sept-07_10q.htm
 


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(X)  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2007

OR

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from               to              

Commission File Number 1-31398
logo 
NATURAL GAS SERVICES GROUP, INC
(Exact name of registrant as specified in its charter)
 
           Colorado
          75-2811855
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
 
2911 SCR 1260
Midland, Texas 79706
(Address of principal executive offices)
(432) 563-3974
(Issuer’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes   x
No   o  
 
Indicate by check mark whether the registrant is a large accelerated filer, and accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o
Accelerated Filer   x
Non Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o
No x
 
APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date.
 
Class
 
  Outstanding at October 31, 2007
Common Stock, $.01 par value
 
12,081,334 



NATURAL GAS SERVICES GROUP, INC.


 
Part I - FINANCIAL INFORMATION
 
 
 
Item 1.  Financial Statements
 
 
 
Page 1
 
 
Page 2
 
 
Page 3
 
 
Page 4
 
 
Page 9
 
 
Page 15
 
 
Page 15
 
 
Part II - OTHER INFORMATION
 
 
 
Page 16
 
 
Item 1A.  Risk Factors
Page 16
 
 
Item 6.  Exhibits
Page 17
 
 
Page 20
 
 




NATURAL GAS SERVICES GROUP, INC.

Item 1.  Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except for per share amounts)
(unaudited)
 
 
December 31, 2006
 
 
September 30, 2007
 
           ASSETS
 
 
 
 
 
 
Current Assets:
 
 
 
 
 
 
   Cash and cash equivalents
 
$
4,391
 
 
$
2,022
 
   Short-term investments
 
 
25,052
 
 
 
22,899
 
   Trade accounts receivable, net of doubtful accounts of $110 each period
 
 
8,463
 
 
 
7,747
 
   Inventory, net of allowance for obsolescence of $347 each period
 
 
16,943
 
 
 
21,122
 
   Prepaid expenses and other
 
 
321
 
 
 
530
 
              Total current assets
 
 
55,170
 
 
 
54,320
 
 
 
 
 
 
 
 
 
 
Rental equipment, net of accumulated depreciation of $11,320 and $15,299, respectively
 
 
59,866
 
 
 
70,782
 
Property and equipment, net of accumulated depreciation of $3,679 and $4,557, respectively
 
 
6,714
 
 
 
6,254
 
Goodwill, net of accumulated amortization $325 each period
 
 
10,039
 
 
 
10,039
 
Intangibles, net of accumulated amortization of $819 and $1,063, respectively
 
 
3,650
 
 
 
3,406
 
Other assets
 
 
113
 
 
 
56
 
             Total assets
 
$
135,552
 
 
$
144,857
 
 
 
 
 
 
 
 
 
 
           LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
 
 
 
 
Current Liabilities:
 
 
 
 
 
 
 
 
   Current portion of long-term debt
 
$
3,442
 
 
$
3,378
 
   Current portion subordinated notes-related parties
 
 
1,000
 
 
 
1,000
 
   Accounts payable
 
 
2,837
 
 
 
3,807
 
   Accrued liabilities
 
 
2,077
 
 
 
3,297
 
   Current portion of tax liability
 
 
1,056
 
 
 
373
 
   Deferred income
 
 
225
 
 
 
246
 
Total current liabilities
 
 
10,637
 
 
 
12,101
 
 
 
 
 
 
 
 
 
 
Long-term debt, less current portion
 
 
12,950
 
 
 
10,417
 
Subordinated notes-related parties, less current portion
 
 
1,000
 
 
 
 
Deferred income tax payable
 
 
9,764
 
 
 
11,970
 
              Total liabilities
 
 
34,351
 
 
 
34,488
 
 
 
 
 
 
 
 
 
 
Stockholders’ Equity:
 
 
 
 
 
 
 
 
Common stock, 30,000 shares authorized, par value $0.01; 12,046 and 12,072 shares issued and outstanding, respectively
 
 
120
 
 
 
121
 
Additional paid-in capital
 
 
82,560
 
 
 
83,063
 
Retained earnings
 
 
18,521
 
 
 
27,185
 
               Total stockholders’ equity
 
 
101,201
 
 
 
110,369
 
              Total liabilities and stockholders’ equity
 
$
135,552
 
 
$
144,857
 

See accompanying notes to these condensed consolidated financial statements.



1

NATURAL GAS SERVICES GROUP, INC.

CONDENSED CONSOLIDATED INCOME STATEMENTS
(in thousands, except earnings per share)
(unaudited) 
 
 
Three months ended September 30,
 
 
Nine months ended September 30,
 
 
 
2006
 
 
2007
 
 
2006
 
 
2007
 
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
   Sales, net
 
$
10,880
 
 
$
10,574
 
 
$
28,509
 
 
$
30,239
 
   Service and maintenance income
 
 
209
 
 
 
220
 
 
 
749
 
 
 
729
 
   Rental income
 
 
6,041
 
 
 
7,857
 
 
 
16,908
 
 
 
22,019
 
      Total revenue
 
 
17,130
 
 
 
18,651
 
 
 
46,166
 
 
 
52,987
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating costs and expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Cost of sales, exclusive of depreciation stated separately below
 
 
8,351
 
 
 
6,894
 
 
 
22,472
 
 
 
20,856
 
   Cost of service and maintenance, exclusive of depreciation stated separately below
 
