December 31, 1996. The investment
income of the trust is subject to federal income tax.

The following schedule presents the plan's funded status reconciled with
amounts recognized in the Company's balance sheets as of December 31, 1995 and
1996 (in thousands):

1995 1996
--------- ---------
Accumulated postretirement benefit
obligation:
Retirees........................ $ (365) $ (263)
Fully eligible active plan
participants.................. (140) (47)
Other active plan
participants.................. (175) (111)
--------- ---------
Total................. (680) (421)
--------- ---------
Plan assets.......................... 202 294
--------- ---------
Accumulated postretirement benefit
obligation in excess of plan
assets............................. (478) (127)
Unrecognized net loss (gain)......... 25 (289)
Unrecognized transition obligation... 470 442
--------- ---------
Accrued postretirement benefit
cost............................... $ 17 $ 26
========= =========

Net periodic postretirement benefit cost included the following components
(in thousands):

1995 1996
--------- ---------
Service cost......................... $ 13 $ 18
Interest cost........................ 49 49
Actual (return) loss on plan
assets............................. (27) (24)
Amortization of transition obligation
over 20 years...................... 28 28
Net amortization and deferral........ 19 9
--------- ---------
Net periodic postretirement benefit
cost............................... $ 82 $ 80
========= =========

The assumed rate of increase in the per capita cost of covered health care
benefits for pre age 65 plan participants is 8.5% for 1997 and is assumed to
decrease gradually to 5.0% by 2004 and then remain level. For post age 64
participants, the rate is 8.5% for 1997 and is assumed to decrease gradually to
5.0% by 2004 and then remain level. Increasing the assumed health care cost
trend rates by one percentage point in each year would increase the accumulated
postretirement benefit obligation as of December 31, 1996 by $300 and the
aggregate of the service and interest cost components of net periodic
postretirement benefit cost for 1996 by $0.

The discount rate used in determining the accumulated postretirement
benefit obligation was 7.25% at December 31, 1995 and 1996.

F-30
<PAGE>
INDEPENDENT AUDITOR'S REPORT

Board of Directors and Shareholders
Midcoast Energy Resources, Inc.
Houston, Texas

We have audited the accompanying historical summary of revenue and direct
operating expenses of the KOCH Hydrocarbon Company -- Harmony Gas Processing
Plant acquired October 7, 1996 for the year ended December 31, 1995. The
historical summary is the responsibility of the Company's management. Our
responsibility is to express an opinion on the historical summary based on our
audit.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the historical summary is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the historical summary. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall historical summary presentation.
We believe that our audit provides a reasonable basis for our opinion.

The accompanying historical summary was prepared for the purpose of
complying with the rules and regulations of the Securities and Exchange
Commission (for inclusion in the Form 8-K of Midcoast Energy Resources, Inc.) as
described in Note 2 and are not intended to be a complete presentation of the
Harmony Gas Processing Plant revenues and expenses.

In our opinion, the historical summary referred to above presents fairly,
in all material respects, the revenue and direct operating expenses of the
Harmony Gas Processing Plant acquired October 7, 1996 for the year ended
December 31, 1995, in conformity with generally accepted accounting principles.

HEIN + ASSOCIATES LLP

Houston, Texas
November 8, 1996

F-31
<PAGE>
MIDCOAST ENERGY RESOURCES, INC.
KOCH HYDROCARBONS COMPANY-HARMONY GAS PROCESSING PLANT
ACQUIRED OCTOBER 7, 1996

HISTORICAL SUMMARY OF REVENUE AND DIRECT OPERATING EXPENSES
FOR THE SIX MONTHS ENDED JUNE 30, 1996 AND 1995 AND FOR THE YEAR ENDED DECEMBER
31, 1995.

<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1996 JUNE 30, 1995 YEAR ENDED
(UNAUDITED) (UNAUDITED) DECEMBER 31, 1995
------------- ------------- -----------------
<S> <C> <C> <C>
Revenues............................. $ 3,052,699 $ 2,284,029 $ 5,223,506

Direct Operating Expenses............ (2,492,780) (1,919,523) (4,618,326)
------------- ------------- -----------------

Net Revenue.......................... $ 559,919 $ 364,506 $ 605,180
============= ============= =================
</TABLE>
See accompanying notes to historical summary.

F-32
<PAGE>
MIDCOAST ENERGY RESOURCES, INC.
ACQUISITION OF KOCH HYDROCARBONS COMPANY
HARMONY GAS PROCESSING PLANT

NOTES TO HISTORICAL SUMMARY OF REVENUE AND
DIRECT OPERATING EXPENSES
FOR THE SIX MONTHS ENDED JUNE 30, 1996 AND 1995 AND THE YEAR ENDED
DECEMBER 31, 1995.

1. BASIS OF PRESENTATION

The accompanying Historical Summary of Revenue and Direct Operating
Expenses relates to the operations of the Harmony Gas Processing Plant
("Harmony") acquired by Midcoast Energy Resources, Inc. ("Midcoast") on
October 7, 1996 from KOCH Hydrocarbons Company ("KOCH") for cash consideration
of $3,638,884, subject to certain purchase price adjustments. All revenues were
derived from sales to KOCH affiliates with pricing established by prevailing
market rates and various contractual agreements. Revenues are recorded when the
natural gas products are delivered to the customer and direct operating expenses
are recorded when the liability is incurred. Depreciation of the plant has been
excluded from direct operating expenses in the accompanying historical summary
because the amounts would not be comparable to those resulting from Midcoast's
cost basis in the plant. Income taxes have not been included in the accompanying
historical summary because income taxes are not considered direct operating
expense of the properties.

The Historical Summary presented herein was prepared for the purpose of
complying with the financial statement requirements of a business acquisition as
promulgated by Regulation S-X Rule 3-05 and Rule 1-02 (v) of the Securities
Exchange Act of 1934.

F-33
<PAGE>
================================================================================

NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING
OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED
HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH
OFFER IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE
MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE
HEREOF OR THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE SUCH
DATE.

------------------------

TABLE OF CONTENTS

Page
----
Available Information .................................................... 3
Prospectus Summary ....................................................... 4
Risk Factors ............................................................. 11
Forward Looking Statements ............................................... 15
Use of Proceeds .......................................................... 16
Price Range of Common Stock and Dividend Policy .......................... 17
Capitalization ........................................................... 18
Selected Historical Consolidated Financial Data .......................... 19
Unaudited Pro Forma Consolidated Financial Statements .................... 20
Management's Discussion and Analysis of Financial Condition and Results
of Operations .......................................................... 26
Business and Properties .................................................. 32
Management ............................................................... 44
Principal Stockholders ................................................... 51
Selling Stockholder ...................................................... 52
Shares Eligible for Future Sale .......................................... 53
Description of Capital Stock ............................................. 54
Underwriting ............................................................. 56
Legal Matters ............................................................ 57
Experts .................................................................. 57
Glossary ................................................................. 58
Index to Financial Statements ............................................ F-1

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================================================================================

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COMMON STOCK

-----------------------
PROSPECTUS
-----------------------

OPPENHEIMER & CO., INC.
A.G. EDWARDS & SONS, INC.
COLEMAN AND COMPANY
SECURITIES, INC.

JUNE 27, 1997

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