UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 2004
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _____________ to _____________
Commission file number 1-31398
NATURAL GAS SERVICES GROUP, INC.
(Name of small business issuer in its charter)
COLORADO 75-2811855
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2911 South County Road 1260
Midland, Texas 79706
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (432) 563-3974
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Securities registered under Section 12(b) of the Exchange Act:
Common Stock $.01 Par Value
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(Title of Class)
Warrants to Purchase Common Stock
---------------------------------
(Title of Class)
Securities registered under Section 12(g) of the Exchange Act:
None
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(Title of Class)
---------------------------------
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 |_|
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. |X|
State issuer's revenue for its most recent fiscal year: $15,958,199
The aggregate market value of the voting and non-voting common equity
held by non-affiliates at March 23, 2004, computed by reference to the closing
price of $6.85 per share on the American Stock Exchange, was $16,096,979.
The number of shares outstanding of each of the issuer's classes of
common equity on March 23, 2005, was 6,765,764.
Documents Incorporated by Reference
None
Transitional Small Business Disclosure Format Yes |_| No |X|
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PART 1
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-KSB (this "Report" or this "Form 10-KSB")
contains certain forward-looking statements and information pertaining to us,
our industries and the oil and gas industry that is based on the beliefs of our
management, as well as assumptions made by and information currently available
to our management. All statements, other than statements of historical facts
contained in this Report, including statements regarding our future financial
position, growth strategy, budgets, projected costs, plans and objectives of
management for future operation, are forward-looking statements. Although we
believe our expectations reflected in these forward-looking statements are based
on reasonable assumptions, no assurance can be given that these expectations
will prove to have been correct. Important factors that could cause actual
results to differ materially from the expectations reflected in the
forward-looking statements include, among other things:
o conditions in the gas and oil industry, including the demand
for natural gas and the price of oil and natural gas,
o competition among the various providers of compression
services and products,
o changes in safety, health and environmental regulations
pertaining to the production and transportation of natural
gas,
o changes in economic or political conditions in the markets in
which we operate, and
o introduction of competing technologies by other companies.
In addition, the factors described in "Management's Discussion and
Analysis of Financial Condition and Results of Operation - Risk Factors" could
cause our actual results to differ materially from the expectations reflected in
the forward-looking statements contained herein. These statements relate to
"Description of Business," "Management's Discussion and Analysis of Financial
Condition and Results of Operation" and other sections of this Report. You can
identify forward-looking statements by terminology such as "may," "will,"
"should," "expect," "plan," "intend," "anticipate" and similar terminology. The
forward-looking statements in this Report are based largely on our expectations
and are subject to a number of risks and uncertainties, which may be beyond our
control. Actual results may differ materially from the anticipated or implied
results in the forward-looking statements. In light of these risks and
uncertainties, we can give no assurance that the forward-looking events and
circumstances included in this Report will occur.
2
ITEM 1. DESCRIPTION OF BUSINESS
History and Organization
We were incorporated under the laws of Colorado on December 17, 1998
and initially operated as a holding company of Flare King, Inc., Hi-Tech
Compressor Company, L.C., NGE Leasing, Inc. and CNG Engines Company. In July
2000, Flare King and Hi-Tech merged and then operated as Rotary Gas Systems,
Inc. Effective March 31, 2000, we sold CNG.
On March 29, 2001, we acquired, through our then subsidiary, Great
Lakes Compression, Inc., all of the compression related assets of Dominion
Michigan Petroleum Services, Inc., an unaffiliated company that is a subsidiary
of Dominion Resources, Inc. and that was in the business of manufacturing,
fabricating, selling, leasing and maintaining natural gas compressors. As a part
of the transaction, an affiliate of Dominion Michigan committed to purchase or
to enter into five year leases for compressors totaling five thousand
horsepower. The purchases or leases are to be made by December 31, 2005.
On October 24, 2002, we closed our initial public offering under a
registration statement on Form SB-2 that was declared effective on October 21,
2002. In the offering, we sold a total of 1,500,000 shares of our common stock
and warrants to purchase 1,500,000 shares of our common stock at a total of
$5.25 per share and one warrant for an aggregate amount $7,875,000. After
deducting the total expenses of the offering, we received net offering proceeds
of approximately $6,529,170.
On March 27, 2003, we acquired 28 compressor packages from Hy-Bon
Engineering Company, Inc. for $2,150,000.
On January 1, 2004, our then wholly-owned subsidiaries were merged into
us and, in June 21, 2004, Hy-bon Rotary Compression LLC, a limited liability
company in which we owned a 50% interest, was dissolved. Presently, all of our
assets are owned by, and our business is conducted through, Natural Gas Services
Group, Inc., and its wholly-owned subsidiary, Screw Compression Systems, Inc. On
October 18, 2004, Natural Gas Services Group, Inc. entered into a Stock Purchase
Agreement with Screw Compression Systems, Inc., or "SCS", and the stockholders
of SCS. Under this agreement, Natural Gas Services Group purchased all of the
outstanding shares of capital stock of SCS. This transaction was completed
January 3, 2005 and Natural Gas Services Group, Inc., will begin reporting
combined financial information with SCS in January 2005. This filing does not
include any financial information related to this transaction since it was
completed in fiscal year 2005.
Company Business
Overview
We provide equipment and services to the natural gas and oil industry.
We manufacture, fabricate, sell and lease natural gas compressors that enhance
the production of oil and gas wells and we provide maintenance services for
those compressors. We define a natural gas compressor as a mechanical device
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with one basic goal - to deliver gas at a pressure higher than that originally
existing. It may be powered by a natural gas burning engine or an electric motor
to accommodate different applications. Gas compression is undertaken to
transport and distribute natural gas to pipelines. Pipeline pressures vary and
with the addition of new wells to the pipeline, the need for compression
increases. We also manufacture and sell flare tips and ignition systems for oil
and gas plant and production facilities. We define a flare tip as a burner on
the upper end of a flare stack that is designed to combust waste gases to assure
a clean environment. An ignition system is a pilot light or a spark generator
that assures continuous ignition of the waste gases going through the burner in
the flare tip.
We primarily lease natural gas compressors. As of December 31, 2004, we
had 549 natural gas compressors under lease to third parties.
We also fabricate natural gas compressors for our customers, designing
compressors to meet unique specifications dictated by well pressures, production
characteristics and particular applications for which compression is sought.
We have established an exchange and rebuild program to attempt to help
minimize costs and maximize revenue for our customers. Under the program, we
work with maintenance and operating personnel of a customer to identify
equipment for exchange. When we receive a compressor for exchange because of a
maintenance problem, we deliver to our customer a replacement compressor at full
price. We then rebuild the exchange compressor and credit our customer an amount
based on the value of the rebuilt compressor. We also offer a retrofitting
service by repackaging a customer's compressor with a compressor that meets our
customer's changed conditions.
We design, manufacture, install and service flare stacks and related
ignition and control devices for onshore and offshore burning of gas compounds
such as hydrogen sulfide, carbon dioxide, natural gas and liquefied petroleum
gases.
We have manufacturing and fabrication facilities located in Lewiston,
Michigan, and Midland, Texas, where we manufacture and fabricate natural gas
compressors. We design and manufacture natural gas flare systems, components and
ignition systems in our facility in Midland, Texas, for use in oilfield,
refinery and petrochemical plant applications. We also have service facilities
located in Midland, Texas, Lewiston, Michigan, Bridgeport, Texas and Bloomfield,
New Mexico to provide maintenance inventory and support for our rental
compressor fleet and for third party services.
We currently provide our products and services to a customer base of
oil and gas exploration and production companies operating primarily in
Colorado, Kansas, Louisiana, Michigan, New Mexico, Oklahoma, Texas and Wyoming.
We maintain our principal office at 2911 South County Road 1260,
Midland, Texas 79706 and our telephone number is (432) 563-3974.
4
Industry Background
Our products and services are related to the oil and natural gas
industries. The oil and natural gas industry is comprised of several large,
well-capitalized companies accounting for the majority of the market. There also
exist a large number of small privately held companies making up the remainder
of the market. According to information from the Energy Information
Administration there is a growing demand for natural gas in this country.
We believe that there will continue to be a growing demand for natural
gas. Because of this, demand for our products and services are expected to
continue to rise as a result of:
o the increasing demand for energy, both domestically and
abroad;
o environmental considerations which provide strong incentives
to use natural gas in place of other carbon fuels;
o the cost savings of using natural gas rather than electricity
for heat generation;
o implementation of international environmental and conservation
laws;
o the aging of producing natural gas reserves worldwide; and
o the extensive supply of undeveloped natural gas reserves.
By using a compressor, the operator of a natural gas well is able to
increase the pressure of natural gas from a well to make it economically viable
by enabling gas to continue to flow in the pipeline to its destination. We feel
that we are well positioned through our gas compression and flare system
activities to take advantage of the aging of reserves and the development of new
reserves.
The Compression Business
Natural gas compressors are used in a number of applications intended
to enhance the productivity of oil and gas wells, gas transportation lines and
processing plants. Compression equipment is often required to boost a well's
production to economically viable levels and enable gas to continue to flow in
the pipeline to its destination. We believe that most producing gas wells in
North America, at some point, will utilize compression. As of December 31, 2003,
the Energy Information Administration reported that there were approximately
393,327 producing gas and gas condensate wells in the United States. The states
where we currently operate, account for approximately 273,123 of these wells.
The Leasing Business
We primarily lease natural gas compressors. As of February 28, 2005, we
had 635 natural gas compressors totaling approximately 70,242 horsepower leased
to 54 third parties, compared to 385 natural gas compressors totaling
approximately 43,149 horsepower leased to 45 third parties at February 28, 2004.
Of the 635 natural gas compressors, 51 were leased to Dominion Michigan and its
affiliates.
5
As a part of our leasing business, in 2000 we formed a limited
liability company, Hy-Bon Rotary Compression LLC, ("HBRC") with Hy-Bon
Engineering Company, Inc., a non-affiliated company, to lease natural gas
compressors. We formed HBRC to lease compressors to a customer with which the
non-affiliated company had a relationship. The non-affiliated company owned 50%
and we owned 50% of HBRC. The non-affiliated company managed HBRC. We split the
expenses of HBRC with the other company. After the payment of expenses, we
received whatever profit is realized by HBRC in proportion to the amount
received by HBRC from the lease of natural gas compressors that are contributed
by us and by the non-affiliated company to HBRC. As of February 28, 2003, we had
contributed 40 compressors and the non-affiliated company had contributed 28
compressors to HBRC.
On March 27, 2003, to be effective January 1, 2003, we purchased and
Hy-Bon sold to us the 28 compressor packages it contributed. In consideration
therefore, we paid Hy-Bon $2,150,000. The $2,150,000 was borrowed by us from our
current lender.
Hy-Bon has withdrawn as a member of HBRC effective as of January 1,
2003. We, as the other member of HBRC, retained all assets of HBRC, which as of
January 1, 2003, had an unaudited aggregate value of approximately $346,000. We
dissolve HBRC in 2004 and have agreed to not operate using the name Hy-Bon.
In addition to 118 units covered under written maintenance agreements
covering non-owned compressor units that we had entered into at February 28,
2005, we provide maintenance as a part of our compressor leases. Many companies
and individuals are turning to leasing of equipment instead of purchasing.
Leasing does not require the purchaser to make large capital expenditures for
new equipment or to obtain financing through a lending institution. This frees
the customer's assets for developing the customer's business. Our leases
generally have initial terms of from six to 24 months and then continue on a
month-to-month basis. The leases with Dominion Exploration have an initial
five-year term expiring between 2006 and 2010. Lease rentals are paid monthly.
At the end of a lease term, the customer may continue to pay monthly rentals on
the equipment, or we may require them to return it to us.
Changing well and pipeline pressures and conditions over the life of a
well often require producers to reconfigure their compressor units to optimize
the well production or pipeline efficiency. Because the equipment is highly
technical, a trained staff of field service personnel, a substantial parts
inventory and a diversified fleet of natural gas compressors are often necessary
to perform reconfiguration functions in an economic manner. It is not efficient
or, in many cases, economically possible for independent natural gas producers
to maintain reconfiguration capabilities individually. Also, our management
believes that, in order to streamline their operations and reduce their capital
expenditures and other costs, a number of major oil and gas companies have sold
6
portions of their domestic energy reserves to independent energy producers and
have outsourced many facets of their operations. We believe that these
initiatives are likely to contribute to increased rental of compressor
equipment. For that reason, we have created our own compressor-rental fleet to
take advantage of the rental market, we spent approximately $10,663,000 in 2004
to expand our natural gas compressor inventory, and we intend to spend
approximately $16,800,000 in 2005 on natural gas compressors.
The size, type and geographic diversity of our rental fleet enables us
to provide our customers with a range of compression units that can serve a wide
variety of applications, and to select the correct equipment for the job, rather
than the customer trying to fit the job to its own equipment. We base our gas
compressor rental rates on several factors, including the cost and size of the
equipment, the type and complexity of service desired by the customer, the
length of contract, and the inclusion of any other services desired, such as
leasing, installation, transportation and daily operation.
Custom Fabrication
We also engineer and fabricate natural gas compressors for our
customers to meet their unique specifications based on well pressure, production
characteristics and the particular applications for which compression is sought.
In order to meet the ongoing needs of our customers for whom we custom
fabricate, we offer a variety of services, including: (i) engineering,
manufacturing and fabrication of the compressors; (ii) installation and testing
of compressors; (iii) ongoing performance review to assess the need for a change
in compression: and (iv) periodic maintenance and parts replacement. We receive
revenue for each service.
Maintenance
Although natural gas compressors generally do not suffer significant
technological obsolescence, they do require routine maintenance and periodic
refurbishing to prolong their useful life. Routine maintenance includes
alignment and compression checks and other parametric checks indicate a change
in the condition of the compressors. In addition, oil and wear-particle analysis
is performed on all compressors. Overhauls are done on a condition-based
interval or a time-based schedule. Based on our past experience, these
maintenance procedures maximize component life and unit availability and
minimize downtime.
As of February 28, 2005, we had written maintenance agreements with
third parties relating to 118 compressors. Each written maintenance agreement
has from two to 5 years left on its term and each expires on December 31 in the
expiration year. During our years ended December 31, 2004 and 2003, we received
revenue of approximately $1,618,000 and $1,073,000 (approximately 10% and 8% of
our total consolidated revenue), respectively, from maintenance agreements.
Exchange and Rebuild Program
We have established an exchange and rebuild program to attempt to help
minimize costs and maximize our customers' revenue. This program is designed for
operations with rotary screw compressors where downtime and lost revenue are
critical.
7
Under the program, we work with our customer's maintenance and
operating personnel to identify and quantify equipment for exchange. When we
receive a compressor for exchange due to a problem with the compressor, we
deliver to our customer a replacement compressor at full price. We then rebuild
the exchange compressor and credit our customer with an amount based on the
value of the compressor we rebuild.
This program enables our customers to obtain replacement compressors
and shorten the time that the customer is unable to realize gas production from
one or more wells because of the lack of a compressor.
During the years ended December 31, 2004 and 2003, we received revenue
of approximately $515,000 and $597,000 (approximately 3.2% and 4.7% of our total
consolidated revenue), respectively, from exchanging and rebuilding rotary screw
compressors for third parties.
Retrofitting Service
We recognize the capital invested by our customers in compressors. We
also recognize that producing wells and gas gathering systems change
significantly during their operating life. To meet these changing conditions and
help our customers maximize their operating income, we offer a retrofitting
service by repackaging a customer's compressor with a compressor that meets our
customer's changed conditions.
The Flare Business
The drilling for and production of oil and gas results in certain
gaseous hydrocarbon byproducts that generally must be burned off at the source.
Although flares and flare systems have been part of the oilfield and
petrochemical environment for many years, increasing regulation of emissions has
resulted in a significant increase in demand for flare systems of increasingly
complex design meeting new environmental regulations. Growth is primarily
related, as is the case for most industries connected with oil and gas, to the
price of oil and gas and new environmental regulations.
We design, manufacture, install and service flare stacks and related
ignition and control devices for the onshore and offshore burning of gas
compounds such as hydrogen sulfide, carbon dioxide, natural gas and liquefied
petroleum gases. We produce two ignition systems for varied applications: (a) a
standing jet-like pipe for minimal fuel consumption, with a patented electronic
igniter; and (b) an electronic sparked ignition system. Flare tips are available
in carbon steel as well as many grades of stainless steel alloys. The stacks can
be free standing, guyed, or trailer mounted. The flare stack and ignition
systems use a smokeless design for reduced emissions to meet or exceed
government regulated clean air standards. Our product line includes
solar-powered flare ignition systems and thermocouple control systems designed
to detect the loss of combustion in the product stream and reignite the product
stream. These products contain specially-designed combustion tips and utilize
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pilot flow Venturi tubes to maximize the efficient burning of waste gas with a
minimal use of pilot or assist gas, thereby minimizing the impact on the
environment of the residual output. Increased emphasis on "clean air" and
industry emissions has had a positive effect on the flare industry. Our broad
energy industry experience has allowed us to work closely with our customers to
seek cost-effective solutions to their flare requirements.