 
170
 
 
 
132
 
 
 
567
 
 
 
456
 
   Cost of rentals, exclusive of depreciation stated separately below
 
 
2,240
 
 
 
3,161
 
 
 
6,513
 
 
 
8,885
 
   Selling, general and administrative expense
 
 
1,182
 
 
 
1,311
 
 
 
3,824
 
 
 
3,773
 
   Depreciation and amortization
 
 
1,497
 
 
 
1,921
 
 
 
4,135
 
 
 
5,448
 
      Total operating costs and expenses
 
 
13,440
 
 
 
13,419
 
 
 
37,511
 
 
 
39,418
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
 
3,690
 
 
 
5,232
 
 
 
8,655
 
 
 
13,569
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Interest expense
 
 
(385
)
 
 
(281
)
 
 
(1,308
)
 
 
(879
)
   Other income
 
 
447
 
 
 
346
 
 
 
1,015
 
 
 
1,062
 
      Total other income (expense)
 
 
62
 
 
 
65
 
 
 
(293
)
 
 
183
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income before provision for income taxes
 
 
3,752
 
 
 
5,297
 
 
 
8,362
 
 
 
13,752
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Provision for income taxes
 
 
1,388
 
 
 
1,960
 
 
 
3,094
 
 
 
5,088
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 
2,364
 
 
 
3,337
 
 
 
5,268
 
 
 
8,664
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
$
0.20
 
 
$
0.28
 
 
$
0.47
 
 
$
0.72
 
Diluted
 
$
0.20
 
 
$
0.28
 
 
$
0.47
 
 
$
0.72
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
 
11,960
 
 
 
12,072
 
 
 
11,199
 
 
 
12,067
 
Diluted
 
 
12,046
 
 
 
12,091
 
 
 
11,264
 
 
 
12,086
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

See accompanying notes to these condensed consolidated financial statements.


2

NATURAL GAS SERVICES GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
(unaudited) 
 
 
Nine Months Ended September 30,
 
 
 
2006
 
 
2007
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
 
 
   Net income
 
$
5,268
 
 
$
8,664
 
      Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
 
 
Depreciation and amortization
 
 
4,135
 
 
 
5,448
 
Deferred taxes
 
 
2,215
 
 
 
2,259
 
Employee stock options expensed
 
 
218
 
 
 
292
 
Gain on sale of property and equipment
 
 
(17
) 
 
 
(1
)
      Changes in current assets and liabilities:
 
 
 
 
 
 
 
 
Trade and other receivables
 
 
(1,823
)
 
 
716
 
Inventory and work in progress
 
 
(298
)
 
 
(4,179
)
Prepaid expenses and other
 
 
106
 
 
 
(209
)
Accounts payable and accrued liabilities
 
 
1,475
 
 
 
2,190
 
Current tax liability
 
 
 
 
 
(683)
 
Deferred income
 
 
33
 
 
 
21
 
Other
 
 
(94
) 
 
 
30
 
NET CASH PROVIDED BY OPERATING ACTIVITIES
 
 
11,218
 
 
 
14,548
 
 
 
 
 
 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
 
 
 
 
Purchase of property and equipment
 
 
(21,583
)
 
 
(15,676
)
Purchase of short-term investments
 
 
(37,905
)
 
 
(2,347
)
Redemption of short-term investments
 
 
8,700
 
 
 
4,500
 
Proceeds from sale of assets
 
 
32
 
 
 
44
 
NET CASH USED IN INVESTING ACTIVITIES
 
 
(50,756
)
 
 
(13,479
)
 
 
 
 
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
 
 
 
 
Proceeds from long-term debt
 
 
68
 
 
 
 
Proceeds from line of credit
   
1,375
     
 
Repayments of long-term debt
 
 
(8,695
)
 
 
(3,597
)
Repayments of line of credit
 
 
(1,675
)
 
 
 
Proceeds from exercise of stock options and warrants
 
 
226
 
 
 
159
 
Proceeds from sale of stock, net of transaction costs
 
 
47,163
 
 
 
 
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
 
 
38,462
 
 
 
(3,438
)
 
 
 
 
 
 
 
 
 
NET CHANGE IN CASH
 
 
(1,076
)
 
 
(2,369
)
 
 
 
 
 
 
 
 
 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
 
 
3,271
 
 
 
4,391
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
2,195
 
 
$
2,022
 
 
 
 
 
 
 
 
 
 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 
 
 
 
 
 
 
Interest paid
 
$
1,146
 
 
$
942
 
Income taxes paid
 
$
879
 
 
$
3,546
 

See accompanying notes to these condensed consolidated financial statements.

3

NATURAL GAS SERVICES GROUP, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 (1) Basis of Presentation and Summary of Significant Accounting Policies

The accompanying unaudited condensed consolidated financial statements present the condensed consolidated results of our company taken from our books and records. In our opinion, such information includes all adjustments, consisting of only normal recurring adjustments, which are necessary to make our financial position at September 30, 2007 and September 30, 2006 and the results of our operations for the three and nine month periods ended September 30, 2007 and September 30, 2006 not misleading.  As permitted by the rules and regulations of the Securities and Exchange Commission (SEC) the accompanying condensed consolidated financial statements do not include all disclosures normally required by accounting principles generally accepted in the United States of America.  These condensed consolidated financial statements should be read in conjunction with the financial statements included in our Annual Report on Form 10-K/A for the year ended December 31, 2006 on file with the SEC.  In our opinion, the condensed consolidated financial statements are a fair presentation of the financial position, results of operations and cash flows for the periods presented.
 