During the years ended December 31, 2004 and 2003, we sold 74 and 62
flare systems, respectively, to our customers generating approximately
$1,160,000 and $821,000 (approximately 7% and 6% of our total consolidated
revenue) in revenue, respectively.
Major Customers
Sales to two customers in the year ended December 31, 2004 amounted to
a total of 21% and 17% respectively of consolidated revenue. Sales to two
customers in the year ended December 31, 2003 amounted to 28% and 10%
respectively of consolidated revenue. No other single customer accounted for
more than 10% of the Company's sales in 2003 or 2004. At December 31, 2004, two
customers accounted for 12% and 10% respectively, of the Company's trade
accounts receivable.
Continuing Product Development
We engage in a continuing effort to improve our compressor and flare
operations. Continuing development activities in this regard include new and
existing product development testing and analysis, process and equipment
development and testing, and product performance improvement. We also focus our
activities on reducing overall costs to the customer, which include the initial
capital cost for equipment, the monthly leasing cost if applicable, and the
operating costs associated with such equipment, including energy consumption,
maintenance costs and environmental emissions.
During our years ended December 31, 2004 and 2003, we did not spend any
material amounts on research and development activities. Rather, product
improvements were made as a part of our normal operating activities.
Sales and Marketing
General. We conduct our operations from four locations. These
locations, with the exception of our executive offices, maintain an inventory
for local customer requirements, trained service technicians, and manufacturing
capabilities to provide quick delivery and service for our customers. Our sales
force also operates out of these locations and focuses on communication with our
customers and potential customers through frequent direct contact, technical
assistance, print literature, direct mail and referrals. Our sales and marketing
is performed by nine employees.
Additionally, our personnel coordinate with each other to develop
relationships with customers who operate in multiple regions. Our sales
personnel maintain intensive contact with our operations personnel in order to
9
promptly respond to and address customer needs. Our overall sales efforts
concentrate on demonstrating our commitment to enhancing the customer's cash
flow through enhanced product design, fabrication, manufacturing, installation,
customer service and support.
During the years ended December 31, 2004 and 2003, we spent
approximately $46,000 and $38,000, respectively, on advertising.
Compression Activity. The compression marketing program emphasizes our
ability to design and fabricate natural gas compressors in accordance with the
customer's unique specifications and to provide all necessary service for such
compressors.
Flare Systems Activity. The flare systems marketing program emphasizes
our ability to design, manufacture, install and service flares with the updated
technology.
Competition
Compression Activity. The natural gas compression business is
competitive. We experience competition from companies with greater financial
resources. On a regional basis, we experience competition from several smaller
companies that compete directly with us. We have a number of competitors in the
natural gas compression segment, but we do not have sufficient information to
determine our competitive position within that group. We believe that we compete
effectively on the basis of price, customer service, including the ability to
place personnel in remote locations, flexibility in meeting customer needs and
quality and reliability of our compressors and related services.
Compressor industry participants can achieve significant advantages
through increased size and geographic breadth. As the number of rental
compressors in our rental fleet increases, the number of sales, support, and
maintenance personnel required and the minimum level of inventory does not
increase commensurately. As a result of economies of scale, we believe that we,
with a growing rental fleet, have relatively lower operating costs and higher
margins than smaller companies.
Flare Systems Activity. The flare business is highly competitive. We
have a number of competitors in the flare systems segment, but we do not have
sufficient information to determine our competitive position within that group.
We believe that we are able to compete by our offering products specifically
engineered for the customer's needs.
Employees
As of December 31, 2004, we had 111 total employees of which 110 were
fulltime employees. No employees are represented by a labor union.
Liability and Other Insurance Coverage
Our equipment and services are provided to customers who are subject to
hazards inherent in the oil and gas industry, such as blowouts, explosions,
10
craterings, fires, and oil spills. We maintain liability insurance that we
believe is customary in the industry. We also maintain insurance with respect to
our facilities. Based on our historical experience, we believe that our
insurance coverage is adequate.
Government Regulation
We are subject to numerous federal, state and local laws and
regulations relating to the storage, handling, emission and discharge of
materials into the environment, including the Comprehensive Environmental
Response, Compensation and Liability Act, the Clean Water Act, the Clean Air Act
and the Resource Conservation and Recovery Act. As a result of our operations,
we generate or manage hazardous wastes, such as solvents, thinner, waste paint,
waste oil, washdown wastes and sandblast material. We currently spend a
negligible amount each year to dispose of the wastes. Although we attempt to
identify and address contamination before acquiring properties, and although we
attempt to utilize generally accepted operating and disposal practices,
hydrocarbons or other wastes may have been disposed of or released on or under
properties owned, leased, or operated by us or on or under locations where such
wastes have been taken for disposal. These properties and the wastes or remedial
sites where they have been released might have to be remediated at our expense.
We believe that our existing environmental control procedures are
adequate and we have no current plans for substantial operating or capital
expenditures relating to environmental control requirements. We believe that we
are in substantial compliance with environmental laws and regulations and that
the phasing in of emission controls and other known regulatory requirements at
the rate currently contemplated by such laws and regulations will not have a
material adverse affect on our financial condition or operational results. Some
risk of environmental liability and other costs are inherent in the nature of
our business, however, and there can be no assurance that environmental costs
will not rise. Moreover, it is possible that future developments, such as
increasingly strict requirements and environmental laws and enforcement policies
thereunder, could lead to material costs of environmental compliance by us.
While we may be able to pass on the additional cost of complying with such laws
to our customers, there can be no assurance that attempts to do so will be
successful.
Patents, Trademarks and Other Intellectual Property
We believe that the success of our business depends more on the
technical competence, creativity and marketing abilities of our employees than
on any individual patent, trademark, or copyright. Nevertheless, as part of our
ongoing research, development and manufacturing activities, we have a policy of
seeking patents when appropriate on inventions concerning new products and
product improvements. We currently own two United States patents covering
certain flare system technologies, which expire in May 2006 and in January 2010,
respectively. We do not own any foreign patents. Although we continue to use the
patented technology and consider it useful in certain applications, we do not
consider these patents to be material to our business as a whole.
11
Suppliers and Raw Materials
With respect to our flare system and compressor operations, our raw
materials used consist of cast and forged iron and steel. Such materials are
generally available from a number of suppliers, and accordingly, we are not
dependent on any particular supplier for these new materials. We currently do
not have long-term contracts with our suppliers of raw materials, but believe
our sources of raw materials are reliable and adequate for our needs. We have
not experienced any significant supply problems in the past.
Certain components of our compressors are obtained primarily from four
suppliers. If either one of our current major suppliers should curtail its
operations or be unable to meet our needs, we would encounter delays in
supplying our customers with compressors until an alternative supplier could be
found. We may not be able to find acceptable alternative suppliers.
ITEM 2. DESCRIPTION OF PROPERTY
We maintain our executive offices in Midland, Texas. This facility is
owned by us and is used for manufacturing, fabrication, remanufacturing,
operations, testing, warehousing and storage, general and administrative
functions and training.
The facility in Midland is an approximately 24,600 square foot building
that provides us with sufficient space to manufacture, fabricate and test our
equipment on site and has land available to expand the building when needed. Our
current facilities in Midland are anticipated to provide us with sufficient
space and capacity for at least the next year and thus there are no current
plans to open new locations, unless they are acquired as a result of any future
acquisitions.
The facilities in Lewiston, Michigan consist of a total of
approximately 15,360 square feet. Approximately 9,360 square feet are used as
offices and a repair shop and approximately 6,000 square feet are used for
manufacturing and fabrication of compressors and storage.
The facility in Bloomfield, New Mexico is an approximately 4,000 square
foot building that is leased at a current rate of $2,650 per month pursuant to a
lease that terminates in May 2008. Approximately 1,000 square feet are used as
office space and approximately 3,000 square feet are used for shop space.
The facility in Bridgeport, Texas is an approximately 4,500 square foot
building that is leased at a current rate of $1,500 per month pursuant to a
lease that terminates in August 2006. Approximately 500 square feet is used as
office space and approximately 4,000 square feet is used as shop space.
12
We also own an approximately 4,100 square foot building in Midland that
is leased at a current rate of $1,050 per month to an unaffiliated party
pursuant to a lease that terminates in May 2005. This facility previously
contained our executive offices and manufacturing and fabrication operations.
We believe that our properties are generally well maintained and in
good condition.
ITEM 3. LEGAL PROCEEDINGS
There are no pending legal proceedings against our properties or us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of our security holders during
the fourth quarter of 2004.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS
ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock and warrants are quoted on the American Stock Exchange
under the symbols NGS and NGS.WS, respectively. The following table sets forth
for the periods indicated the high and low sales prices for our common stock and
warrants as reported by the American Stock Exchange. Our common stock and
warrants began trading on October 21, 2002.
---------------------------------------- ----------------- ---------------------
Common Stock Warrants
---------------------------------------- ----------------- ---------------------
High Low High Low
---------------------------------------- -------- -------- --------- -----------
---------------------------------------- -------- -------- --------- -----------
Oct. 21, 2002 through Dec. 31, 2002 $4.25 $3.35 $0.90 $0.25
---------------------------------------- -------- -------- --------- -----------
---------------------------------------- -------- -------- --------- -----------
2003
---------------------------------------- -------- -------- --------- -----------
First Quarter $4.30 $3.70 $0.80 $0.63
---------------------------------------- -------- -------- --------- -----------
Second Quarter $7.25 $3.65 $1.55 $0.55
---------------------------------------- -------- -------- --------- -----------
Third Quarter $6.75 $5.45 $1.65 $1.06
---------------------------------------- -------- -------- --------- -----------
Fourth Quarter $6.24 $5.25 $1.70 $1.25
---------------------------------------- -------- -------- --------- -----------
---------------------------------------- -------- -------- --------- -----------
2004
---------------------------------------- -------- -------- --------- -----------
First Quarter $7.20 $5.41 $2.30 $1.15
---------------------------------------- -------- -------- --------- -----------
Second Quarter $10.04 $7.20 $4.10 $2.00
---------------------------------------- -------- -------- --------- -----------
Third Quarter $9.45 $7.12 $3.85 $2.48
---------------------------------------- -------- -------- --------- -----------
Fourth Quarter $9.43 $8.07 $3.82 $3.08
---------------------------------------- -------- -------- --------- -----------
As of December 31, 2004, there were approximately 32 holders of record
of our common stock and 3 holders of record of our warrants. The number of
holders of record does not include holders whose securities are held in street
name.
14
We have never declared or paid any dividends on our common stock. We
anticipate that, for the foreseeable future, all earnings will be retained for
use in our business and no cash dividends will be paid to holders of our common
stock. If we were to pay cash dividends in the future on the common stock, it
would be dependent upon our:
o financial condition,
o results of operations,
o current and anticipated cash requirements,
o plans for expansion,
o restrictions, if any, under debt obligations,
As well as other factors that our board of directors deemed relevant.
Our agreement with our bank contains provisions that restrict us from paying
dividends on our common stock.
The following is a table with information regarding our equity
compensation plans as of December 31, 2004:
----------------------- ------------------------- ---------------------- -------------------------
Plan category Number of securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available for
of outstanding options, outstanding options, future issuance under
warrants and rights warrants and rights equity compensation
plans (excluding
securities reflected in
column (a))
(a) (b) (c)
----------------------- ------------------------- ---------------------- -------------------------
Equity compensation
plans approved by
security holders 107,000 $5.26 32,000
----------------------- ------------------------- ---------------------- -------------------------
Equity compensation
plans not approved by
security holders - - -
----------------------- ------------------------- ---------------------- -------------------------
Total 107,000 $5.26 32,000
----------------------- ------------------------- ---------------------------- -------------------
Sales of Unregistered Securities during the Year Ended December 31, 2004
On July 20, 2004, the Company and CBarney Investments, Ltd. entered
into a Securities Purchase Agreement. Under this agreement, the Company issued
and sold 649,574 shares of its common stock to CBarney at $7.69736 per share.
15
The per share price was determined by multiplying (x) $8.747, the average
closing market price of the common stock on the American Stock Exchange for the
twenty consecutive trading days ended July 15, 2004, times (y) eighty-eight
percent. The Company received aggregate gross proceeds of $5,000,000 and net
proceeds of $4,950,000. The issuance and sale of the common stock was made in
reliance upon the exemption from registration under Section 4(2) of the
Securities Act of 1933, as amended, as a transaction not involving a public
offering. All of the shares are "restricted" securities within the meaning of
Rule 144 under the Securities Act and bear a legend to that effect. However, we
did file a registration statement with the Securities and Exchange Commission
registering the resale of the common stock. There were no underwriters involved
in the transaction.
On March 26, 2004, all the remaining holders of the shares of our
outstanding 10% Convertible Series A Preferred Stock converted their shares into
shares of our common stock. There was no underwriter involved in the
transactions. The shares of our common stock were issued in reliance upon the
exemption contained in Section 4(2) of the Securities Act of 1933, as amended,
as a transaction not involving a public offering. All of the shares are
"restricted" securities within the meaning of rule 144 under the Securities Act
and bear a legend to that effect. All of the holders were accredited investors.
During the twelve months ended December 31, 2004 we issued 74,560
shares of common stock to three persons upon the exercise of their warrants. The
shares were issued in a transaction not involving a public offering and were
issued in reliance upon the exemption from registration provided by Section 4(2)
of the Securities Act of 1933. The persons to whom the shares were issued had
access to full information concerning us. The certificates for the shares
contain restrictive legends advising that the shares may not be offered for
sale, sold or otherwise transferred without having first been registered under
the 1933 Act or pursuant to an exemption from registration under the Securities
Act of 1933. There was no underwriter involved in the issuance of the 74,560
shares.
No repurchases of our securities were made by on our behalf of us or
any "affiliated purchaser" as defined in Rule 10b - 18(a)(3) during the fourth
quarter of the year ended December 31, 2004.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion should be read in conjunction with the
consolidated financial statements and attached notes thereto and the other
financial information included elsewhere in this Report. This discussion
contains forward-looking statements that involve risks and uncertainties. Our
actual results could differ materially from those anticipated in these forward
looking statements as a result of any number of factors, including those set
forth under the section entitled "Risk Factors" and elsewhere in this Report.
16
Overview
We have combined the operations of our wholly-owned subsidiaries:
Rotary Gas Systems, NGE Leasing and Great Lakes Compression. These entities
provide products and services to the oil and gas industry and are engaged in (1)
the manufacture, sale and rental of natural gas compressors to enhance the
productivity of oil and gas wells, and (2) the manufacture, sale and rental of
flares and flare ignition systems for plant and production facilities. We have
been the parent company and provide administrative and management support and,
therefore, have expenses associated with that activity. On January 1, 2004, we
merged our subsidiaries into us.
Results of Operations
Twelve Months Ended December 31, 2004, Compared to the Twelve Months
Ended December 31, 2003.
Total revenue increased from $12,750,000 to $15,958,000 or 25% for the
twelve months ended December 31, 2004 compared to the same period ended December
31, 2003. This was mainly the result of increased leasing income as discussed
below.
Sales revenue from outside sources decreased from $3,865,000 to
$3,593,000, or 7% for the twelve months ended December 31, 2004 compared to the
same period ended December 31, 2003. Sales from outside sources included: (1)
Compressor unit sales, (2) Flare sales, (3) Parts sales and (4) Compressor
rebuilds. This decrease was mainly the result of a reduction in the sale of
compressor units to outside third parties in the twelve months ended December
31, 2004 compared to the same period in 2003. Because our products are
custom-built, fluctuations in revenue from outside sources is not unusual and
our focus has been more on building a rental base than on the sale of equipment.
Service and maintenance revenue increased from $1,773,000 to
$1,874,000, or 6% for the twelve months ended December 31, 2004 compared to the
same period ended December 31, 2003.
Leasing revenue increased from $7,111,000 to $10,491,000, or 48% for
the twelve months ended December 31, 2004 compared to the same period ended
December 31, 2003. This increase was the result of additional units added to our
rental fleet and leased to third parties. The company ended the 2004 year with
585 compressor packages in its rental fleet, up from 399 units at December 31,
2003.
---------------------------------------------------------------
Total Revenue Breakdown for Twelve months ended
December 31, 2004
---------------------------------- ----------------------------
---------------------------------- ----------------------------
Sales Revenue 23%
---------------------------------- ----------------------------
Service & Maintenance
Revenue 12%
---------------------------------- ----------------------------
Leasing Revenue 65%
---------------------------------- ----------------------------
17
The gross margin percentage increased from 52% for the twelve months
ended December 31, 2003, to 56% for the same period ended December 31, 2004.
This improvement resulted mainly from the relative increase in leasing revenue
as a percentage of the total revenue. Our rental fleet carries a gross margin
averaging 70%, and an increase in rentals improves our total gross margin.
Selling, general and administrative expense increased from $2,292,000
to $2,652,000 or 16% for the twelve months ended December 31, 2004, as compared
to the same period ended December 31, 2003. This was mainly the result of the
increase in commissions from additional leasing contracts on gas compressors to
third parties, and an increase in professional fees related to regulatory
filings and Sarbanes- Oxley compliance matters.
Depreciation and amortization expense increased 42 % from $1,726,000 to
$2,444,000 for the twelve months ended December 31, 2004, compared to the same
period ended December 31, 2003. This increase was the result of 186 new gas
compressor rental units being added to rental equipment from December 31, 2003
to December 31, 2004.
Other income and expense increased approximately $1,445,000 for the
twelve months ended December 31, 2004, compared to the same period ended
December 31, 2003. This increase was due mainly from the receipt of $1,500,000
in life insurance payable in connection with the death of Mr. Wayne L. Vinson,
our former President and C.E.O. His death on March 15, 2004 left the company as
the beneficiary of two life insurance policies, one for $1,000,000, and one for
$500,000.
Interest expense increased $770,000 or 26% for the twelve months ended
December 31, 2004 compared to the same period ended December 31, 2003, mainly
due to the increased loan balances on vehicles and rental equipment.
Provision for income tax increased $443,000 or 64%, primarily due to
the increase in net taxable income. The income from the life insurance proceeds
described above is not subject to federal income tax.
Net Income for the year increased 158% mainly from increased rental
activity and life insurance proceeds.
18
Critical Accounting Policies and Practices
We have identified the policies below as critical to our business
operations and the understanding of our results of operations. In the ordinary
course of business, we have made a number of estimates and assumptions relating
to the reporting of results of operations and financial condition in the
preparation of our financial statements in conformity with accounting principles
generally accepted in the United States. Actual results could differ
significantly from those estimates under different assumptions and conditions.
We believe that the following discussion addresses our most critical accounting
policies, which are those that are most important to the portrayal of our
financial condition and results of operations and require our most difficult,
subjective, and complex judgments, often as a result of the need to make
estimates about the effect of matters that are inherently uncertain.
Our critical accounting policies are as follows:
o revenue recognition;
o estimating the allowance for doubtful accounts;
o accounting for income taxes;
o valuation of long-lived and intangible assets and goodwill;
and
o valuation of inventory
Revenue recognition
We recognize revenue from sales of compressors or flare systems at the
time of shipment and passage of title when collectability is reasonably assured.
We also offer certain of our customers the right to return products that do not
function properly within a limited time after delivery. We continuously monitor
and track such product returns and we record a provision for the estimated
amount of such future returns, based on historical experience and any
notification we receive of pending returns. While such returns have historically
been within our expectations and the provisions established, we cannot guarantee
that we will continue to experience the same return rates that we have in the
past. Any significant increase in product failure rates and the resulting credit
returns could have a material adverse impact on our operating results for the
period or periods in which such returns occur.
When product is billed to customers based on contractual agreements,
but has not yet been shipped, payments are recorded as deferred revenue, pending
shipment.
Rental and lease revenue are recognized over the terms of the
respective lease agreements based upon the classification of the lease.
Service and maintenance revenue is recognized as the service is
provided or over the term of the agreement, as applicable.
19
Allowance for doubtful accounts receivable
We perform ongoing credit evaluations of our customers and adjust
credit limits based upon payment history and the customer's current credit
worthiness, as determined by our review of their current credit information. We
continuously monitor collections and payments from our customers and maintain a
provision for estimated credit losses based upon our historical experience and
any specific customer collection issues that we have identified. While such
credit losses have historically been within our expectations and the provisions
established, we cannot guarantee that we will continue to experience the same
credit loss rates that we have in the past. Since 22% of our accounts receivable
are concentrated in approximately two customers at December 31, 2004, a
significant change in the liquidity or financial position of any one of these
customers could have a material adverse impact on the collectability of our
accounts receivables and our future operating results.
Accounting for income taxes
As part of the process of preparing our consolidated financial
statements we are required to estimate our Federal income taxes as well as
income taxes in each of the states in which we operate. This process involves us
estimating our actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items for tax and accounting
purposes. These differences result in deferred tax assets and liabilities, which
are included in our consolidated balance sheet. We must then assess the
likelihood that our deferred tax assets will be recovered from future taxable
income and to the extent we believe that recovery is not probable, we must
establish a valuation allowance. To the extent we establish a valuation
allowance or increase this allowance in a period, we must include an expense in
the tax provision in the statement of operations.
Significant management judgment is required in determining our
provision for income taxes, our deferred tax assets and liabilities and any
valuation allowance recorded against our net deferred tax assets.
Valuation of long-lived and intangible assets and goodwill
We assess the impairment of identifiable intangibles, long-lived assets
and related goodwill whenever events or changes in circumstances indicate that
the carrying value may not be recoverable. Factors we consider important which
could trigger an impairment review include the following:
o significant underperformance relative to expected historical
or projected future operating results;
o significant changes in the manner of our use of the acquired
assets or the strategy for our overall business; and
o significant negative industry or economic trends;
20
When we determine that the carrying value of intangibles, long-lived
assets and related goodwill may not be recoverable based upon the existence of
one or more of the above indicators of impairment, we measure any impairment
based on a projected discounted cash flow method using a discount rate
determined by our management to be commensurate with the risk inherent in our
current business model.
In 2002, Statement of Financial Accounting Standards ("FAS") No. 142,
"Goodwill and Other Intangible Assets" became effective and as a result, we
ceased to amortize approximately $2.6 million of goodwill as of January 1, 2002.
In lieu of amortization, we are required to perform an annual impairment review
of our goodwill. Based upon valuations in June 2003 and June 2004, of our
reporting units with goodwill, we did not record an impairment charge during
either year.
Inventories
We value our inventory at the lower of the actual cost to purchase
and/or manufacture the inventory or the current estimated market value of the
inventory. We regularly review inventory quantities on hand and record a
provision for excess and obsolete inventory based primarily on our estimated
forecast of product demand and production requirements.
Recently Issued Accounting Pronouncements
On December 16, 2004, the FASB published FASB Statement No. 123
(revised 2004), Share-Based Payment. Statement 123(R) requiring that the
compensation cost relating to share-based payment transactions be recognized in
financial statements. That cost will be measured based on the fair value of the
equity or liability instruments issued. Public entities (other than those filing
as small business issuers) will be required to apply Statement 123(R) as of the
first interim or annual reporting period that begins after June 15, 2005. Public
entities that file as small business issuers will be required to apply Statement
123(R) in the first interim or annual reporting period that begins after
December 15, 2005. Statement 123(R) replaces FASB Statement No. 123, Accounting
for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees. Statement 123, as originally issued in 1995,
established as preferable a fair-value-based method of accounting for
share-based payment transactions with employees. However, that Statement
permitted entities the option of continuing to apply the guidance in Opinion 25,
as long as the footnotes to financial statements disclosed what net income would
have been had the preferable fair-value-based method been used.
Seasonality and Economic Conditions
Our sales are affected by the timing of planned development and
construction projects by energy industry customers.
21
We do not believe that inflation had a material impact upon our results
of operations during the year ended December 31, 2004, or during the year ended
December 31, 2003.
Liquidity and Capital Resources
We have funded our operations through public and private offerings of
our common and preferred stock, subordinated debt, and bank debt. At December
31, 2004, we had cash and cash equivalents of approximately $685,000, working
capital of approximately $640,000 and debt of approximately $13,018,000 of which
approximately $3,728,000 was classified as current. We had approximately
$4,697,000 of net cash flow from operating activities during the twelve months
ending December 31, 2004. This was primarily from net income of approximately
$3,374,000 plus depreciation and amortization of approximately $2,444,000 and
increases in deferred taxes of approximately $1,120,000, offset by an increase
in accounts receivable and inventory of approximately $1,182,000 and 1,915,000
respectively.
Market Risk
We significantly rely upon debt financing provided by various financial
institutions. Most of these instruments contain interest provisions that are at
least a percentage point above the published prime rate. This creates a
vulnerability to us relative to the movement of the prime rate. Should the prime
rate increase, our cost of funds will increase and affect our ability to obtain
additional debt. We have not engaged in any hedging activities to offset such
risks.
Risk Factors
You should carefully consider the following risks. The risks and
uncertainties described below are not the only ones facing us. Additional risks
and uncertainties that are not presently known to us or that we currently deem
immaterial may also impair our business.
If any of the events described in the following risks actually occur,
our business, financial condition and results of operations could be materially
adversely affected. In such case, the trading prices of our common stock or
warrants could decline and you could lose all or part of your investment.
Our current debt is large and may negatively impact our current and future
financial stability.
As of December 31, 2004 we had an aggregate of approximately
$13,018,000 of outstanding indebtedness not including accounts payable and
accrued expenses of approximately $2,355,000. As a result of our significant
indebtedness, we might not have the ability to incur any substantial additional
indebtedness. The level of our indebtedness could have several important effects
on our future operations, including:
22
o our ability to obtain additional financing for working
capital, acquisitions, capital expenditures and other purposes
may be limited;
o a significant portion of our cash flow from operations may be
dedicated to the payment of principal and interest on our
debt, thereby reducing funds available for other purposes; and
o our significant leverage could make us more vulnerable to
economic downturns.
If we are unable to service our debt, we will likely be forced to take remedial
steps that are contrary to our business plan.
As of December 31, 2004, our principal payments for our debt service
requirements on a monthly, quarterly and annual basis were approximately
$312,000, $936,000, and $3,745,000, respectively. It is possible that our
business will not generate sufficient cash flow from operations to meet our debt
service requirements and the payment of principal when due. If this were to
occur, we may be forced to:
o sell assets at disadvantageous prices;
o obtain additional financing; or
o refinance all or a portion of our indebtedness on terms that
may be very unfavorable to us.
Our current bank loan contains covenants that limit our operating and financial
flexibility and, if breached, could expose us to severe remedial provisions.
Under the terms of the bank loan, we must:
o comply with a debt to asset ratio;
o maintain minimum levels of tangible net worth;
o not exceed specified levels of debt;
o comply with a cash flow to fixed charges ratio;
o comply with a debt to net worth ratio; and
o not incur additional debt over a specified amount.
Our ability to meet the financial ratios and tests under our bank loan
can be affected by events beyond our control, and we may not be able to satisfy
those ratios and tests. A breach under either could permit the bank to
23
accelerate the debt so that it is immediately due and payable. No further
borrowings would be available under the credit facility. If we were unable to
repay the debt, the bank could proceed against our assets.
Approximately 69% of our compressor leases are leased for terms of six months or
less that, if terminated, would adversely impact our revenue and our ability to
recover our initial equipment costs.
Approximately 69% of our compressor leases are for terms of up to six
months. There is a possibility that these leases could be terminated by lessees
within short periods of time and that we may not be able to recover the cost of
the compressor for which a lease is terminated.
The anticipated revenue from the affiliate of Dominion Michigan cannot be
guaranteed.
In connection with our acquisition of the compression related assets of
Dominion Michigan, an affiliate of Dominion Michigan committed to purchase
compressors from us or enter into five year leases of compressors with us
totaling five-thousand horsepower an expires December 31, 2005. If, for any
reason, the affiliate does not fulfill this obligation to any material extent,
our cash flow will be significantly reduced and we may not be able to pay the
principal or interest on our debt as it becomes due.
We rely on one customer for a significant amount of our business and the loss of
this customer could adversely affect our operating results and lower the price
of our common stock
During the years ended December 2004 and 2003, Dominion Exploration &
Production, Inc. accounted for approximately 21% and 28% of our consolidated
revenue, respectively. The loss of Dominion Exploration as a customer could
cause our operating results to fall below market analysts' expectations and
lower the price of our common stock.
We are dependent on a few suppliers for some of our compressor components and
the loss of one of these suppliers could cause a delay in the manufacturing of
our compressors and reduce our revenue.
We currently obtain approximately 20% of our compressor components from
three suppliers. We order from these suppliers as needed and we have no
long-term contracts with any of these suppliers. If any of these of these
suppliers should curtail its operations or be unable to meet our needs, we would
encounter delays in supplying our customers with compressors until an
alternative supplier, if any, could be found. Such delays in our manufacturing
process could reduce our revenue and negatively impact our relationships with
customers.
Decreased oil and gas industry expenditure levels would adversely affect our
revenue.
24
Our revenue is derived from expenditures in the oil and gas industry
which, in turn, are based on budgets to explore for, develop and produce oil and
natural gas. If these expenditures decline, our revenue will suffer. The
industry's willingness to explore, develop and produce depends largely upon the
prevailing view of future oil and gas prices. Many factors affect the supply and
demand for oil and gas and, therefore, influence product prices including:
o the level of oil and gas production;
o the levels of oil and gas inventories;
o the expected cost of developing new reserves;
o the cost of producing oil and gas;
o the level of drilling activity;
o inclement weather;
o worldwide economic activity;
o regulatory and other federal and state requirements in the
United States;
o the ability of the Organization of Petroleum Exporting
Countries to set and maintain production levels and prices for
oil;
o terrorist activities in the United States and elsewhere;
o the cost of developing alternate energy sources;
o environmental regulation; and
o tax policies.
If the demand for oil and gas decreases, then demand for our
compressors likely will decrease.
The intense competition in our industry could result in reduced profitability
and loss of market share for us.
We sell or lease our products and sell our services in competitive
markets. In most of our business segments, we compete with the oil and gas
industry's largest equipment and service providers who have greater name
recognition than we do. These companies also have substantially greater
financial resources, larger operations and greater budgets for marketing,
research and development than we do. They may be better able to compete in
making equipment available quickly and more efficiently, meeting delivery
schedules or reducing prices. As a result, we could lose customers and market
share to those competitors. These companies may also be better positioned than
us to successfully endure down turns in the oil and gas industry.
25
Our operations may be adversely affected if our current competitors or
new market entrants introduce new products or services with better prices,
features, performance or other competitive characteristics than our products and
services. Competitive pressures or other factors also may result in significant
price competition that could harm our revenue and our business.
We might be unable to employ adequate technical personnel, which could hamper
our plans for expansion or increase our costs.
Many of the compressors that we sell or lease are technically complex
and often must perform in harsh conditions. We believe that our success depends
upon our ability to employ and retain a sufficient number of technical personnel
who have the ability to design, utilize, enhance and maintain these compressors.
Our ability to expand our operations depends in part on our ability to increase
our skilled labor force. The demand for skilled workers is high and supply is
limited. A significant increase in the wages paid by competing employers could
result in a reduction of our skilled labor force or cause an increase in the
wage rates that we must pay or both. If either of these events were to occur,
our cost structure could increase and our operations and growth potential could
be impaired.
If we do not develop, produce and commercialize new competitive technologies and
products, our revenue may decline.
The markets for natural gas compressor products and services and for
flare systems, ignition systems and components for plant and production
facilities are characterized by continual technological developments. As a
result, substantial improvements in the scope and quality of product function
and performance can occur over a short period of time. If we are not able to
develop commercially competitive products in a timely manner in response to
changes in technology, our business and revenue may be adversely affected.
We may encounter financial constraints or technical or other
difficulties that could delay introduction of new products and services in the
future. Our competitors may introduce new products before we do and achieve a
competitive advantage.
Additionally, the time and expense invested in product development may
not result in commercial applications that provide revenue. We could be required
to write off our entire investment in a new product that does not reach
commercial viability. Moreover, we may experience operating losses after new
products are introduced and commercialized because of high start-up costs,
unexpected manufacturing costs or problems, or lack of demand.
We are subject to extensive environmental laws and regulations that could
require us to take costly compliance actions that could harm our financial
condition.
26
Our manufacturing and maintenance operations are significantly affected
by stringent and complex federal, state and local laws and regulations governing
the discharge of substances into the environment or otherwise relating to
environmental protection. In these operations, we generate and manage hazardous
wastes such as solvents, thinner, waste paint, waste oil, washdown wastes, and
sandblast material. We attempt to use generally accepted operating and disposal
practices and, with respect to acquisitions, will attempt to identify and assess
whether there is any environmental risk before completing an acquisition. Based
on the nature of the industry, however, hydrocarbons or other wastes may have
been disposed of or released on or under properties owned, leased, or operated
by us or on or under other locations where such wastes have been taken for
disposal. The waste on these properties may be subject to federal or state
environmental laws that could require us to remove the wastes or remediate sites
where they have been released. We could be exposed to liability for cleanup
costs, natural resource and other damages as a result of our conduct or the
conduct of, or conditions caused by, prior operators or other third parties.
Environmental laws and regulations have changed in the past, and they are likely
to change in the future. If existing regulatory requirements or enforcement
policies change, we may be required to make significant unanticipated capital
and operating expenditures.
Any failure by us to comply with applicable environmental laws and
regulations may result in governmental authorities taking actions against our
business that could harm our operations and financial condition, including the:
o issuance of administrative, civil and criminal penalties;
o denial or revocation of permits or other authorizations;
o reduction or cessation in operations; and
o performance of site investigatory, remedial or other
corrective actions.
We could be subject to substantial liability claims that could harm our
financial condition.
Our products are used in hazardous drilling and production applications
where an accident or a failure of a product can cause personal injury, loss of
life, damage to property, equipment or the environment, or suspension of
operations.
27
While we maintain insurance coverage, we face the following risks under
our insurance coverage:
o we may not be able to continue to obtain insurance on
commercially reasonable terms;
o we may be faced with types of liabilities that will not be
covered by our insurance, such as damages from significant
product liabilities and from environmental contamination;
o the dollar amount of any liabilities may exceed our policy
limits; and
o we do not maintain coverage against the risk of interruption
of our business.