The results of operations for the three and nine month periods ended September 30, 2007 are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2007.
 
Unless otherwise noted, amounts reported in tables are in thousands, except per share data and stock option data.
 
    On June 25, 2007, we entered into Articles of Merger with our wholly owned subsidiary, Screw Compression Systems, Inc. (SCS).  On June 30, 2007, all of the issued and outstanding shares of common stock for SCS, all of which the we held, were cancelled without consideration and SCS was merged into our company.  The purpose of the merger was to consolidate and simplify our internal accounting and tax reporting functions.  There was no impact to the consolidated financial statment for this merger.

Short-Term investments
 
Short-term investments consist primarily of government and corporate bonds with original maturities of ninety days to one year.

Revenue recognition
 
Revenue from the sales of custom and fabricated compressors, and flare systems is recognized upon shipment of the equipment to customers. Exchange and rebuild compressor revenue is recognized when both the replacement compressor has been delivered and the rebuild assessment has been completed. Revenue from compressor services is recognized upon providing services to the customer. Maintenance agreement revenue is recognized as services are rendered. Rental revenue is recognized over the term of the respective rental agreements based upon the classification of the rental agreement. Deferred income represents payments received before a product is shipped.  Revenue from the sale of rental units is included in sales revenue when equipment is shipped or title is transferred to the customer.

Recently Issued Accounting Pronouncements

In July 2006 the FASB issued FASB Interpretation ("FIN") No.  48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement 109.  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No.  109, Accounting for Income Taxes.  FIN 48 prescribes a comprehensive model for recognizing, measuring, presenting and disclosing, in the financial statements, tax positions taken or expected to be taken on a tax return.  FIN 48 is effective for fiscal years beginning after December 15, 2006.  We adopted FIN 48 on January 1, 2007, and its adoption did not have a material impact on our consolidated financial position and results of operations.  See Note 5 for additional information regarding income taxes.
 
In September 2006, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements.  This Statement applies under other accounting pronouncements that require or permit fair value measurements and is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact of adopting this Statement.
 
In February 2007, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115 (“SFAS 159”).  SFAS 159 permits entities to measure eligible assets and liabilities at fair value.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings.  SFAS 159 is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact of adopting this Statement.


4

NATURAL GAS SERVICES GROUP, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
(2) Stock-Based Compensation
 
Effective January 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standard 123(R) “Share-Based Payment” (“SFAS 123(R)”) using the modified prospective transition method.  In addition, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 “Share-Based Payment” (“SAB 107”) in March, 2006, which provides supplemental SFAS 123(R) application guidance based on the views of the SEC.  Under the modified prospective transition method, compensation cost recognized in the quarterly periods ended September 30, 2006 and 2007 included: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted beginning January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R).
 
A summary of stock option activity under our 1998 Stock Option plan as of September 30, 2007 and changes during the nine months ended September 30, 2007 is presented below.

 
 
Number
 of
Stock Options
 
 
Weighted Average
Exercise
 Price
 
 
Weighted Average
Remaining Contractual Life (years)
 
 
Aggregate
Intrinsic
Value
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
 
Outstanding, December 31, 2006
 
 
174,170
 
 
$
9.63
 
 
 
8.22
 
 
$
744
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Granted
 
 
7,500
 
 
 
15.60
 
 
 
 
 
 
 
 
 
   Exercised
 
 
(21,168
)
 
 
5.67
 
 
 
 
 
 
 
 
 
   Forfeited or expired
 
 
(4,334
)
 
 
12.15
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Outstanding, September 30, 2007
 
 
156,168
 
 
$
10.39
 
 
 
7.79
 
 
$
1,060
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercisable, September 30, 2007
 
 
102,168
 
 
$
8.99
 
 
 
7.20
 
 
$
836
 
 
We granted employee stock options on August 13, 2007.  There were no options granted during the nine months ended September 30, 2006.  The total intrinsic value or the difference between the exercise price and the market price on the date of exercise, of stock options exercised during the three and nine months ended September 30, 2007, were approximately $6 thousand and $176 thousand, respectively.  We received cash from the exercise of stock options of approximately $5 thousand and $120 thousand during the three and nine months ended September 30, 2007, respectively.  We realized an income tax net deduction of approximately $1 thousand and $52 thousand from stock options exercised during the three and nine months ended September 30, 2007, respectively.


5

NATURAL GAS SERVICES GROUP, INC.

The following table summarizes information about the stock options outstanding at September 30, 2007: 

 
 
 
Stock Options Outstanding
 
 
Stock Options Exercisable
 
Range of Exercise Prices
 
 
Number of Stock Options
 
 
Weighted Average
Remaining Contractual Life (years)
 
 
Weighted
Average
Exercise
Price
 
 
 
Number of Stock Options
 
 
Weighted
Average
Exercise
Price
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
0.00 – 5.58
 
 
 
28,000
 
 
 
5.24
 
 
$
4.17
 
 
 
28,000
 
 
$
4.17
 
 
5.59 – 9.43
 
 
 
66,668
 
 
 
7.63
 
 
 
8.95
 
 
 
51,668
 
 
 
8.87
 
 
9.44 – 16.96
 
 
 
61,500
 
 
 
9.11
 
 
 
14.77
 
 
 
22,500
 
 
 
15.26
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
0.00 - 16.96
 
 
 
156,168
 
 
 
7.79
 
 
$
10.39
 
 
 
102,168
 
 
$
8.99
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
A summary of the status of our unvested stock options as of September 30, 2007 and changes during the nine months ended September 30, 2007 is presented below.