Any claims made under our policy will likely cause our premiums to
increase. Any future damages caused by our products or services that are not
covered by insurance, are in excess of policy limits or are subject to
substantial deductibles, would reduce our earnings and our cash available for
operations.
Liability to customers under warranties may materially and adversely affect our
earnings.
We provide warranties as to the proper operation and conformance to
specifications of the equipment we manufacture. Our equipment is complex and
often deployed in harsh environments. Failure of this equipment to operate
properly or to meet specifications may increase our costs by requiring
additional engineering resources and services, replacement of parts and
equipment or monetary reimbursement to a customer. We have in the past received
warranty claims and we expect to continue to receive them in the future. To the
extent that we incur substantial warranty claims in any period, our reputation,
our ability to obtain future business and our earnings could be materially and
adversely affected.
Loss of key members of our management could adversely affect our business while
we attempt to find their replacements.
We depend on the continued employment and performance of Wallace C.
Sparkman, our Chairman, Stephen C. Taylor our President and Earl R. Wait, our
Treasurer and Chief Financial Officer, and other key members of our management.
If any of our key managers resigns or becomes unable to continue in his present
role and is not adequately replaced, our business operations could be materially
adversely affected.
We are reliant on our current customers for future cash flows and the loss of
one or more of our current customers could adversely affect our results of
operations.
Our business is dependent not only on securing new customers but also
on maintaining current customers. Dominion Exploration & Production, Inc., an
affiliate of Dominion Resources, Inc., accounted for approximately 21% and
28
approximately 28% of our consolidated revenue during the year ended December 31,
2004 and the year ended December 31, 2003, respectively. The loss of one or more
of our significant customers would have an adverse effect on our revenue and
results of operations.
Provisions contained in our governing documents could hinder a change in our
control.
Our articles of incorporation and bylaws contain provisions that may
discourage acquisition bids and may limit the price investors are willing to pay
for our common stock and warrants. Our articles of incorporation and bylaws
provide that:
o directors will be elected for three-year terms, with
approximately one-third of the board of directors standing for
election each year;
o cumulative voting is not allowed which limits the ability of
minority shareholders to elect any directors;
o the unanimous vote of the board of directors or the
affirmative vote of the holders of not less than 80% of the
votes entitled to be cast by the holders of all shares
entitled to vote in the election of directors is required to
change the size of the board of directors; and
o directors may only be removed for cause by holders of not less
than 80% of the votes entitled to be cast on the matter.
Our board of directors has the authority to issue up to five million
shares of preferred stock. The board of directors can fix the terms of the
preferred stock without any action on the part of our shareholders. The issuance
of shares of preferred stock may delay or prevent a change in control
transaction. In addition, preferred stock could be used in connection with the
board of director's adoption of a shareholders' rights plan (also known as a
poison pill), which would make it much more difficult to effect a change in
control of our company through acquiring or controlling blocks of stock. Also,
after completion of this offering, our directors and officers as a group will
continue to beneficially own stock. Although this is not a majority of our
stock, it confers substantial voting power in the election of directors and
management of our company. This would make it difficult for other minority
shareholders, such as the investors in this offering, to effect a change in
control or otherwise extend any significant control over the management of our
company. This may adversely affect the market price and interfere with the
voting and other rights of our common stock.
We must evaluate our intangible assets annually for impairment.
Our intangible assets are recorded at cost less accumulated
amortization and consist of goodwill and patent costs. Through December 31,
2001, goodwill was amortized using the straight-line method over 15 years and
patent costs were amortized over 13 to 15 years.
29
In June 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets." FAS 142 provides that: 1) goodwill and intangible assets with
indefinite lives will no longer be amortized; 2) goodwill and intangible assets
with indefinite lives must be tested for impairment at least annually; and 3)
the amortization period for intangible assets with finite lives will no longer
be limited to forty years. In the event that we determine our intangible assets
with indefinite lives have been impaired, we must record a write-down of those
assets on our statement of operations during the period of impairment. Our
determination of impairment will be based on various factors, including any of
the following factors, if they materialize:
o significant underperformance relative to expected historical
or projected future operating results;
o significant changes in the manner of our use of the acquired
assets or the strategy for our overall business;
o significant negative industry or economic trends;
o significant decline in our stock price for a sustained period;
and
o our market capitalization relative to net book value.
We adopted FAS 142 as of January 1, 2002. Based on an independent
valuation in July 2002 and June 2003 and an internal evaluation in June 2004 of
our reporting units with goodwill, adoption of FAS 142 did not have a material
adverse effect on us in 2003 or 2004. In the future it could result in
impairments of our intangible assets or goodwill. We expect to continue to
amortize our intangible assets with finite lives over the same time periods as
previously used, and we will test our intangible assets with indefinite lives
for impairment at least once each year. In addition, we are required to assess
the consumptive life, or longevity, of our intangible assets with finite lives
and adjust their amortization periods accordingly. Our net intangible assets
were recorded on our balance sheet at approximately $2,676,000 as of December
31, 2004, and we increased the carrying value of net intangible assets
significantly with the SCS acquisition, which was completed January 3, 2005. Any
impairment in future periods of those assets, or a reduction in their
consumptive lives, could materially and adversely affect our statement of
operations and financial position.
Item 7. FINANCIAL STATEMENTS
See Financial Statements beginning on page F-1.
Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
30
Item 8A. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our chief executive officer and our principal accounting officer, we
have evaluated the effectiveness of our disclosure controls and procedures as of
December 31, 2004. They have concluded that these disclosure controls provide
reasonable assurance that we can collect, process and disclose, within the time
periods specified in the Commission's rules and forms, the information required
to be disclosed in our periodic Exchange Act reports.
There have been no significant changes in our internal controls or in
other factors that could significantly affect our internal controls subsequent
to the date of their most recent evaluation.
Item 8B. Other Information
None.
31
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executive Officers and Directors
The table below contains information about our executive officers and
directors at March 23, 2005:
Name Age Position
Wallace C. Sparkman(5) 74 Director, Chairman
Wallace O. Sellers(1)(2)(3) 75 Director,
Charles G. Curtis(1)(2) (3) 72 Director
William F. Hughes, Jr. (1)(2) (3) 52 Director
Gene A. Strasheim(1)(2)(3)(4) 63 Director
Richard L. Yadon(1)(2)(3) 46 Director
Paul Hensley 52 Director, President of SCS
Stephen C. Taylor 51 President, Chief Executive
Officer
Earl R. Wait 61 Chief Financial Officer and
Treasurer
Ronald D. Bingham 60 Vice President
S. Craig Rogers 42 Vice President
William R. Larkin 39 Vice President
Scott W. Sparkman(5) 43 Secretary
---------------------
(1) Member of our audit committee
(2) Member of our compensation committee
(3) Member of our nominating committee
(4) Gene A. Strasheim has been determined by our Board of Directors
to be the financial expert on our audit committee. Mr. Strasheim
is independent as that term is used in Item 7 (d)(3)(iv) of
Schedule 14A under the Exchange Act.
(5) Wallace C. Sparkman is the father of Scott W. Sparkman.
The Board of Directors has been divided into three classes with
directors serving staggered three-year terms. The terms of Messrs. Curtis,
Sellers and Strasheim will expire at the 2005 annual meeting of shareholders,
and the terms of Messrs. Hughes and Sparkman will expire in 2006. Mr. Yadon's
term will expire in 2007. In January 2005, Mr. Hensley was appointed as a
director to fill a vacancy on the Board of Directors, to hold office until the
2005 annual meeting of shareholders. All officers serve at the discretion of the
Board of Directors.
32
Wallace C. Sparkman is one of our founders and has served as a director
since 2003 and as Chairman of the Board of Directors since March 2005. Mr.
Sparkman served from April 1993 in various executive and director positions in
several subsidiary companies prior to their merger into the Company on December
31, 2003. Mr. Sparkman served as our interim President and Chief Executive
Officer from March 2004 to January 2005, when Stephen Taylor was employed for
the position. From December 1998 to 2003, Mr. Sparkman was a consultant to our
Board of Directors. Mr. Sparkman acted as a management consultant to various
entities and acted as a principal in forming several privately-owned companies.
Mr. Sparkman was a co-founder of Sparkman Energy Corporation, a natural gas
gathering and transmission company, in 1979 and served as its Chairman of the
Board, President and Chief Executive Officer until 1985 when ownership control
changed. From 1968 to 1979, Mr. Sparkman held various executive positions and
served as a director of Tejas Gas Corporation, a natural gas gathering and
transmission company. At the time of his resignation from Tejas Gas Corporation
in 1979, Mr. Sparkman was President and Chief Executive Officer. Mr. Sparkman
has more than 37 years of experience in the energy service industry.
Wallace O. Sellers is one of our founders and has served as a director
of Natural Gas Services Group, Inc. since December 1998 and as Chairman of our
Board of Directors from December 1998 to March 2005. Mr. Sellers was the
Chairman of the Board of Directors of Great Lakes Compression from February 2001
to December 31, 2003. Although Mr. Sellers retired in December 1994, he served
as Vice-Chairman of the Board and Chairman of the Executive Committee of Enhance
Financial Services, Inc., a financial guaranty reinsurer, from January 1995 to
2001. From November 1986 to December 1991 he was President and Chief Executive
Officer of Enhance. From 1951 to 1986 Mr. Sellers was employed by Merrill Lynch,
Pierce, Fenner & Smith Incorporated, an investment banker, in various
capacities, including Director of the Municipal and Corporate Bond Division and
Director of the Securities Research Division. Immediately prior to his
retirement from Merrill Lynch, he served as Senior Vice President and Director
of Strategic Development. Mr. Sellers received a BA degree from the University
of New Mexico, an MA degree from New York University and attended the Advanced
Management Program at Harvard University. Mr. Sellers is a Chartered Financial
Analyst.
Charles G. Curtis has been one of our directors since April 2001. Since
1992, Mr. Curtis has been the President and Chief Executive Officer of Curtis
One, Inc. d/b/a/ Roll Stair, a manufacturer of aluminum and steel mobile stools
and mobile ladders. From 1988 to 1992, Mr. Curtis was the President and Chief
Executive Officer of Cramer, Inc. a manufacturer of office furniture. Mr. Curtis
has a B.S. degree from the United States Naval Academy and a MSAE degree from
the University of Southern California.
William F. Hughes, Jr. has been one of our directors since December
2003. Since 1983, Mr. Hughes has been co-owner of The Whole Wheatery, LLC, a
natural foods store located in Lancaster, California. Mr. Hughes holds a
Bachelor of Science degree in Civil Engineering from the U.S. Air Force Academy
and a Masters of Science in Engineering from UCLA.
33
Gene A. Strasheim has served as one of our directors since 2003. Since
2001, Mr. Strasheim has been a financial consultant to Skyline
Electronics/Products, a manufacturer of circuit boards and large remotely
controlled digital interstate highway signs. From 1992 to 2001, Mr. Strasheim
was the Chief Financial Officer of Skyline Electronics/Products. From 1985 to
1992, Mr. Strasheim was the Vice President-Finance and Treasurer of CF&I Steel
Corporation. Prior to that, Mr. Strasheim was the Vice President-Finance for two
companies and was a partner with Deloitte Haskins & Sells, a large accounting
firm. Mr. Strasheim practiced as a Certified Public Accountant in three states
and has a BS degree from the University of Wyoming.
Richard L. Yadon has served as one of our directors since 2003. Mr.
Yadon is one of the original founders of Rotary and served as advisor to Natural
Gas' Board of Directors from June 2002 to June 2003. Since 1981, Mr. Yadon has
owned and operated Yadeco Pipe & Equipment. Since December 1994, he has co-owned
and presided as President of Midland Pipe & Equipment, Inc. Both companies are
directly related to drilling and completion of oil and gas wells in Texas, New
Mexico, Louisiana and Oklahoma. Since 1981, he has owned Yadon Properties, which
owns and operates real estate in Midland, Texas. Mr. Yadon has 22 years of
experience in the energy service industry.
Paul D. Hensley is the founder and has served as president of Screw
Compression Systems (SCS) from its inception in 1997. Mr. Hensley has 25 years
of experience in the natural gas compressor industry and was the driving force
behind the development and successful manufacture of SCS's reciprocating
compressor product line. Mr. Hensley was appointed as a director of Natural Gas
Services Group, Inc. in January 2005, to fill a vacancy on the Board of
Directors.
Stephen C. Taylor was elected by the Board of Directors of NGSG to
assume the position of President/CEO in January, 2005. Immediately prior to
joining NGSG, Mr. Taylor held the position of General Manager-US Operations for
Trican Production Services, Inc., a Canadian-based pressure pumping company,
from 2002 through 2004. Mr. Taylor joined Halliburton Resource Management
(Halliburton Company's gas compression rental division) in 1976 and progressed
through numerous engineering, sales and operational positions throughout the
U.S. to be its VP-Operations in 1989. In 1993 he transferred to the
corporate-entity of Halliburton Energy Services and held multiple senior level
management and operational positions, including extensive international travel
and responsibilities. In 2000 he was elected Sr. VP/Chief Operating Officer of
Enventure Global Technology, LLC, a joint-venture company owned by Halliburton
and Shell Oil Company involved in leading-edge deepwater drilling technologies.
Mr. Taylor elected early retirement from Halliburton in 2002 to join Trican
Production Services, Inc. Mr. Taylor holds a Bachelor of Science degree in
Mechanical Engineering from Texas Tech University and an MBA from The University
of Texas in Austin.
34
Earl R. Wait has served as our Chief Financial Officer since May 2000
and our Treasurer since 1998. Mr. Wait was our Chief Accounting Officer from
1998 to May 2000. Mr. Wait was the Chief Financial Officer and
Secretary/Treasurer of Flare King and then Rotary from April 1993 to December
31, 2003, the Controller and Assistant Secretary/Treasurer for Hi-Tech from 1994
to 1999, a director of NGE and Rotary from July 1999 to April 2001 and the Chief
Accounting Officer and Treasurer of Great Lakes Compression from February 2001
to December 31, 2003. Mr. Wait is a certified public accountant with an MBA in
management and has more than 25 years of experience in the energy industry.
Ronald D. Bingham has served as one of our Vice Presidents since
December 2003 and was the President of Great Lakes Compression from 2001 to
December 31, 2003. From March 2001 to July 2001, Mr. Bingham was the General
Manager of Great Lakes Compression. From January 1989 to March 2001, Mr. Bingham
was the District Manager for Waukesha Pearce Industries, Inc., a distributor of
Waukesha natural gas engines. Mr. Bingham is a member of the Michigan Oil and
Gas Association and received a bachelors degree in Graphic Arts from Sam Houston
State University.
S. Craig Rogers has served as one of our Vice Presidents since June
2003. He served as Operations Manager for Rotary from 1995 to December 31, 2003,
and Vice President of Rotary from April 2002 to December 31, 2003. From March
1987 to January 1995, Mr. Rogers was the Shop Manager for CSI, a major
manufacturer of natural gas compressors.
W. Randy Larkin has served as Vice President since October 13, 2003. He
held various positions with Compressors Systems, Inc. from 1993 until his
employment began with Natural Gas Services Group, Inc. Those positions included:
Manager of Engineering, Chief engineer, Asset Manager and Regional Sales
Manager. Mr. Larkin holds a Bachelors Degree in Mechanical Engineering from the
University of Texas in Austin, Texas.
Scott W. Sparkman has served as our Secretary since December 1998. Mr.
Sparkman was Executive Vice-President of NGE from July 2001 to December 31,
2003, was a director of NGE from December 1998 to December 31, 2003, was
Secretary and Treasurer of NGE from March 1999 to December 31, 2003 and was the
Secretary of Great Lakes Compression from February 2001 to December 31, 2003.
Mr. Sparkman was one of our directors from 1998 to 2003. Mr. Sparkman served as
the President of NGE from December 1998 to July 2001. From May 1997 to July
1998, Mr. Sparkman served as Project Manager and Comptroller for Business
Development Strategies, Inc., a designer of internet websites. Mr. Sparkman
received a BBA degree from Texas A&M University.
All of the officers devote substantially all of their working time to
our business.
35
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our
officers and directors and persons who beneficially own more than 10% of our
outstanding common stock to file reports of beneficial ownership with the
Securities and Exchange Commission and to furnish us with copies of the reports.
Based solely on a review of the Forms 3, 4 and 5 and amendments thereto
furnished to us for 2004, no persons who were either one of our directors or
officers or who beneficially owned more than 10% of our common stock failed to
file on a timely basis reports required by Section 16(a) of the Securities
Exchange Act of 1934.
Code of Ethics
Our Board of Directors has adopted a Code of Business Conduct and
Ethics ("Code"), which we posted on our web site located at www.ngsgi.com. You
may also obtain a copy of our Code by requesting a copy in writing at 2911 SCR
1260, Midland, Texas 79706 or by calling us at (432) 563-3974.
Our Code provides general statements of our expectations regarding
ethical standards that we expect our directors, officers and employees,
including our Chief Executive Officer and Chief Financial Officer, to adhere to
while acting on our behalf. Among other things, the Code provides that:
o We will comply with all laws, rules and regulations;
o Our directors, officers and employees are to avoid conflicts
of interest and are prohibited from competing with us or
personally exploiting our corporate opportunities;
o Our directors, officers and employees are to protect our
assets and maintain our confidentiality;
o We are committed to promoting values of integrity and fair
dealing; and
o We are committed to accurately maintaining our accounting
records under generally accepted accounting principles and
timely filing our periodic reports.
Our Code also contains procedures for our employees to report,
anonymously or otherwise, violations of the Code.
36
ITEM 10. EXECUTIVE COMPENSATION
Executive Compensation
The following table sets forth information regarding the compensation
paid during the years ended December 31, 2004, 2003, and 2002 by us to Wayne L.
Vinson, Earl R. Wait, Wallace Sparkman, Craig Rogers, Randy Larkin, and Scott
Sparkman, our only officers whose combined salary and bonuses exceeded $100,000
during the year ended December 31, 2004.
Annual Long-Term
Compensation Compensation
------------ ------------
Name
Principal Position Year Salary Bonus Securities Underlying Options
------------------ ---- ------ ----- -----------------------------
Wayne L. Vinson 2004 $ 39,614(1) -0- -0-
President & CEO 2003 $120,000(2) $ 48,000 -0-
2002 $120,000(2) $ 39,452 -0-
Earl R. Wait 2004 $ 90,000 $ 40,250 -0-
Chief Financial Officer 2003 $ 90,000 $ 41,256 -0-
2002 $ 90,000 $ 29,589 15,000
Wallace Sparkman 2004 $120,000(3) $ 53,500 -0-
Director, Chairman
Scott Sparkman 2004 $ 75,000 $ 20,000 3,000
Secretary 2003 $ 75,000 $ 17,939 -0-
2002 $ 75,000 $ 25,678 -0-
William R. Larkin 2004 $ 90,000 $ 40,250 12,000
Vice President 2003 $ 19,288(4) -0- -0-
S. Craig Rogers 2004 $ 95,000 $ 42,750 -0-
Vice President 2003 $ 88,500 $ 37,669 -0-
2002 $ 80,000 $ 26,301 12,000
--------------------------
(1) Mr. Vinson served as President and Chief Executive Officer until his
death in March 2004.
(2) Does not include any compensation paid to the wife of Wayne L. Vinson
for her services as our accounts payable and payroll clerk for 2004,
2003 and 2002 and , respectively.
(3) Mr. Sparkman served as interim CEO for a portion of 2004.
(4) Mr. Larkin was first employed by us on October 13, 2003
37
We have established a bonus program for our officers. At the end of
each of our fiscal years, our compensation committee reviews our operating
history and determines whether or not any bonuses should be paid to our
officers. If so, the Board of Directors determines what amount should be paid to
our officers. The Board of Directors may discontinue the bonus program at any
time.
Option Grants in Last Fiscal Year
We did not grant any stock options in 2004 to Earl R. Wait, Wallace
Sparkman, or S. Craig Rogers. However, we did grant stock options to William R.
Larkin and Scott Sparkman. In the table below, we show certain information about
the stock options granted to Messrs. Larkin and Sparkman.
Option/SAR Grants in Last Fiscal Year
Individual Grants
------------------ -------------- ------------- ------------------ -------------
Number of % of Total
Securities Options/SARS
Underlying Granted to
Options/ SARs Employees in Exercise or Base Expiration
Name Granted (#) Fiscal Year Price($/Sh) Date
------------------ -------------- ------------- ------------------ -------------
William R. Larkin 12,000 32% $ 7.50 08/16/2014
Scott Sparkman 3,000 8% $ 7.50 08/16/2014
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option
Values
The following table sets forth information pertaining to option
exercises by, and fiscal year end option values of options held by, Wayne L.
Vinson, Earl R. Wait, and S. Craig Rogers, our only executive officers whose
combined salary and bonuses exceeded $100,000 during the year ended December 31,
2003:
38
Fiscal Year End Option Values
Number of Unexercised Value of Unexercised
Securities Underlying In-the-Money Options
Shares Options at Fiscal Year End at Fiscal Year End
Acquired Value -------------------------- -------------------------
Name On Exercise Received Exercisable/Unexercisable Exercisable/Unexercisable
---- ----------- -------- -------------------------- -------------------------
Wayne L. Vinson 0 0 0/0 0/0
Earl R. Wait 0 0 10,000/15,000 $23,000/$34,500
William R. Larkin 0 0 0/12,000 0/$23,160
Scott Sparkman 0 0 0/3,000 0/$5,790
S. Craig Rogers 0 0 8,000/12,000 $18,400/$27,600
Compensation of Directors
Our directors who are not employees are paid $2,500 per quarter and at
December 31 of each year are issued a five year option to purchase 2,500 shares
of our common stock at the then market value. On January 3, 2005, we granted an
option to each of our non-employee directors (other than Paul Hensley) to
purchase 2,500 shares of our common stock at $9.43 per share, for serving as
directors in 2004. The fair market value of our common stock on the date of
grant was $9.26 per share. The options are exercisable immediately and expire 10
years from the date of grant. We also reimburse our directors for accountable
expenses incurred on our behalf.
1998 Stock Option Plan
Our 1998 Stock Option Plan provides for the issuance of options to
purchase up to 150,000 shares of our common stock. The purpose of the plan is to
attract and retain the best available personnel for positions of substantial
responsibility and to provide additional incentive to employees and consultants
and to promote the success of our business. The plan is administered by the
Board of Directors and a compensation committee consisting of two or more
non-employee directors, if appointed. At its discretion, the administrator of
the plan may determine the persons to whom options may be granted and the terms
upon which such options will be granted. In addition, the administrator of the
plan may interpret the plan and may adopt, amend and rescind rules and
regulations for its administration. At March 23, 2005 options to purchase a
total of 107,000 shares of our common stock were outstanding under the 1998
Stock Option Plan.
Limitations on Directors' and Officers' Liability
Our Articles of Incorporation provide our officers and directors with
certain limitations on liability to us or any of our shareholders for damages
for breach of fiduciary duty as a director or officer involving certain acts or
omissions of any such director or officer.
This limitation on liability may have the effect of reducing the
likelihood of derivative litigation against directors and officers and may
discourage or deter shareholders or management from bringing a lawsuit against
directors and officers for breach of their duty of care even though such an
action, if successful, might otherwise have benefited our shareholders and us.
39
Our Articles of Incorporation and bylaws provide certain
indemnification privileges to our directors, employees, agents and officers
against liabilities incurred in legal proceedings. Also, our directors,
employees, agents or officers who are successful, on the merits or otherwise, in
defense of any proceeding to which he or she was a party, are entitled to
receive indemnification against expenses, including attorneys' fees, incurred in
connection with the proceeding.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to our directors, officers and controlling persons pursuant
to the foregoing provisions, or otherwise, we have been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable.
We are not aware of any pending litigation or proceeding involving any
of our directors, officers, employees or agents as to which indemnification is
being or may be sought, and we are not aware of any other pending or threatened
litigation that may result in claims for indemnification by any of our
directors, officers, employees or agents.
40
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table sets forth, as of March 18, 2005, the beneficial
ownership of our common stock: (i) by each of our directors and executive
officers; (ii) by all of our executive officers and directors as a group; and
(iii) by all persons known by us to beneficially own more than five percent of
our common stock.
Shares of Common Stock Percent Beneficially
Name and Address Beneficially Owned Owned
-------------------------------- ------------------------ --------------------
Wallace O. and Naudain Sellers 693,159(1) 10%
P.O. Box 106
6539 Upper York Road
Solebury, PA 18963-0106
Charles G. Curtis 80,500(2) 1%
1 Penrose Lane
Colorado Springs, CO 80906
Paul D. Hensley 426,829 6%
3005 N. 15th Street
Broken Arrow, OK 74012
William F. Hughes 247,000(3) 4%
42921 Normandy Lane
Lancaster, CA 93536
Wallace C. Sparkman 167,691(4) 2%
4906 Oakwood Court
Midland, TX 79707
Gene A Strasheim 8,500(5) *
165 Huntington Place
Colorado Springs, CO 80906
Richard L. Yadon 299,183(6) 4%
P.O. Box 8715
Midland, TX 79708-8715
Ron L. Bingham 6,000(7) *
P.O. Box 945
Lewiston, MI 49756
W. Randy Larkin 12,000(8) *
5609 Heartland
Midland, TX 79707
41
S. Craig Rogers 14,250(9) *
14732 Bluestem Ave
Gardendale, TX 79758
Earl R. Wait 75,520(10) 1%
5102 Teakwood Trace
Midland, TX 79707
Scott W. Sparkman 519,467(11) 8%
1604 Ventura Ave
Midland, TX 79705
All directors and executive
officers as a group (12 persons) 2,550,099 38%
RWG Investments LLC 369,000(12) 5%
5980 Wildwood Drive
Rapid City, SD 57902
-------------------------------- ------------------------ --------------------
* Less than one percent
(1) Includes 196,091 shares of common stock owned by the Wallace Sellers
Trust dated June 21, 1991, 196,091 shares of common stock owned by the
Wallace O. Sellers Trust dated June 22, 1971, options to purchase 2,500
shares of common stock at $3.88 per share, options to purchase 2,500
shares of common stock at $5.55 per share, and options to purchase
2,500 shares of common stock at $9.34 per share, owned by Wallace
Sellers, 158,600 shares owned by Naudain Sellers. Wallace and Naudain
Sellers are husband and wife. The trustee of each trust is an unrelated
third party. Naudain Sellers is a contingent remainder beneficiary of
one trust and a beneficiary during her lifetime of the other.
(2) Includes options to purchase 2,500 shares of common stock at $3.88 per
share, options to purchase 2,500 shares of common stock at $5.55 per
share, options to purchase 2,500 shares of common stock at $9.34 per
share, and warrants to purchase 40,000 shares of common stock at $3.25
per share.
(3) Includes 180,500 shares of common stock and a warrant to purchase
60,000 shares of common stock at $3.25 per share owned by the William
and Cheryl Hughes Family Trust, an option to purchase 2,500 share of
common stock at $5.55, and an option to purchase 2,500 shares of common
stock at $9.34.
(4) Includes 105,691 shares owned by Diamente Investments, LLP, a Texas
limited partnership of which Mr. Sparkman is a general and limited
partner.
(5) Includes options to purchase 2,500 shares of common stock at $5.55 per
share and options to purchase 2,500 shares of common stock at $9.34 per
share.
(6) Included warrants to purchase 9,365 shares of common stock at $2.50 per
share, warrants to purchase 5,318 shares of common stock at $3.25 per
share, options to purchase 2,500 shares of common stock at $5.55 per
share and options to purchase 2,500 shares of common stock at $9.34 per
share.
(7) Includes an option to purchase 6,000 shares of common stock at $5.58
per share.
(8) Includes an option to purchase 12,000 shares of common stock at $7.50
per share.
(9) Includes warrants to purchase 1,125 shares of common stock at $6.25 per
share and an option to purchase 12,000 shares of common stock at $3.25
per share that began to vest in April 2003.
(10) Includes an option to purchase 15,000 shares of common stock at $3.25
per share that began to vest in April 2003
(11) Includes an option to purchase 3,000 shares of common stock at $7.50
per share that began vesting in August 2004, and 475,000 shares of
common stock and warrants to purchase 21,467 shares of common stock at
$2.50 per share owned by Diamond S DGT, a trust of which Mr. Sparkman
is a co-trustee and co-beneficiary with his sister.
(12) Includes a warrant to purchase 15,000 shares of common stock at $6.25
per share, 245,000 shares of common stock owned by RWG Investments LLC,
82,000 shares of common stock owned by G Five Development LLC. RWG
Investments LLC is a limited liability company the beneficial owner of
which is Roland W. Gentner. G Five Development LLC is a company the
beneficial owners of which are Roland W. Gentner, his spouse, and his
three sons.
42
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Earl R. Wait and Wallace C. Sparkman have guaranteed approximately
$84,000 and $92,000, respectively, of debt for us without consideration. This
debt was incurred when we acquired vehicles, equipment and software. The
following schedule provides information as to the remaining debt balances as of
February 28, 2005:
Balance at Interest Maturity
Guarantor February 28, 2005 Rate Date
--------- ----------------- --------- -----------
Earl Wait 13,154 10.50% 10/10/2005
Wallace Sparkman 0 10% 10/15/2010
None of the guarantees is still in effect.
ITEM 13. EXHIBITS
The following is a list of all exhibits filed as part of this Form
10-KSB:
Exhibit No. Description
----------- -----------
2.1 Purchase and Sale Agreement by and between Hy-Bon Engineering
Company, Inc. and NGE Leasing, Inc. (Incorporated by reference
to Exhibit 2.1 of the Registrant's Current Report on Form 8-K
dated February 28, 2003 and filed with the Securities and
Exchange Commission on March 6, 2003)
3.1 Articles of Incorporation, as amended (Incorporated by
reference to Exhibit 3.1 of the 10QSB filed and dated November
10, 2004)
3.2 Bylaws (Incorporated by reference to Exhibit 3.4 of the
Registrant's Registration Statement on Form SB-2, No.
333-88314)
4.1 Form of warrant certificate (Incorporated by reference to
Exhibit 4.1 of the Registrant's Registration Statement on Form
SB-2, No. 333-88314)
4.2 Form of warrant agent agreement (Incorporated by reference to
Exhibit 4.2 of the Registrant's Registration Statement on Form
SB-2, No. 333-88314)
4.3 Form of lock-up agreement (Incorporated by reference to
Exhibit 4.3 of the Registrant's Registration Statement on Form
SB-2, No. 333-88314)
4.4 Form of representative's option for the purchase of common
stock (Incorporated by reference to Exhibit 4.4 of the
Registrant's Registration Statement on Form SB-2, No.
333-88314)
43
Exhibit No. Description
----------- -----------
4.5 Form of representative's option for the purchase of warrants
(Incorporated by reference to Exhibit 4.5 of the Registrant's
Registration Statement on Form SB-2, No. 333-88314)
4.6 Stockholders Agreement, dated January 3, 2005 among Paul D.
Hensley, Tony Vohjesus, Jim Hazlett and Natural Gas Services
Group, Inc. (Incorporated by reference to Exhibit 4.3 of the
Registrant's Form 8-K Report, dated January 3, 2005, as filed
with the Securities and Exchange Commission on January 7,
2005)
Executive Compensation Plans and Arrangements (Exhibits 10.1,
10.24, 10.25, and 10.26)
10.1 1998 Stock Option Plan (Incorporated by reference to Exhibit
10.1 of the Registrant's Registration Statement on Form SB-2,
No. 333-88314)
10.2 Asset Purchase Agreement, dated January 1, 2001, between the
Registrant and Great Lakes Compression, Inc. (Incorporated by
reference to Exhibit 10.2 of the Registrant's Registration
Statement on Form SB-2, No. 333-88314)
10.3 Exhibits 3(c)(1), 3(c)(2), 3(c)(3), 3(c)(4), 13(d)(1),
13(d)(2) and 13(d)(3) to Asset Purchase Agreement, dated
January 1, 2001, between the Registrant and Great Lakes
Compression, Inc. (Incorporated by reference to Exhibit 10.14
of the Registrant's Registration Statement on Form SB-2, No.
333-88314)
10.4 Amendment to Guaranty Agreement between Natural Gas Services
Group, Inc. and Dominion Michigan Production Services, Inc.
(Incorporated by reference to Exhibit 10.3 of the Registrant's
Registration Statement on Form SB-2, No. 333-88314)
10.5 Form of Series A 10% Subordinated Notes due December 31, 2006
(Incorporated by reference to Exhibit 10.8 of the Registrant's
Registration Statement on Form SB-2, No. 333-88314)
10.6 Form of Five-Year Warrants to Purchase Common Stock
(Incorporated by reference to Exhibit 10.9 of the Registrant's
Registration Statement on Form SB-2, No. 333-88314)
44
Exhibit No. Description
----------- -----------
10.7 Warrants issued to Berry-Shino Securities, Inc. (Incorporated
by reference to Exhibit 10.10 of the Registrant's Registration
Statement on Form SB-2, No. 333-88314)
10.8 Warrants issued to Neidiger, Tucker, Bruner, Inc.
(Incorporated by reference to Exhibit 10.11 of the
Registrant's Registration Statement on Form SB-2, No.
333-88314)
10.9 Form of warrant issued in March 2001 for guaranteeing debt
(Incorporated by reference to Exhibit 10.12 of the
Registrant's Registration Statement on Form SB-2, No.
333-88314)
10.10 Form of warrant issued in April 2002 for guaranteeing debt
(Incorporated by reference to Exhibit 10.13 of the
Registrant's Registration Statement on Form SB-2, No.