  
 
 
Number of Stock Options
 
 
Weighted Average
Grant Date Fair Value
 
 
 
 
 
 
 
 
Unvested at December 31, 2006
 
 
85,838
 
 
$
9.32
 
 
 
 
 
 
 
 
 
 
      Granted
 
 
7,500
 
 
 
5.71
 
      Vested
 
 
(35,671
 
 
10.11
 
      Forfeited
 
 
(3,667
)
 
 
5.12
 
 
 
 
 
 
 
 
 
 
Unvested at September 30, 2007
 
 
54,000
 
 
$
8.57
 
 
 
 
 
 
 
 
 
 
 
As of September 30, 2007, there was approximately $261 thousand of unrecognized compensation cost related to unvested stock options.  Such cost is expected to be recognized over a weighted-average period of one year.  Total compensation expense for stock options was $73 thousand and $99 thousand for the three months ended September 30, 2006 and 2007, respectively.  Total compensation expense for stock options was $146 thousand and $292 thousand for the nine months ended September 30, 2006 and 2007, respectively.  An income tax benefit was recognized of approximately $27 thousand and $37 thousand for the three months ended September 30, 2006 and 2007, respectively.  An income tax benefit was recognized of approximately $81 thousand and $108 thousand for the nine months ended September 30, 2006 and 2007, respectively.

 (3) Inventory
 
Inventory, net of allowance for obsolescence of $347 thousand at December 31, 2006 and September 30, 2007, consisted of the following amounts:

 
 
December 31,
 
 
September 30,
 
 
 
2006
 
 
2007
 
 
 
 
 
 
 
 
      Raw materials
 
$
12,154
 
 
$
15,511
 
      Finished goods
 
 
1,084
 
 
 
772
 
      Work in process
 
 
3,705
 
 
 
4,839
 
 
 
$
16,943
 
 
$
21,122
 


6

NATURAL GAS SERVICES GROUP, INC.  

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(4) Earnings per Share
 
The following table reconciles the numerators and denominators of the basic and diluted earnings per share computation.

  
 
Three months Ended September 30,
 
 
Nine months Ended September 30,
 
 
 
2006
 
 
2007
 
 
2006
 
 
2007
 
   Numerator:
 
 
 
 
 
 
 
 
 
 
 
 
      Net income
 
$
2,364
 
 
$
3,337
 
 
$
5,268
 
 
$
8,664
 
   Denominator for basic net income per common share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
         Weighted average common shares outstanding
 
 
11,960
 
 
 
12,072
 
 
 
11,199
 
 
 
12,067
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Denominator for diluted net income per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
         Weighted average common shares outstanding
 
 
11,960
 
 
 
12,072
 
 
 
11,199
 
 
 
12,067
 
         Dilutive effect of stock options and warrants
 
 
86
 
 
 
19
 
 
 
65
 
 
 
19
 
            Diluted weighted average shares
 
 
12,046
 
 
 
12,091
 
 
 
11,264
 
 
 
12,086
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Earnings per common share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
      Basic
 
$
0.20
 
 
$
0.28
 
 
$
0.47
 
 
$
0.72
 
      Diluted
 
$
0.20
 
 
$
0.28
 
 
$
0.47
 
 
$
0.72
 

(5) Income Taxes
 
We adopted the provisions of FIN 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. We had no material unrecognized income tax assets or liabilities at the date of adoption or during the three and nine months ended September 30, 2007.
 
Our policy regarding income tax interest and penalties is to expense those items as general and administrative expense but to identify them for tax purposes. During the three and nine months ended September 30, 2007, there were no income tax interest and penalty items in the income statement, or as a liability on the balance sheet.
 
We file income tax returns in the U.S. federal jurisdiction and various state jurisdictions.  With few exceptions, we are no longer subject to U.S. federal or state income tax examination by tax authorities for years before 2003.  We are not currently involved in any income tax examinations.



7

NATURAL GAS SERVICES GROUP, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(6) Segment Information
 
FAS No. 131, Disclosures About Segments of an Enterprise and Related Information, establishes standards for public companies relating to the reporting of financial and descriptive information about their operating segments in financial statements.  Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by chief operating decision makers in how to allocate resources and in assessing performance.
 