333-88314)
10.11 Articles of Organization of Hy-Bon Rotary Compression, L.L.C.,
dated April 17, 2000 (Incorporated by reference to Exhibit
10.18 of the Registrant's Registration Statement on Form SB-2,
No. 333-88314)
10.12 Regulations of Hy-Bon Rotary Compression, L.L.C. (Incorporated
by reference to Exhibit 10.19 of the Registrant's Registration
Statement on Form SB-2, No. 333-88314)
10.13 First Amended and Restated Loan Agreement between the
Registrant and Western National Bank (Incorporated by
reference to Exhibit 10.1 of the Registrant's Current Report
on Form 8-K, dated March 27, 2003 and filed with the
Securities and Exchange Commission on April 14, 2003)
10.14 Form of Termination of Employment Agreement Letter relating to
the Employment Agreement of Alan Kurus (Incorporated by
reference to Exhibit 10.25 of the Registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 2002)
10.15 Form of Termination of Employment Agreement Letter relating to
the Employment Agreement of Wayne Vinson (Incorporated by
reference to Exhibit 10.26 of the Registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 2002)
45
Exhibit No. Description
----------- -----------
10.16 Form of Termination of Employment Agreement Letter relating to
the Employment Agreement of Earl Wait (Incorporated by
reference to Exhibit 10.27 of the Registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 2002)
10.17 Triple Net Lease Agreement, dated June 1, 2003, between NGE
Leasing, Inc. and Steven J. & Katherina L. Winer (Incorporated
by reference to Exhibit 10.17 of the Registrant's Annual
Report on Form 10-KSB for the fiscal year ended December 31,
2003)
10.18 Lease Agreement, dated June 19, 2003, between NGE Leasing,
Inc. and Wise Commercial Properties (Incorporated by reference
to Exhibit 10.18 of the Registrant's Annual Report on Form
10-KSB for the fiscal year ended December 31, 2003)
10.19 Lease Agreement, dated March 1, 2004, between the Registrant
and the City of Midland, Texas (Incorporated by reference to
Exhibit 10.19 of the Registrant's Form 10-QSB for the fiscal
quarter ended June 30, 2004)
10.20 Second Amended and Restated Loan Agreement, dated November 3,
2003, between the Registrant and Western National Bank
(Incorporated by reference to Exhibit 10.20 of the
Registrant's Form 10-QSB for the fiscal quarter ended June 30,
2004)
10.21 Securities Purchase Agreement, dated July 20, 2004, between
the Registrant and CBarney Investments, Ltd. (Incorporated by
reference to Exhibit 4.1 of the Registrant's Current Report on
Form 8-K dated July 20, 2004 and filed with the Securities and
Exchange Commission on July 27, 2004)
10.22 Stock Purchase Agreement, dated October 18, 2004, by and among
the Registrant, Screw Compression Systems, Inc., Paul D.
Hensley, Jim Hazlett and Tony Vohjesus (Incorporated by
reference to Exhibit 4.1 of the Registrant's Current Report on
Form 8-K dated October 18, 2004 and filed with the Securities
and Exchange Commission on October 21, 2004)
10.23 Fourth Amended and Restated Loan Agreement (Incorporated by
reference to Exhibit 10.1 of the Registrant's Current Report
on Form 8-K, dated March 14, 2005 as filed with the Securities
and Exchange Commission on March 18, 2005)
46
Exhibit No. Description
----------- -----------
10.24 Employment Agreement between Paul D. Hensley and Natural Gas
Services Group, Inc. (Incorporated by reference to Exhibit
10.1 of the Registrants form 8-K Report, dated January 3,
2005, as filed with the Securities and Exchange Commission on
January 7, 2005)
*10.25 Employment Agreement between William R. Larkin and Natural Gas
Services Group, Inc.
*10.26 Promissory Note, dated January 3, 2005, in the original
principal amount of $2,100, 000.00 made by Natural Gas
Services Group, Inc. payable to Paul D. Hensley
*14.0 Code of Ethics
*21.0 Subsidiaries
*23.1 Consent of HEIN & ASSOCIATES LLP
*31.1 Certification of Chief Executive Officer required by Section
302 of the Sarbanes-Oxley Act of 2002
*31.2 Certification of Chief Financial Officer required by Section
302 of the Sarbanes-Oxley Act of 2002
*32.1 Certification required by Section 906 of the Sarbanes-Oxley
Act of 2002
*32.2 Certification required by Section 906 of the Sarbanes-Oxley
Act of 2002
--------------------
* Filed herewith.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Our principal accountant for the fiscal years ended December 31, 2004
and 2003 was HEIN & ASSOCIATES LLP.
Audit Fees
The aggregate fees billed for professional services rendered by HEIN &
ASSOCIATES LLP for the audit of our financial statements for our fiscal years
ended December 31, 2004 and 2003 and the review of the financial statements in
our Forms 10-QSB for the fiscal quarters in such fiscal years were $82,172 and
$75,749, respectively. These fees also include update audit procedures performed
by HEIN & ASSOCIATES LLP for the issuance of consents for the inclusion of their
audit opinions in various registration filings by the company during these
years.
47
Audit Related Fees
The aggregate fees billed for assurance and related services by HEIN &
ASSOCIATES LLP during our fiscal years ended December 31, 2004 and 2003 were
approximately $67,000 and $0 respectively. These fees were mainly related to the
audit for the acquisition of SCS and consultation regarding Sarbanes Oxley
internal controls implementation.
Tax Fees
The aggregate fees billed for professional services rendered by HEIN &
ASSOCIATES LLP for our Fiscal years ended December 31, 2004 and 2003 for
compliance, tax advice and tax planning were $18,330 and $18,391 respectively.
All Other Fees
No other fees were billed by HEIN & ASSOCIATES LLP, during our fiscal
years ended December 31, 2003 and 2004 other than as described above.
Audit Committees Pre-Approval Policies and Procedures
As of March 25, 2004 our audit committee had not established
pre-approval policies and procedures for the engagement of our principal
accountant to render audit or non-audit services. However, in accordance with
Section 10A(i) of the Exchange Act, our audit committee, as a whole, approves
the engagement of our principal accountant prior to the accountant rendering
audit or non-audit services.
Certain rules of the Securities and Exchange Commission provide that an
auditor is not independent of an audit client if the services it provides to the
client are not appropriately approved, subject, however, to a de minimus
exception contained in the rules. The audit committee pre-approved all services
provided by Hein & Associates LLP in 2004 and the de minimus exception was not
use
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Date: March 25, 2005 NATURAL GAS SERVICES GROUP, INC.
/s/ Stephen C.
Taylor
------------------------------------------
Stephen C. Taylor, President and Principal
Executive Officer
48
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated:
Signature Title Date
--------- ----- ----
/s/ Charles G. Curtis Director March 25, 2005
-----------------------------
Charles G. Curtis
/s/ William F. Hughes, Jr. Director March 25, 2005
-----------------------------
William F. Hughes, Jr.
/s/ Wallace C. Sparkman Director March 25, 2005
-----------------------------
Wallace C. Sparkman
/s/ Richard L. Yadon Director March 25, 2005
-----------------------------
Richard L. Yadon
/s/ Paul D. Hensley Director March 25, 2005
-----------------------------
Paul D. Hensley
49
INDEX OF EXHIBITS
The following is a list of all exhibits filed as part of this Form
10-KSB:
Exhibit No. Description
----------- -----------
2.1 Purchase and Sale Agreement by and between Hy-Bon Engineering
Company, Inc. and NGE Leasing, Inc. (Incorporated by reference
to Exhibit 2.1 of the Registrant's Current Report on Form 8-K
dated February 28, 2003 and filed with the Securities and
Exchange Commission on March 6, 2003)
3.1 Articles of Incorporation, as amended (Incorporated by
reference to Exhibit 3.1 of the 10QSB filed and dated November
10, 2004)
3.2 Bylaws (Incorporated by reference to Exhibit 3.4 of the
Registrant's Registration Statement on Form SB-2, No.
333-88314)
4.1 Form of warrant certificate (Incorporated by reference to
Exhibit 4.1 of the Registrant's Registration Statement on Form
SB-2, No. 333-88314)
4.2 Form of warrant agent agreement (Incorporated by reference to
Exhibit 4.2 of the Registrant's Registration Statement on Form
SB-2, No. 333-88314)
4.3 Form of lock-up agreement (Incorporated by reference to
Exhibit 4.3 of the Registrant's Registration Statement on Form
SB-2, No. 333-88314)
4.4 Form of representative's option for the purchase of common
stock (Incorporated by reference to Exhibit 4.4 of the
Registrant's Registration Statement on Form SB-2, No.
333-88314)
4.5 Form of representative's option for the purchase of warrants
(Incorporated by reference to Exhibit 4.5 of the Registrant's
Registration Statement on Form SB-2, No. 333-88314)
4.6 Stockholders Agreement, dated January 3, 2005 among Paul D.
Hensley, Tony Vohjesus, Jim Hazlett and Natural Gas Services
Group, Inc. (Incorporated by reference to Exhibit 4.3 of the
Registrant's Form 8-K Report, dated January 3, 2005, as filed
with the Securities and Exchange Commission on January 7,
2005)
Executive Compensation Plans and Arrangements (Exhibits 10.1,
10.24, 10.25, and 10.26)
50
Exhibit No. Description
----------- -----------
10.1 1998 Stock Option Plan (Incorporated by reference to Exhibit
10.1 of the Registrant's Registration Statement on Form SB-2,
No. 333-88314)
10.2 Asset Purchase Agreement, dated January 1, 2001, between the
Registrant and Great Lakes Compression, Inc. (Incorporated by
reference to Exhibit 10.2 of the Registrant's Registration
Statement on Form SB-2, No. 333-88314)
10.3 Exhibits 3(c)(1), 3(c)(2), 3(c)(3), 3(c)(4), 13(d)(1),
13(d)(2) and 13(d)(3) to Asset Purchase Agreement, dated
January 1, 2001, between the Registrant and Great Lakes
Compression, Inc. (Incorporated by reference to Exhibit 10.14
of the Registrant's Registration Statement on Form SB-2, No.
333-88314)
10.4 Amendment to Guaranty Agreement between Natural Gas Services
Group, Inc. and Dominion Michigan Production Services, Inc.
(Incorporated by reference to Exhibit 10.3 of the Registrant's
Registration Statement on Form SB-2, No. 333-88314)
10.5 Form of Series A 10% Subordinated Notes due December 31, 2006
(Incorporated by reference to Exhibit 10.8 of the Registrant's
Registration Statement on Form SB-2, No. 333-88314)
10.6 Form of Five-Year Warrants to Purchase Common Stock
(Incorporated by reference to Exhibit 10.9 of the Registrant's
Registration Statement on Form SB-2, No. 333-88314)
10.7 Warrants issued to Berry-Shino Securities, Inc. (Incorporated
by reference to Exhibit 10.10 of the Registrant's Registration
Statement on Form SB-2, No. 333-88314)
10.8 Warrants issued to Neidiger, Tucker, Bruner, Inc.
(Incorporated by reference to Exhibit 10.11 of the
Registrant's Registration Statement on Form SB-2, No.
333-88314)
10.9 Form of warrant issued in March 2001 for guaranteeing debt
(Incorporated by reference to Exhibit 10.12 of the
Registrant's Registration Statement on Form SB-2, No.
333-88314)
51
Exhibit No. Description
----------- -----------
10.10 Form of warrant issued in April 2002 for guaranteeing debt
(Incorporated by reference to Exhibit 10.13 of the
Registrant's Registration Statement on Form SB-2, No.
333-88314)
10.11 Articles of Organization of Hy-Bon Rotary Compression, L.L.C.,
dated April 17, 2000 (Incorporated by reference to Exhibit
10.18 of the Registrant's Registration Statement on Form SB-2,
No. 333-88314)
10.12 Regulations of Hy-Bon Rotary Compression, L.L.C. (Incorporated
by reference to Exhibit 10.19 of the Registrant's Registration
Statement on Form SB-2, No. 333-88314)
10.13 First Amended and Restated Loan Agreement between the
Registrant and Western National Bank (Incorporated by
reference to Exhibit 10.1 of the Registrant's Current Report
on Form 8-K, dated March 27, 2003 and filed with the
Securities and Exchange Commission on April 14, 2003)
10.14 Form of Termination of Employment Agreement Letter relating to
the Employment Agreement of Alan Kurus (Incorporated by
reference to Exhibit 10.25 of the Registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 2002)
10.15 Form of Termination of Employment Agreement Letter relating to
the Employment Agreement of Wayne Vinson (Incorporated by
reference to Exhibit 10.26 of the Registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 2002)
10.16 Form of Termination of Employment Agreement Letter relating to
the Employment Agreement of Earl Wait (Incorporated by
reference to Exhibit 10.27 of the Registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 2002)
10.17 Triple Net Lease Agreement, dated June 1, 2003, between NGE
Leasing, Inc. and Steven J. & Katherina L. Winer (Incorporated
by reference to Exhibit 10.17 of the Registrant's Annual
Report on Form 10-KSB for the fiscal year ended December 31,
2003)
10.18 Lease Agreement, dated June 19, 2003, between NGE Leasing,
Inc. and Wise Commercial Properties (Incorporated by reference
to Exhibit 10.18 of the Registrant's Annual Report on Form
10-KSB for the fiscal year ended December 31, 2003)
52
Exhibit No. Description
----------- -----------
10.19 Lease Agreement, dated March 1, 2004, between the Registrant
and the City of Midland, Texas (Incorporated by reference to
Exhibit 10.19 of the Registrant's Form 10-QSB for the fiscal
quarter ended June 30, 2004)
10.20 Second Amended and Restated Loan Agreement, dated November 3,
2003, between the Registrant and Western National Bank
(Incorporated by reference to Exhibit 10.20 of the
Registrant's Form 10-QSB for the fiscal quarter ended June 30,
2004)
10.21 Securities Purchase Agreement, dated July 20, 2004, between
the Registrant and CBarney Investments, Ltd. (Incorporated by
reference to Exhibit 4.1 of the Registrant's Current Report on
Form 8-K dated July 20, 2004 and filed with the Securities and
Exchange Commission on July 27, 2004)
10.22 Stock Purchase Agreement, dated October 18, 2004, by and among
the Registrant, Screw Compression Systems, Inc., Paul D.
Hensley, Jim Hazlett and Tony Vohjesus (Incorporated by
reference to Exhibit 4.1 of the Registrant's Current Report on
Form 8-K dated October 18, 2004 and filed with the Securities
and Exchange Commission on October 21, 2004)
10.23 Fourth Amended and Restated Loan Agreement (Incorporated by
reference to Exhibit 10.1 of the Registrant's Current Report
on Form 8-K, dated March 14, 2005 as filed with the Securities
and Exchange Commission on March 18, 2005)
10.24 Employment Agreement between Paul D. Hensley and Natural Gas
Services Group, Inc. (Incorporated by reference to Exhibit
10.1 of the Registrants form 8-K Report, dated January 3,
2005, as filed with the Securities and Exchange Commission on
January 7, 2005)
*10.25 Employment Agreement between William R. Larkin and Natural Gas
Services Group, Inc.
*10.26 Promissory Note, dated January 3, 2005, in the original
principal amount of $2,100, 000.00 made by Natural Gas
Services Group, Inc. payable to Paul D. Hensley
*14.0 Code of Ethics
*21.0 Subsidiaries
*23.1 Consent of HEIN & ASSOCIATES LLP
53
Exhibit No. Description
----------- -----------
*31.1 Certification of Chief Executive Officer required by Section
302 of the Sarbanes-Oxley Act of 2002
*31.2 Certification of Chief Financial Officer required by Section
302 of the Sarbanes-Oxley Act of 2002
*32.1 Certification required by Section 906 of the Sarbanes-Oxley
Act of 2002
*32.2 Certification required by Section 906 of the Sarbanes-Oxley
Act of 2002
--------------------
* Filed herewith.
54
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Natural Gas Services Group, Inc.
We have audited the accompanying consolidated balance sheet of Natural Gas
Services Group, Inc. and Subsidiaries (the "Company") as of December 31, 2004,
and the related consolidated statements of income, stockholders' equity and cash
flows for the years ended December 31, 2004 and 2003. These 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 the standards of the Public Company
Accounting Oversight Board (United States). 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 the Company as of
December 31, 2004, and the results of its operations and its cash flows for the
years ended December 31, 2004 and 2003 in conformity with U.S. generally
accepted accounting principles.
HEIN & ASSOCIATES LLP
Dallas, Texas
February 11, 2005
F-1
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2004
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 685,187
Trade accounts receivable, net of doubtful accounts of $25,000 1,998,965
Inventory 4,469,606
Prepaid expenses and other 141,140
-----------
Total current assets 7,294,898
LEASE EQUIPMENT, net of accumulated depreciation of $4,820,774 27,734,030
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $1,446,141 3,134,167
GOODWILL, net of accumulated amortization of $325,192 2,589,655
PATENTS, net of accumulated amortization of $164,907 86,457
RESTRICTED CASH 2,000,000
OTHER ASSETS
416,269
-----------
Total assets $43,255,476
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 3,728,048
Line of credit 549,856
Accounts payable and accrued liabilities 2,354,612
Deferred income 22,128
-----------
Total current liabilities 6,654,644
LONG-TERM DEBT, less current portion 9,290,209
SUBORDINATED NOTES, net of discount of $89,962 1,449,299
DEFERRED TAX LIABILITY 2,958,000
COMMITMENTS (Note 11)
STOCKHOLDERS' EQUITY:
Preferred stock, 5,000,000 shares authorized, no shares issued
Common stock, 30,000,000 shares authorized, par value $0.01;
6,104,269 shares issued and outstanding 61,042
Additional paid-in capital 16,355,492
Retained earnings 6,486,790
-----------
Total stockholders' equity 22,903,324
-----------
Total liabilities and stockholders' equity $43,255,476
===========
See accompanying notes to these consolidated financial statements.
F-2
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------
2004 2003
------------ ------------
REVENUE:
Sales, net $ 3,593,376 $ 3,865,045
Service and maintenance income 1,873,905 1,773,256
Leasing income 10,490,918 7,111,221
------------ ------------
Total revenue 15,958,199 12,749,522
COSTS OF REVENUE:
Cost of sales 2,556,573 2,859,572
Cost of service 1,357,016 1,243,499
Cost of leasing 3,037,906 1,953,525
------------ ------------
Total costs of revenue 6,951,495 6,056,596
------------ ------------
GROSS PROFIT 9,006,704 6,692,926
OPERATING EXPENSES:
Selling expenses 875,289 678,777
General and administrative 1,776,630 1,613,076
Depreciation and amortization 2,444,264 1,725,717
------------ ------------
Total operating expenses 5,096,183 4,017,570
------------ ------------
INCOME FROM OPERATIONS 3,910,521 2,675,356
OTHER INCOME (EXPENSE):
Interest expense (837,486) (667,122)
Other income (expense) 1,440,912 (4,302)
------------ ------------
Total other income (expense) 603,426 (671,424)
------------ ------------
INCOME BEFORE PROVISION FOR INCOME TAXES 4,513,947 2,003,932
PROVISION FOR INCOME TAXES:
Current 20,000 25,000
Deferred 1,119,919 671,799
------------ ------------
Total income tax expense 1,139,919 696,799
------------ ------------
NET INCOME 3,374,028 1,307,133
PREFERRED DIVIDENDS 53,277 120,941
------------ ------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 3,320,751 $ 1,186,192
============ ============
NET INCOME PER COMMON SHARE:
Basic $ 0.59 $ 0.24
============ ============
Diluted $ 0.52 $ 0.23
============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic 5,591,313 4,946,922
Diluted 6,382,777 5,252,531
See accompanying notes to these consolidated financial statements.
F-3
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
PREFERRED STOCK COMMON STOCK
--------------------------- ---------------------------
SHARES AMOUNT SHARES AMOUNT
------------ ------------ ------------ ------------
BALANCES, January 1, 2003 381,654 $ 3,817 4,857,632 $ 48,576
Exercise of common stock options
and warrants -- -- 135,549 1,355
Conversion of preferred stock to
common stock (38,000) (380) 38,000 380
Dividends on preferred stock -- -- -- --
Net income -- -- -- --
------------ ------------ ------------ ------------
BALANCES, January 1, 2004 343,654 3,437 5,031,181 50,311
Exercise of common stock options
and warrants -- -- 79,860 798
Conversion of preferred stock to
common stock (343,654) (3,437) 343,654 3,437
Transaction costs of private placement
of common stock -- -- -- --
Issuance of common stock -- -- 649,574 6,496
Dividends on preferred stock -- -- -- --
Net income -- -- -- --
------------ ------------ ------------ ------------
BALANCES, December 31, 2004 -- -- $ 6,104,269 $ 61,042
============ ============ ============ ============
ADDITIONAL TOTAL
PAID-IN RETAINED STOCKHOLDERS'
CAPITAL EARNINGS EQUITY
------------ ------------ ------------
BALANCES, January 1, 2003 $ 10,968,733 $ 1,979,847 $ 13,000,973
Exercise of common stock options
and warrants 236,642 -- 237,997
Conversion of preferred stock to
common stock -- -- --
Dividends on preferred stock -- (120,941) (120,941)
Net income -- 1,307,133 1,307,133
------------ ------------ ------------
BALANCES, January 1, 2004 11,205,375 3,166,039 14,425,162
Exercise of common stock options
and warrants 245,651 -- 246,449
Conversion of preferred stock to
common stock -- -- --
Transaction costs of private placement
of common stock (39,038) -- (39,038)
Issuance of common stock 4,943,504 -- 4,950,000
Dividends on preferred stock -- (53,277) (53,277)
Net income -- 3,374,028 3,374,028
------------ ------------ ------------
BALANCES, December 31, 2004 $ 16,355,492 $ 6,486,790 $ 22,903,324
============ ============ ============
See accompanying notes to these consolidated financial statements.
F-4
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2004 2003
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,374,028 $ 1,307,133
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 2,444,264 1,725,717
Deferred taxes 1,119,919 671,799
Amortization of debt issuance costs 64,956 64,956
Loss on disposal of assets 71,341 18,615
Changes in current assets:
Trade and other receivables (1,182,369) (391,498)
Inventory (1,915,367) (1,078,445)
Prepaid expenses and other (34,110) 66,272
Changes in current liabilities:
Accounts payable and accrued liabilities 1,283,960 542,790
Deferred income (185,087) 173,678
Other changes (344,341) (76,597)
-------------- --------------
Net cash provided by operating activities 4,697,194 3,024,420
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (11,595,811) (7,881,720)
Proceeds from sale of property and equipment 50,123 119,500
Increase in restricted cash (2,000,000) --
Distribution from equity method investment -- 107,774
Decrease in lease receivable -- 210,512
-------------- --------------
Net cash used in investing activities (13,545,688) (7,443,934)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from lines of credit 549,856 300,000
Proceeds from long-term debt 6,592,012 3,478,568
Repayments of long-term debt (2,588,522) (2,013,546)
Repayment of line of credit (300,000) --
Dividends on preferred stock (53,277) (120,941)
Proceeds from sale of stock and exercise of stock options and
warrants, net of transaction costs 5,157,410 237,997
-------------- --------------
Net cash provided by financing activities 9,357,479 1,882,078
NET CHANGE IN CASH 508,985 (2,537,436)
CASH, beginning of year 176,202 2,713,638
-------------- --------------
CASH, end of year $ 685,187 $ 176,202
============== ==============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 775,429 $ 667,122
============== ==============
Income taxes paid $ 31,300 $ 35,292
============== ==============
See accompanying notes to these consolidated financial statements.
F-5
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
Organization and Principles of Consolidation
--------------------------------------------
Natural Gas Services Group, Inc. (the "Company" or "NGSG") (a Colorado
corporation) was formed on December 18, 1998 for the purposes of combining
the operations of certain manufacturing, service and leasing entities.
During 2003, NGSG conducted its operations through the following
wholly-owned subsidiaries:
|X| Rotary Gas Systems, Inc. ("RGS") (a Texas corporation) was engaged in
the manufacturing and distribution of natural gas compressor packages
for use in the petroleum industry and natural gas flare stacks and
ignition systems for use in oilfield, refinery, petrochemical plant,
and landfill applications in New Mexico, California and Texas.
|X| NGE Leasing, Inc. ("NGE") (a Texas corporation) was engaged in leasing
natural gas compressor packages to entities in the petroleum industry
and irrigation motor units to entities in the agricultural industry.
NGE's leasing income is concentrated in New Mexico, California and
Texas.
|X| Great Lakes Compression, Inc., ("GLC") (a Colorado corporation) was
formed in March 2001 and acquired the assets and certain operations of
a business that fabricates, leases, and services natural gas
compressors to producers of oil and natural gas, primarily in
Michigan.
Effective January 1, 2004, RGS, GLC and NGE were merged into NGSG.
Cash Equivalents
----------------
For purposes of reporting cash flows, the Company considers all short-term
investments with an original maturity of three months or less to be cash
equivalents.
Restricted Cash
---------------
The Company has a Certificate of Deposit for $2 million which is used to
secure certain promissory notes issued in the aggregate principal amount of
$3 million maturing three years from the date of closing of the acquisition
of Screw Compression Systems, Inc. ("SCS") at January 3, 2005 and secured
by a letter of credit in the face amount of $2 million.
Accounts Receivable
-------------------
The Company's trade receivables consist of customer obligations for the
sale of compressors and flare systems due under normal trade terms and
operating leases for the use of the Company's compressors. The receivables
are not collateralized except as provided for under lease agreements.
However, the Company requires deposits of as much as 50% for large custom
contracts. The Company extends credit based on management's assessment of
the customer's financial condition, receivable aging, customer disputes and
general business and economic conditions. Management believes the allowance
for doubtful accounts for trade receivables of $25,000 at December 31, 2004
is adequate.
Inventory
---------
Inventory is valued at the lower of cost or market. The cost of inventories
is determined by the weighted average method. At December 31, 2004,
inventory consisted of the following:
F-6
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Raw materials $3,033,726
Work in process 1,435,880
----------
$4,469,606
==========
Property and Equipment
----------------------
Property and equipment are recorded at cost less accumulated depreciation
and amortization. Depreciation and amortization are computed using the
straight-line method over the estimated useful lives of the assets, which
range from five to thirty years.
Gains and losses resulting from sales and dispositions of property and
equipment are included in current operations. Maintenance and repairs are
charged to operations as incurred.
Patents
-------
The Company has patents for a flare tip ignition device and flare tip
burner pilot. The costs of the patents are being amortized on a
straight-line basis over nine years, the remaining life of the patents when
acquired. Amortization expense for patents of $27,484 was recognized for
each of the years ended December 31, 2004 and 2003. Amortization expense
for each of the next four years is expected to be $27,484 per year.
Goodwill
--------
Goodwill represents the cost in excess of fair value of the identifiable
net assets acquired in two acquisitions. Goodwill was being amortized on a
straight-line basis over 20 years, but the Company ceased amortization of
goodwill effective January 1, 2002 in accordance with Statement of
Financial Accounting Standards ("FAS") No. 142.
FAS 142 requires that goodwill be tested for impairment at least annually.
The Company completed its most recent test for goodwill impairment as of
June, 2004, at which time no impairment was indicated.
Long-Lived Assets
-----------------
The Company's policy is to periodically review the net realizable value of
its long-lived assets, other than goodwill, through an assessment of the
estimated future cash flows related to such assets. In the event that
assets are found to be carried at amounts in excess of estimated
undiscounted future cash flows, then the assets will be adjusted for
impairment to a level commensurate with a discounted cash flow analysis of
the underlying assets. Based upon its most recent analysis, the Company
believes no impairment of long-lived assets exists at December 31, 2004.
Advertising Costs
-----------------
Advertising costs are expensed as incurred. Total advertising expense was
$37,644 in 2004 and $46,337 in 2003.
F-7
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Instruments
---------------------
Management believes that generally the fair value of the Company's notes
payable at December 31, 2004 approximate their carrying values due to the
short-term nature of the instruments or the use of prevailing market
interest rates.
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 rebuilt compressor revenue is recognized when both the replacement
compressor has been delivered and the rebuild assessment has been
completed. Revenue from compressor service and retrofitting services is
recognized upon providing services to the customer. Maintenance agreement
revenue is recognized as services are rendered. Rental and lease revenue is
recognized over the terms of the respective lease agreements based upon the
classification of the lease. Deferred income represents payments received
before a product is shipped.
Per Share Data
--------------
Basic earnings per common share is computed using the weighted average
number of common shares outstanding during the period. Diluted earnings per
common share is computed using the weighted average number of common and
common stock equivalent shares outstanding during the period. Common stock
equivalent shares are excluded from the computation if their effect is
anti-dilutive. In 2003 anti-dilutive shares related to common stock options
and warrants and convertible preferred stock totaled 2,156,154. There was
no anti-dilutive effect in 2004 since all preferred shares were converted
to common shares in 2004.
The following table sets forth the computation of basic and diluted
earnings per share:
YEAR ENDED DECEMBER 31,
-----------------------
2004 2003
---------- ----------
Numerator:
Net income $3,374,028 $1,307,133
Less preferred dividends 53,277 120,941
---------- ----------
Net income available to common stockholders 3,320,751 1,186,192
========== ==========
Denominator for basic net income per share:
Weighted average common shares outstanding 5,591,313 4,946,922
========== ==========
Denominator for diluted net income per share:
Weighted average common shares outstanding 5,591,313 4,946,922
Dilutive effect of stock options and warrants 791,464 305,609
---------- ----------
Diluted weighted average shares 6,382,777 5,252,531
========== ==========
Net income per share:
Basic $ 0.59 $ 0.24
Diluted $ 0.52 $ 0.23
F-8
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock-Based Compensation
------------------------
The Company accounts for stock-based awards to employees using the
intrinsic value method described in Accounting Principles Board Opinion
(APB) No. 25, Accounting for Stock Issued to Employees, and its related
interpretations. Accordingly, no compensation expense has been recognized
in the accompanying consolidated financial statements for stock-based
awards to employees or directors when the exercise price of the award is
equal to or greater than the quoted market price of the stock on the date
of the grant.
FAS No. 123, Accounting for Stock-Based Compensation as amended for
transition and disclosure by FAS No. 148, requires disclosures as if the
Company had applied the fair value method to employee awards rather than
the intrinsic value method. The fair value of stock-based awards to
employees is calculated through the use of option pricing models, which
were developed for use in estimating the fair value of traded options,
which have no vesting restrictions and are fully transferable. These models
also require subjective assumptions, including future stock price
volatility and expected time to exercise, which greatly affect the
calculated values. The Company's fair value calculations for awards from
stock option plans in 2003 and 2004 were made using the Black-Scholes
option pricing model with the following weighted average assumptions:
expected term, ten years from the date of grant; stock price volatility 44%
in 2004 and 2003; risk free interest rate of 5.25% in 2004 and 4.0% in 2003
and no dividends during the expected term as the Company does not have a
history of paying cash dividends on common stock.
If the computed fair values of the stock-based awards had been amortized to
expense over the vesting period of the awards, net income and net income
per share, basic and diluted, would have been as follows:
YEARS ENDED DECEMBER 31,
------------------------------
2004 2003
------------- -------------
Net income $ 3,374,028 $ 1,307,133
Less preferred dividends 53,277 120,941
------------- -------------
Net income available to common stockholders 3,320,751 1,186,192
Deduct: Total stock-based employee compensation expense
determined under air value method for all awards (net of tax) (38,000) (39,000)
------------- -------------
Net income, pro forma $ 3,282,751 $ 1,147,192
------------- -------------
Net income per share:
Basic, as reported $ 0.59 $ 0.24
============= =============
Basic, pro forma $ 0.59 $ 0.23
============= =============
Diluted, as reported $ 0.52 $ 0.23
============= =============
Diluted, pro forma $ 0.51 $ 0.21
============= =============
Weighted average fair value of options granted during the year $ 4.75 $ 3.35
============= =============
F-9
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Description of Leasing Arrangements
-----------------------------------
The Company's leasing operations principally consist of the leasing of
natural gas compressor packages and flare stacks. The leases are classified
as operating leases. See Note 4.
Income Taxes
------------
The Company files a consolidated tax return with its subsidiaries. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to temporary differences between the financial statement
carrying amounts of assets and liabilities and their respective tax bases,
and operating losses and tax credit carry-forwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are
expected to be recovered or settled.
Use of Estimates
----------------
The preparation of the Company's financial statements in conformity with
generally accepted accounting principles requires the Company's management
to make estimates and assumptions that affect the amounts reported in these
financial statements and accompanying notes. Actual results could differ
from those estimates. Significant estimates include the valuation of assets
and goodwill acquired in acquisitions. It is at least reasonably possible
these estimates could be revised in the near term and the revisions would
be material.
Recently Issued Accounting Pronouncements
-----------------------------------------
On December 16, 2004, the FASB published FASB Statement No. 123 (revised
2004), Share-Based Payment. Statement 123(R) requiring that the
compensation cost relating to share-based payment transactions be
recognized in financial statements. That cost will be measured based on the
fair value of the equity or liability instruments issued. Public entities
(other than those filing as small business issuers) will be required to
apply Statement 123(R) as of the first interim or annual reporting period
that begins after June 15, 2005. Public entities that file as small
business issuers will be required to apply Statement 123(R) in the first
interim or annual reporting period that begins after December 15, 2005.
Statement 123(R) replaces FASB Statement No. 123, Accounting for
Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees. Statement 123, as originally issued in 1995,
established as preferable a fair-value-based method of accounting for
share-based payment transactions with employees. However, that Statement
permitted entities the option of continuing to apply the guidance in
Opinion 25, as long as the footnotes to financial statements disclosed what
net income would have been had the preferable fair-value-based method been
used.
2. PROPERTY AND EQUIPMENT
----------------------
Property and equipment consists of the following at December 31, 2004:
Land and building $ 1,345,740
Leasehold improvements 207,596
Office equipment and furniture 199,860
Software 143,420
Machinery and equipment 507,010
Vehicles 2,176,682
Less accumulated depreciation (1,446,141)
-----------
$ 3,134,167
===========
Depreciation expense for property and equipment and the leased compressors
described in Note 4 was $2,410,780 and $1,681,232 for the years ended
December 31, 2004 and 2003, respectively.
F-10
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. ACQUISITIONS
------------
On March 31, 2003, the Company acquired 28 gas compressor packages from
Hy-Bon Engineering Company, Inc. ("Hy-Bon"). The adjusted purchase price
amounted to approximately $2,150,000. As part of the purchase and sale
agreement, Hy-Bon withdrew as a member of Hy-Bon Rotary Compression, L.L.C.