 We identify our segments based upon major revenue sources as follows:

For the three months ended September 30, 2007:
 
 
 
Sales
 
 
Service & Maintenance
 
 
Rental
 
 
Corporate
 
 
Total
 
Revenue
 
$
10,574
 
 
$
220
 
 
$
7,857
 
 
 
-
 
 
$
18,651
 
Operating costs and expenses
 
 
6,894
 
 
 
132
 
 
 
3,161
 
 
 
3,232
 
 
 
13,419
 
Operating income
 
$
3,680
 
 
$
88
 
 
$
4,696
 
 
$
(3,232
)
 
$
5,232
 
*Segment Assets
 
$
-
 
 
$
-
 
 
$
-
 
 
$
144,857
 
 
$
144,857
 

For the three months ended September 30, 2006:
 
 
 
Sales
 
 
Service & Maintenance
 
 
Rental
 
 
Corporate
 
 
Total
 
Revenue
 
$
10,880
 
 
$
209
 
 
$
6,041
 
 
 
-
 
 
$
17,130
 
Operating costs and expenses
 
 
8,351
 
 
 
170
 
 
 
2,240
 
 
 
2,679
 
 
 
13,440
 
Operating income
 
$
2,529
 
 
$
39
 
 
$
3,801
 
 
$
(2,679
)
 
$
3,690
 
*Segment Assets
 
$
-
 
 
$
-
 
 
$
-
 
 
$
134,039
 
 
$
134,039
 

For the nine months ended September 30, 2007:
 
 
 
Sales
 
 
Service & Maintenance
 
 
Rental
 
 
Corporate
 
 
Total
 
Revenue
 
$
30,239
 
 
$
729
 
 
$
22,019
 
 
 
-
 
 
$
52,987
 
Operating costs and expenses
 
 
20,856
 
 
 
456
 
 
 
8,885
 
 
 
9,221
 
 
 
39,418
 
Operating income
 
$
9,383
 
 
$
273
 
 
$
13,134
 
 
$
(9,221
)
 
$
13,569
 
*Segment Assets
 
$
-
 
 
$
-
 
 
$
-
 
 
$
144,857
 
 
$
144,857
 

For the nine months ended September 30, 2006:
 
 
 
Sales
 
 
Service & Maintenance
 
 
Rental
 
 
Corporate
 
 
Total
 
Revenue
 
$
28,509
 
 
$
749
 
 
$
16,908
 
 
 
-
 
 
$
46,166
 
Operating costs and expenses
 
 
22,472
 
 
 
567
 
 
 
6,513
 
 
 
7,959
 
 
 
37,511
 
Operating income
 
$
6,037
 
 
$
182
 
 
$
10,395
 
 
$
(7,959
)
 
$
8,655
 
*Segment Assets
 
$
-
 
 
$
-
 
 
$
-
 
 
$
134,039
 
 
$
134,039
 
* Management does not track assets by segment

(7)  Legal Proceedings
 
From time to time, we are a party to various legal proceedings in the ordinary course of our business.  We are not currently a party to any material pending legal proceedings.  We have not been a party to any bankruptcy, receivership, reorganization, adjustment or similar proceeding.
 
(8)  Subsequent Event

We are pursuing the purchase of an existing manufacturing facility in Midland, Texas.  This facility would expand our current manufacturing capabilities.  We will relocate our corporate office to a professional building located in the downtown area of Midland, Texas.
 
**********************
8

NATURAL GAS SERVICES GROUP, INC.


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

The discussion and analysis of our financial condition and results of operations are based on, and should be read in conjunction with, our condensed consolidated financial statements and the related notes included elsewhere in this report and  in our December 31, 2006 Form 10-K/A Report filed with the SEC.  All amounts reported in tables are in thousands of dollars unless otherwise noted.

Overview
 
We fabricate, manufacture, rent and sell natural gas compressors and related equipment. Our primary focus is on the rental of natural gas compressors. Our rental contracts generally provide for initial terms of 9 to 24 months. After the initial term of our rental contracts, most of our customers have continued to rent our compressors on a month-to-month basis. Rental amounts are paid one month in advance and include maintenance of the rented compressors. As of September 30, 2007, we had 1,136 natural gas compressors totaling 132,147 horsepower rented to 92 third parties, compared to 909 natural gas compressors totaling 105,213 horsepower rented to 85 third parties at September 30, 2006.
 
We also fabricate natural gas compressors for sale to our customers, designing compressors to meet unique specifications dictated by well pressures, production characteristics and particular applications for which compression is sought. Fabrication of compressors involves the purchase of engines, compressors, coolers and other components, and then assembling these components on skids for delivery to customer locations. These major components of our compressors are acquired through periodic purchase orders placed with third-party suppliers on an “as needed” basis, which presently requires a three to four month lead time with delivery dates scheduled to coincide with our estimated production schedules. Although we do not have formal continuing supply contracts with any major supplier, we believe we have adequate alternative sources available. In the past, we have not experienced any sudden and dramatic increases in the prices of the major components for our compressors. However, the occurrence of such an event could have a material adverse effect on the results of our operations and financial condition, particularly if we were unable to increase our rental rates and sales prices proportionate to any such component price increases.
 
We also manufacture a proprietary line of compressor frames, cylinders and parts, known as our CiP (Cylinder-in-Plane) product line. We use finished CiP components in the fabrication of compressor units for sale or rental. We also sell the finished component products to other compressor fabricators. We design, fabricate, sell, install and service flare stacks and related ignition and control devices for onshore and offshore incineration of natural gas compounds such as hydrogen sulfide, carbon dioxide, natural gas and liquefied petroleum gases. To provide customer support for our compressor and flare sales businesses, we stock varying levels of replacement parts at our Midland, Texas facility, Tulsa, Oklahoma facility and at field service locations. We also provide an exchange and rebuild program for screw compressors and maintain an inventory of new and used compressors to facilitate this business.
 
We provide service and maintenance to our customers under written maintenance contracts or on an “as required” basis in the absence of a service contract. As of September 30, 2007, we had written maintenance agreements with third parties relating to 46 compressors.  Maintenance agreements typically have terms of nine months to one year and require payment of a monthly fee.
 
The oil and gas equipment rental and services industry is cyclical in nature. The most critical factor in assessing the outlook for the industry is the worldwide supply and demand for natural gas and the corresponding changes in commodity prices. As demand and prices increase, oil and gas producers increase their capital expenditures for drilling, development and production activities. The increased capital expenditures generally result in greater revenues and profits for services and equipment companies.

In general, we expect our overall business activity and revenues to track the level of activity in the natural gas industry, with changes in domestic natural gas production and consumption levels and prices more significantly affecting our business than changes in crude oil and condensate production and consumption levels and prices. We also believe that demand for compression services and products is driven by declining reservoir pressure in maturing natural gas producing fields and, more recently, by increased focus by producers on non-conventional natural gas production, such as coalbed methane, gas shales and tight gas, which typically requires more compression than production from conventional natural gas reservoirs.
 
Demand for our products and service was strong throughout 2006 and the first nine months of 2007. We believe demand will remain strong throughout the remainder of 2007 and 2008 due to high oil and natural gas prices and increased demand for natural gas. Because of these market fundamentals for natural gas, we believe the long-term trend of activity in our markets is favorable. However, these factors could be more than offset by other developments affecting the worldwide supply and demand for natural gas.


9

NATURAL GAS SERVICES GROUP, INC.


For fiscal year 2007, our forecasted capital expenditures are $24 to $27 million, primarily for additions to our compressor rental fleet. We believe that the proceeds from our public offering of common stock in March 2006, together with funds available to us under our bank credit facility and cash flows from operations will be sufficient to satisfy our capital and liquidity requirements through the remainder of 2007. We may further require additional capital to fund any unanticipated expenditures, including any acquisitions of other businesses. Additional capital may not be available to us when we need it or on acceptable terms.

Results of Operations

Three months ended September 30, 2006, compared to the three months ended September 30, 2007.
 
The table below shows our revenues and percentage of total revenues for each of our segments for the three months ended September 30, 2006 and September 30, 2007. 

 
 
Revenue
 
 
 
Three months Ended September 30,
 
 
 
2006
 
 
2007
 
Sales
 
$
10,880
 
 
 
64
%
 
$
10,574
 
 
 
57
%
Service and Maintenance
 
 
209
 
 
 
1
%
 
 
220
 
 
 
1
%
Rental
 
 
6,041
 
 
 
35
%
 
 
7,857
 
 
 
42
%
Total
 
$
17,130
 
 
 
100
%
 
$
18,651
 
 
 
100
%

Total revenue increased from $17.1 million to $18.7 million, or 8.9%, for the three months ended September 30, 2007, compared to the same period ended September 30, 2006. This was mainly the result of increased rental revenue of 30.1%, service and maintenance revenue of 5.3%, the total being offset by a decrease in sales revenue of 2.8%. This decrease was due to the sales of $1.5 million of rental equipment to an existing customer during the three months ended September 30, 2006.  Excluding the sales of rental equipment, the compressor unit sales actually increased $1.2 million, or 12.8%, for the three months ended September 30, 2007 compared to the same period ended September 30, 2006.
 
Rental revenue increased from $6.0 million to $7.9 million, or 30.1%, for the three months ended September 30, 2007, compared to the same period ended September 30, 2006.  This increase was the result of additional units added to our rental fleet and rented to third parties.  We ended the period with 1,277 compressor packages in its rental fleet, up from 1,052 units at September 30, 2006.  The rental fleet has a utilization of 89.0% as of September 30, 2007.
 
Sales revenue decreased from $10.9 million to $10.6 million, or 2.8%, for the three months ended September 30, 2007, compared to the same period ended September 30, 2006.  This apparent decrease was due to the inflated sales of $1.5 million of rental equipment to an existing customer during the three months ended September 30, 2006.  Excluding the sales of rental equipment, the compressor unit sales actually increased $1.2 million, or 12.8%, for the three months ended September 30, 2007 compared to the same period ended September 30, 2006.  Sales from outside sources included: (1) compressor unit sales, (2) flare sales, (3) parts sales, (4) compressor rebuilds and (5) rental unit sales.
 
Service and maintenance revenue increased from $209 thousand to $220 thousand, or 5.3%, for the three months ended September 30, 2007, compared to the same period ended September 30, 2006.  This increase was mainly the result of additional activity in our New Mexico area.
 
The overall operating margin percentage increased to 28.1% for the three months ended September 30, 2007, from 21.5% for the same period ended September 30, 2006.  This was mainly the result of improvements in our sales margins were 23.2% for the third quarter of 2006 compared to 34.8% in third quarter of 2007.  The improvement in margins resulted from refinements in our quote process and and the use of more frequent overhead calculations.

Selling, general and administrative expenses increased from $1.2 million to $1.3 million, or 10.9%, for the three months ended September 30, 2007, as compared to the same period ended September 30, 2006.  This increase was mainly the result of increase in the officer salaries category because we filled some vacancies.
 
Depreciation and amortization expense increased from $1.5 million to $1.9 million, or 28.3%, for the three months ended September 30, 2007, compared to the same period ended September 30, 2006.  This increase is the result of 225 new gas compressor rental units added to the rental fleet from September 30, 2006 to September 30, 2007, thus increasing the depreciable base.
 

10

NATURAL GAS SERVICES GROUP, INC.