("Joint Venture") effective as of January 1, 2003. The Company, as the
other member, retained all assets of the Joint Venture, which had an
unaudited aggregate value of $346,511 as of December 31, 2002. The Company
dissolved the Joint Venture and agreed not to operate under the name
Hy-Bon. The Company consolidated the operations of the Joint Venture
beginning January 1, 2003 and began recording its share of the profit of
the acquired interest beginning April 1, 2003. Prior to the acquisition,
the Company had owned a non-controlling 50% interest in the Joint Venture
and accounted for it on the equity method.
On October 18, 2004, Natural Gas Services Group, Inc. entered into a Stock
Purchase Agreement with Screw Compression Systems, Inc., or "SCS", and the
stockholders of SCS. Under this agreement, Natural Gas Services Group
agreed to purchase all of the outstanding shares of capital stock of SCS.
SCS is a privately owned manufacturer of natural gas compressors, with its
principal offices located in Tulsa, Oklahoma.
The stockholders of SCS will receive, in proportionate shares (based on
their stock ownership of SCS), total consideration consisting of:
o $8 million in cash;
o promissory notes issued by Natural Gas Services in the aggregate
principal amount of $3 million bearing interest at the rate of
4.00% per annum, maturing three years from the date of closing
and secured by a letter of credit in the face amount of $2
million; and
o 609,576 shares of Natural Gas Services common stock. All of the
shares, upon issuance, will be "restricted" securities within the
meaning of Rule 144 under the Securities Act of 1933, as amended,
and will bear a legend to that effect.
This transaction was completed January 3, 2005 and Natural Gas Services
Group Inc will begin reporting combined financial information with SCS in
January 2005.
4. LEASING ACTIVITY
----------------
The Company leases natural gas compressor packages to entities in the
petroleum industry. The Company's cost and accumulated depreciation for the
leased compressors as of December 31, 2004 was $27,734,030 and $4,820,774,
respectively. These leases are classified as operating leases and generally
have original lease terms of six months to five years and continue on a
month-to-month basis thereafter. Future minimum lease payments for leases
not on a month-to-month basis at December 31, 2004 are as follows:
Year Ended December 31,
2005 $ 3,292,164
2006 855,845
2007 341,955
2008 178,723
-------------
Total $ 4,668,687
=============
F-11
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. LINE OF CREDIT
--------------
The Company has a line of credit with a financial institution that allows
for borrowings up to $750,000, bears interest at the prime rate plus 1% and
requires monthly interest payments with principal due at maturity on May
15, 2005. The line of credit is collateralized by substantially all of the
assets of the Company. At December 31, 2004, there was a $549,856
outstanding balance on this line of credit.
The Company entered into a new Line of Credit on January 3, 2005 with the
same financial institution which allows for borrowings up to $2,000,000,
bears interest at the prime rate plus 1% and requires monthly interest
payments with principal due at maturity on January 1, 2006. The line of
credit is collateralized by substantially all of the assets of the Company.
At December 31, 2004, there was no outstanding balance on this line of
credit.
The line of credit and first three notes listed in Note 6 below are with
the same bank and include certain covenants, the most restrictive of which
require the Company to maintain certain working capital, debt to equity and
cash flow ratios and certain minimum net worth. The Company was in
compliance with all covenants at December 31, 2004.
6. LONG-TERM DEBT
--------------
Long-term debt at December 31, 2004 consisted of the following:
Note payable to a bank, interest at bank's prime rate plus 1.0% but
not less than 5.25% (6.25% at December 31, 2004), monthly
payments of principal of $170,801 plus interest until maturity
on September 15, 2007. The note is collateralized by substantially
all of the assets of the Company. See Note 5 regarding loan covenants $ 5,300,696
Note payable to a bank, interest at bank's prime rate plus 1% but not
less than 5.25% (6.25% at December 31, 2004). This is an
advance line of credit note for $10,000,000. Interest is payable
monthly. Principal is due in 60 consecutive payments beginning
December 15, 2004 until November 15, 2009. The note is
collateralized by substantially all of the assets of the Company
See Note 5 regarding loan covenants 7,133,333
Note payable to a bank, interest at 7%, monthly payments of
principal and interest totaling $2,614 until maturity in September
2010, collateralized by a building 182,025
Various notes payable to a bank, interest rates ranging from prime
plus 1% (6.25% at December 31, 2004) to 7.50% 176,946
Capital lease 13,141
Other notes payable for vehicles, various terms 212,116
------------
Total 13,018,257
Less current portion (3,728,048)
------------
$ 9,290,209
============
F-12
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Maturities of long-term debt based on contractual requirements for the
years ending December 31 are as follows:
2005 $ 3,728,048
2006 3,615,172
2007 2,667,228
2008 1,438,053
2009 1,439,370
Thereafter 130,386
-------------
$ 13,018,257
=============
7. SUBORDINATED NOTES
------------------
In 2001, the Company completed an offering of units consisting of
subordinated debt and warrants. The balance of the subordinated debt, net
of unamortized discount of $89,962, is $1,449,299 at December 31, 2004.
Each unit consists of a $25,000 10% subordinated note due December 31, 2006
and a five-year warrant to purchase 10,000 shares of the Company's common
stock at $3.25 per share. Interest only is payable annually, with all
principal due at maturity. Warrants to purchase 61,570 shares were also
granted on the same terms to a placement agent in connection with the
offering. Certain stockholders, officers and directors purchased units in
the subordinated debt offering, (totaling $259,261 in notes and warrants
representing 103,704 shares) on the same terms and conditions as
non-affiliated purchasers in the offering. As of December 31, 2004,
warrants were outstanding from the offering for the purchase of a total of
548,175 shares.
8. INCOME TAXES
------------
The provision for income taxes consists of the following:
2004 2003
---------- ----------
Current provision:
Federal $ -- $ --
State 20,000 25,000
---------- ----------
20,000 25,000
Deferred provision:
Federal 1,028,538 592,799
State 91,381 79,000
---------- ----------
1,119,919 671,799
---------- ----------
$1,139,919 $ 696,799
========== ==========
F-13
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The income tax effects of temporary differences that give rise to
significant portions of deferred income tax assets and (liabilities) are as
follows:
2004 2003
----------- -----------
Deferred income tax assets:
Net operating loss $ 2,669,000 $ 727,000
Other 7,000 5,000
----------- -----------
Total deferred income tax assets 2,676,000 732,000
=========== ===========
Deferred income tax liabilities:
Property and equipment (5,483,000) (2,410,000)
Goodwill and other intangible assets (142,000) (154,000)
Other (9,000) (11,000)
----------- -----------
Total deferred income tax liabilities (5,634,000) (2,575,000)
----------- -----------
Net deferred income tax liabilities (2,958,000) $(1,843,000)
=========== ===========
The effective tax rate differs from the statutory rate as follows:
2004 2003
--------------------------
Statutory rate 34% 34%
State and local taxes 3% 5%
Nontaxable life insurance proceeds (12)% --
Other -- (4)%
--------------------------
Effective rate 25% 35%
==========================
At December 31, 2004, the Company had available federal net operating loss
("NOL") carryforwards of approximately $7,200,000, which may be used to
reduce future taxable income and expire in 2020 through 2024. The company
also had alternative minimum tax NOL carryforwards of approximately
$5,000,000. The company has also accumulated charitable contribution
carryforwards of $9,000.
9. STOCKHOLDERS' EQUITY
--------------------
Initial Public Offering
-----------------------
In October, 2002, the Company closed an initial public offering in which it
sold 1,500,000 shares of common stock and warrants to purchase 1,500,000
shares of common stock for a total of $7,875,000. Costs and commissions
associated with the offering totaled $1,345,830. The warrants are
exercisable anytime through October 21, 2006 at $6.25 per share. In
connection with this offering, the underwriter received options to purchase
150,000 shares of common stock at $6.25 per share and warrants at $0.3125
per share. The warrants, if purchased by the underwriter, will contain an
exercise price of $7.81 per share. The underwriter's options expire in
October 2007 and include a cashless exercise provision utilizing the
Company's common stock.
Conversion
----------
The Company may redeem the warrants upon 30 days' prior written notice at a
price of $.25 per warrant if the closing price of our common stock equals
or exceeds $10.9375 for 20 consecutive trading days.
F-14
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Warrants
--------
In April 2002 and March 2001, five-year warrants to purchase 16,472 shares
of common stock at $3.25 per share and 68,524 shares at $2.50 per share,
respectively, were issued to certain board members and stockholders as
compensation for their debt guarantees. These warrants were immediately
exercisable and were recorded at their estimated fair values of $42,025 in
2002 and $23,137 in 2001. All of these warrants remained outstanding as of
December 31, 2004.
Preferred Stock
---------------
The Company has a total of 5,000,000 authorized preferred shares, with
rights and preferences as designated by the Board of Directors. The Company
had a private placement of Series A shares in 2001 and 2002. In connection
with the offering, the underwriter received warrants to purchase 38,165
shares of common stock at $3.25 per share through December 1, 2006. The
Series A shares had a cumulative annual dividend rate of 10%, when and if
declared by the Board of Directors payable thirty days after the end of
each quarter. Holders were entitled to one vote per share and the Series A
shares were convertible into common stock initially at a price of $3.25 per
share, subject to adjustment based on the market price and various other
contingencies. In addition, Series A shares automatically converted to
common stock on a one-for-one basis when the Company's common stock traded
on a public exchange at a price of $6.50 per share or greater for twenty
consecutive days. The Series A shares had a liquidation preference of $3.25
per share plus accrued and unpaid dividends over common stock.
In 2003, 38,000 Series A shares were converted to common stock. Total
Series A shares outstanding at December 31, 2003 were 343,654.
In accordance with the provisions of the Convertible Series A Preferred
Stock, on March 26, 2004 each share of Preferred Stock automatically
converted to one share of Common Stock. The conversion occurred after the
closing market price of the stock was equal to or higher than $6.50 for 20
consecutive trading days. 343,654 Preferred shares were converted at that
time. Dividends payable at the conversion date were approximately $25,355.
Common Stock Private Placement
------------------------------
On July 20, 2004, the Company and CBarney Investments, Ltd. entered into a
Securities Purchase Agreement. Under this agreement, the Company issued and
sold 649,574 shares of its common stock to CBarney at $7.69736 per share.
The per share price was determined by multiplying (x) $8.747, the average
closing market price of the common stock on the American Stock Exchange for
the twenty consecutive trading days ended July 15, 2004, times (y)
eighty-eight percent. The Company received aggregate gross proceeds of
$5,000,000 and net proceeds of $4,950,000.
10. STOCK-BASED COMPENSATION
------------------------
Stock Options
-------------
In December 1998, the Board of Directors adopted the 1998 Stock Option Plan
(the "Plan"). 150,000 shares of common stock have been reserved for
issuance under the Plan. All options granted under the Plan will expire ten
years after date of grant. The option price is to be determined by the
Board of Directors on date of grant. The Company has also issued options
that are not subject to the Plan.
In December 2003, the Company granted a total of 12,500 non-qualified stock
options to its outside directors to purchase the Company's common stock at
$5.55 per share any time through December 2013. At December 31, 2004,
F-15
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10,000 of these options were outstanding. Also, in December 2003, options
were granted to employees to purchase 15,000 shares of common stock at
$5.58 per share. The employee options vest over three years and expire in
December 2013.
In August 2004, options were granted to employees to purchase 38,000 shares
of common stock at $7.50 per share. The employee options vest over three
years and expire in December 2014.
The following is a summary of activity for the stock options outstanding
for the years ended December 31, 2004 and 2003:
DECEMBER 31, 2004 DECEMBER 31, 2003
-------------------- ---------------------
Weighted Weighted
Number Average Number Average
Of Exercise Of Exercise
Shares Price Shares Price
-------- -------- --------- --------
Outstanding, beginning of year 80,000 $ 3.92 161,500 $ 2.41
Canceled or expired -- -- (9,000) 3.25
Granted 38,000 7.50 27,500 5.57
Exercised (11,000) 3.23 (100,000) 2.00
-------- -------- --------- --------
Outstanding, end of year 107,000 $ 3.92 80,000 $ 3.92
======== ======== ======== ========
Exercisable, end of year 46,000 $ 5.06 43,000 $ 3.68
======== ======== ======== ========
11. COMMITMENTS
-----------
401(k) Plan
-----------
The Company offers a 401(k) Plan (the "401(k) Plan") to all employees that
have reached the age of eighteen and have completed six months of service.
The participants may contribute up to 15% of their salary. Employer
contributions are subject to Board discretion and are subject to a vesting
schedule of 20% each year after the first year and 100% after six years.
The Company contributed $60,735 and $77,538 to the 401(k) Plan in 2003 and
2004, respectively.
Rented Facilities
-----------------
The facility in Bloomfield, New Mexico is an approximately 4,000 square
foot building that is leased at a current rate of $2,650 per month pursuant
to a lease that terminates in May 2008. Approximately 1,000 square feet are
used as office space and approximately 3,000 square feet are used for shop
space. The facility in Bridgeport, Texas is an approximately 4,500 square
foot building that is leased at a current rate of $1,500 per month pursuant
to a lease that terminates in August 2006. Approximately 4,000 square feet
is used as office space and approximately 500 square feet is used as shop
space. Future rental payments under these leases for the years ended
December 31 are as follows:
2005 $ 49,800
2006 43,800
2007 31,800
2008 13,250
-----------
$ 138,650
===========
F-16
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK
------------------------------------------------
Sales to two customers in the year ended December 31, 2004 amounted to 21%
and 17% respectively of consolidated revenue. Sales to two customers in the
year ended December 31, 2003 amounted to 28% and 10% respectively of
consolidated revenue. No other single customer accounted for more than 10%
of the Company's sales in 2003 or 2004. At December 31, 2004, two customers
accounted for 12% and 10% respectively, of the Company's trade accounts
receivable. The Company generally does not obtain collateral, but requires
deposits of as much as 50% on large custom contracts.
13. OTHER INCOME
------------
On March 15, 2004 the President and C.E.O. of the Company, Mr. Wayne L.
Vinson, passed away after a battle with cancer. The Company held two life
insurance policies on him, one for $1,000,000 and one for $500,000, with
the Company as the beneficiary. The proceeds of $1,500,000 were recorded as
other income.
14. 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 deciding how to
allocate resources and in assessing performance.
The Company identifies its segments based upon major revenue sources as
follows:
For the year ended December 31, 2004 (in thousands of dollars)
Service &
Sales Maintenance Leasing Corporate Total
----------- ----------- ----------- ----------- -----------
Revenue $ 3,593 $ 1,874 $ 10,491 $ -- $ 15,958
Cost of Sales 2,556 1,357 3,038 -- 6,951
----------- ----------- ----------- ----------- -----------
Gross Margin $ 1,037 $ 517 $ 7,453 $ -- $ 9,007
Operating Expenses -- -- -- (5,096) (5,096)
Other Income/(Expense) -- -- -- 603 603
----------- ----------- ----------- ----------- -----------
Income before Provision for $ 1,037 $ 517 $ 7,453 $ (4,493) $ 4,514
Income Taxes
=========== =========== =========== =========== ===========
*Segment Assets $ -- $ -- $ -- $ 43,255 $ 43,255
=========== =========== =========== =========== ===========
F-17
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the year ended December 31, 2003 (in thousands of dollars)
Service &
Sales Maintenance Leasing Corporate Total
----------- ----------- ----------- ----------- -----------
Revenue $ 3,865 $ 1,773 $ 7,112 $ -- $ 12,750
Cost of Sales 2,860 1,243 1,954 -- 6,057
----------- ----------- ----------- ----------- -----------
Gross Margin $ 1,005 $ 530 $ 5,158 $ -- $ 6,693
Operating Expenses -- -- -- (4,018) (4,018)
Other Income/(Expense) -- -- -- (671) (671)
----------- ----------- ----------- ----------- -----------
Income before Provision for
Income Taxes $ 1,005 $ 530 $ 5,158 $ (4,689) $ 2,004
=========== =========== =========== =========== ===========
*Segment Assets $ -- $ -- $ -- $ 28,270 $ 28,270
=========== =========== =========== =========== ===========
* Management does not track assets by segment.
15. SUBSEQUENT EVENTS
-----------------
As described in Note 3, on January 3, 2005 the Company completed the
acquisition of Screw Compression Systems, Inc ("SCS"). In connection with
the acquisition of SCS, on January 3, 2005 the Company, as borrower, and
SCS, as guarantor, entered into a Third Amended and Restated Loan Agreement
with Western National Bank (or WNB) for the following purposes:
o to facilitate the purchase of SCS
o to refinance SCS' existing real estate debt;
o to increase the amount of funds available for general working
capital purposes;
o to modify our existing term loan facility; and
o to reflect the availability of additional funds for the
construction of new compressor units for lease and resale.
The Loan Agreement provides for three term loan facilities, a revolving
line of credit facility and an advancing term loan facility. The three term
loan facilities are evidenced by three separate notes, two of which reflect
new loans in the original principal amounts of $8,000,000 and $1,415,836,
respectively, and one of which reflects our existing term loan evidenced by
the $7,521,109 Term Note, as modified by the Modification Agreement. All
outstanding principal under the $8,000,000 note is due and payable on
January 1, 2012, and all outstanding principal under the $1,415,836 note is
due and payable on January 1, 2010. The $7,521,109 Term Note evidences our
existing term loan facility.