Other income net of other expense decreased $101 thousand for the three months ended September 30, 2007, compared to the same period ended September 30, 2006. This decrease is mainly the result of reduced interest income from our short-term investments.  Short-term investments declined from the use of funds to build rental equipment, which has been and remains the intended purpose.

Interest expense decreased 27.0% for the three months ended September 30, 2007, compared to the same period ended September 30, 2006, mainly due to decreased loan balances financing rental equipment. The loan balances decreased from the amortization of the debt.  There were no additional borrowings during the quarter ended September 30, 2007.

Provision for income tax increased from $1.4 million to $2.0 million, or 41.2%, for the three months ended September 30, 2007, compared to the same period ended September 30, 2006.  This increase is the result of an increase in taxable income.
 
Nine months ended September 30, 2006, compared to the nine months ended September 30, 2007.
 
The table below shows our revenues and percentage of total revenues of each of our segments for the nine months ended September 30, 2006 and September 30, 2007. 

 
 
Revenue
 
 
 
Nine months Ended September 30,
 
 
 
2006
 
 
2007
 
Sales
 
$
28,509
 
 
 
62
%
 
$
30,239
 
 
 
57
%
Service and Maintenance
 
 
749
 
 
 
1
%
 
 
729
 
 
 
1
%
Rental
 
 
16,908
 
 
 
37
%
 
 
22,019
 
 
 
42
%
Total
 
$
46,166
 
 
 
100
%
 
$
52,987
 
 
 
100
%
 
Total revenue increased from $46.2 million to $53.0 million, or 14.8%, for the nine months ended September 30, 2007, compared to the same period ended September 30, 2006. This was mainly the result of increased rental revenue of 30.2%, sales revenue of 6.1%, the total being offset by a decrease in service and maintenance revenue of 2.7%.

Rental revenue increased from $16.9 million to $22.0 million, or 30.2%, for the nine months ended September 30, 2007, compared to the same period ended September 30, 2006.  This increase was the result of additional units added to our rental fleet and rented to third parties.  We ended the period with 1,277 compressor packages in its rental fleet, up from 1,052 units at September 30, 2006.  The rental fleet has a utilization of 89.0% as of September 30, 2007.

Sales revenue increased from $28.5 million to $30.2 million, or 6.1%, for the nine months ended September 30, 2007, compared to the same period ended September 30, 2006.  Sales revenue for the nine months ended September 30, 2006 included $4.2 million in sales of rental equipment to an existing rental customer.  Excluding the rental equipment sales, actual unit sales increased $5.9 million, or 23.8%, for the nine months ended September 30, 2007, compared to the same period ended September 30, 2006.  Sales from outside sources included: (1) compressor unit sales, (2) flare sales, (3) parts sales, (4) compressor rebuilds and (5) rental unit sales.

Service and maintenance revenue decreased from $749 thousand to $729 thousand, or 2.7%, for the nine months ended September 30, 2007, compared to the same period ended September 30, 2006.  This decrease was expected because the company does not intend to pursue third party service work.

The overall operating margin percentage increased to 25.6% for the nine months ended September 30, 2007, from 18.8% for the same period ended September 30, 2006.  This was mainly the result of refinements in the quote process and more frequent overhead calculations.  The overall operating margin increased from 21.2% for the nine months ended September 30, 2006 compared to 31.0% for same period ended September 30, 2007.

Selling, general and administrative expenses remained flat at $3.8 million for the nine months ended September 30, 2007, compared to the same period ended September 30, 2006.  This was expected because late in 2006 we had a reduction in our sales force from resignations, therefore our commissions expense did not increase with sales.

11

NATURAL GAS SERVICES GROUP, INC.


Depreciation and amortization expense increased 31.8% from $4.1 million to $5.4 million for the nine months ended September 30, 2007, compared to the same period ended September 30, 2006.  This increase was the result of 225 new gas compressor rental units being added to the rental fleet from September 30, 2006 to September 30, 2007, thus increasing the depreciable base.

Other income net of other expense increased by $47 thousand for the nine months ended September 30, 2007, compared to the same period ended September 30, 2006. This increase is mainly the result of additional interest income from our short-term investment account.

Interest expense decreased 32.8% for the nine months ended September 30, 2007, compared to the same period ended September 30, 2006, mainly due to decreased loan balances financing rental equipment. Our loan balances decreased from the amortization of debt.  There were no additional borrowings during the nine months ended September 30, 2007.

Provision for income tax increased from $3.1 million to $5.1 million, or 64.4%, for the nine months ended September 30, 2007, compared to the same period ended September 30, 2006.  This increase is the result of an increase in taxable income.
 
Critical Accounting Policies and Practices
 
A discussion of our critical accounting policies is included in our Form 10-K/A for the year ended December 31, 2006.  There have been no significant changes in the nine months ended September 30, 2007.

Recently Issued Accounting Pronouncements

In July 2006 the FASB issued FASB Interpretation ("FIN") No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement 109.  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No.  109, Accounting for Income Taxes.  FIN 48 prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on a tax return.  FIN 48 is effective for fiscal years beginning after December 15, 2006.  We adopted FIN 48 on January 1, 2007, and its adoption did not have a material impact on our consolidated financial position and results of operations.
 
In September 2006, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements.  This Statement applies under other accounting pronouncements that require or permit fair value measurements and is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact of adopting this Statement.
 
In February 2007, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115 (“SFAS 159”).  SFAS 159 permits entities to measure eligible assets and liabilities at fair value.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings.  SFAS 159 is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact of adopting this Statement.

12

NATURAL GAS SERVICES GROUP, INC.

 
Liquidity and Capital Resources
 
The following represents our working capital position as of December 31, 2006 and September 30, 2007.

 
 
December 31, 2006
 
 
September 30, 2007
 
Current Assets:
 
 
 
 
 
 
   Cash & cash equivalents
 
$
4,391
 
 
$
2,022
 
   Short-term investments
 
 
25,052
 
 
 
22,899
 
   Trade accounts receivable
 
 
8,463
 
 
 
7,747
 
   Inventory
 
 
16,943
 
 
 
21,122
 
   Prepaid expenses and other
 
 
321
 
 
 
530
 
              Total current assets
 
$
55,170
 
 
$
54,320
 
 
 
 
 
 
 
 
 
 
Current Liabilities:
 
 
 
 
 
 
 
 
   Current portion of long-term debt
 
$
4,442
 
 
$
4,378
 
   Accounts payable & accrued liabilities
 
 
4,914
 
 
 
7,104
 
   Current portion of tax liability
 
 
1,056
 
 
 
373
 
   Deferred income
 
 
225
 
 
 
246
 
              Total current liabilities
 
$
10,637
 
 
$
12,101
 
 
 
 
 
 
 
 
 
 
Total working capital
 
$
44,533
 
 
$
42,219
 


Historically, we have funded our operations through public and private offerings of our equity securities, subordinated debt, bank borrowings and cash flow from operations. Proceeds from financing were primarily used to service debt and fund the manufacture and fabrication of additional units for our rental fleet of natural gas compressors.
 
For the nine months ended September 30, 2007, we invested $15.7 million in equipment for our rental fleet and service vehicles.  We financed this activity with cash flow from operations and public offering proceeds. In addition, we have repaid $3.6 million of our existing debt.

Cash flows

At September 30, 2007, we had cash, cash equivalents and short-term investments of $24.9 million compared to $29.4 million at December 31 2006. We had working capital of $42.2 million at September 30, 2007 compared to $44.5 million at December 31, 2006. At September 30, 2007, our total debt was $14.8 million of which $4.4 million was classified as current compared to $18.4 million and $4.4 million, respectively at December 31, 2006. We had positive net cash flow from operating activities of $14.5 million during the first nine months of 2007 compared to $11.2 million for the first nine months of 2006.  This was primarily from net income of $8.7 million and an increase in accounts payable and accrued liabilities of $2.2 million, offset by an increase in inventory of $4.2 million and the add back of depreciation and amortization of $5.4 million during the nine months ended September 30, 2007.
 
Accounts receivable decreased $716 thousand to $7.7 million at September 30, 2007 as compared to $8.5 million at December 31, 2006. At the end of the third quarter of 2007, the average of aged accounts receivable decreased to 41 days outstanding compared to 49 days outstanding at the end of year December 31, 2006.
 
Inventory increased $4.2 million to $21.1 million as of September 30, 2007, as compared to $16.9 million as of December 31, 2006. This increase is mainly the result of an increase in raw materials and work in progress associated with the production of third party compressor sales and rental units. Our service facilities inventories have increased as the result of an increase in our rental fleet.
 
Long-term debt decreased $3.6 million to $14.8 million at September 30, 2007, compared to $18.4 million at December 31, 2006. The current portion of long-term debt remained at $4.4 million for both September 30, 2007 and December 31, 2006.

13

NATURAL GAS SERVICES GROUP, INC.

 
Subordinated Debt-Related Parties

We have subordinated debt, which is included in the current portion of long-term debt. The $3.0 million principal amount of this debt is in the form of promissory notes issued to the three stockholders of Screw Compression Systems, Inc., or "SCS", who are currently employed by us, as part of the consideration for the acquisition of SCS, a former subsidiary. The principal of each note is payable in three equal annual installments, which commenced on January 3, 2006. Accrued and unpaid interest on the unpaid principal balance of each note is payable on the same dates as, and in addition to, the installments of principal. To secure payment of these notes, our bank lender issued letters of credit for the benefit of the holders in the aggregate amount $2.0 million.  On February 3, 2007, the face amount of the letter of credit was reduced by one-half and is currently $1.0 million. On January 3, 2007, we paid the second installment of the annual payments in the amount of $1.0 million in principal. The current balance of these notes is $1.0 million.

Contractual Obligations and Commitments
 
We have contractual obligations and commitments that affect our consolidated results of operations, financial condition and liquidity.  The following table is a summary of our significant cash contractual obligations:

 
 
Obligation Due in Periods
(in thousands of dollars)
 
 
 
2007(1)
 
 
2008
 
 
2009
 
 
2010
 
 
2011
 
 
Thereafter
 
 
Total
 
Credit facility (secured)
 
$
845
 
 
$
3,378
 
 
$
3,378
 
 
$
3,378
 
 
$
2,816
 
 
$
-
 
 
$
13,795
 
Interest on credit facility(2)
 
 
259
 
 
 
884
 
 
 
591
 
 
 
338
 
 
 
106
 
 
 
-
 
 
 
2,178
 
Subordinated debt
 
 
-
 
 
 
1,000
 
 
 
-
 
 
 
-