As filed with the Securities and Exchange Commission on October 1, 2003
Registration No. 333-88314
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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POST-EFFECTIVE AMENDMENT NO. 2
TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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NATURAL GAS SERVICES GROUP, INC.
(Name of small business issuer in its charter)
Colorado 3533 75-2811855
- ------------------------------ ---------------------------- -------------------
(State or jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
2911 South County Road 1260
Midland, Texas 79706
(915) 563-3974
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(Address and telephone number of principal executive offices
and principal place of business)
Wayne L. Vinson
2911 South County Road 1260
Midland, Texas 79706
(915) 563-3974
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(Name, address and telephone number of agent for service)
COPIES TO:
Thomas S. Smith, Esq.
Jones & Keller, P.C.
1625 Broadway, Suite 1600
Denver, Colorado 80202
Telephone: (303) 573-1600
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Approximate date of proposed sale to the public: As soon as practicable after
the effective date of this Post-Effective Amendment No. 2
to the Registration Statement.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule
462(c) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule
462(d) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule
434, check the following box. [_]
PROSPECTUS SUBJECT TO COMPLETION, DATED OCTOBER 1, 2003
NATURAL GAS SERVICES GROUP, INC.
We are offering 1,500,000 shares of our common stock to holders
electing to exercise warrants issued as part of our initial public offering in
October 2002. The 1,500,000 warrants sold to the public in our offering are
exercisable at $6.25 per share. If all of the warrants are exercised, we will
receive gross proceeds of $9,375,000.
We also issued options to the underwriter of our initial public
offering to purchase 150,000 shares of our common stock for $6.25 per share and
to purchase warrants to purchase 150,000 shares of our common stock at $0.3125
per warrant. The underwriter subsequently transferred the options to the selling
securityholders. Each warrant entitles the holders to purchase one share of our
common stock for $7.8125 per share. If the options and warrants are exercised,
we will receive gross proceeds of $2,156,250.
Our common stock and public warrants trade on the American Stock
Exchange under the symbols NGS and NGS.WS.
-------------------------
You should carefully consider the risk factors beginning on page 6
before purchasing any of the securities.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
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The date of this prospectus is _______________, 2003
ABOUT NATURAL GAS SERVICES GROUP, INC.
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
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 June 30, 2003, we had
312 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 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 (915) 563-3974.
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SUMMARY OF THE OFFERING
Securities offered by us....................... 1,500,000 shares of common stock
issuable upon exercise of
warrants that are held by the
public and are exercisable at
$6.25 per share at any time
prior to 5:00 p.m. (MST) October
20, 2006.
Securities offered by
selling securityholders(1)..................... 300,000 shares of common stock
underlying options and warrants.
Common stock outstanding ...................... 5,022,181 shares.
Common stock to be outstanding if
all warrants and options are exercised......... 6,822,181 shares.(2)
Public Warrant Terms:
Exercise price............................... $6.25 per share.
Expiration date.............................. 5:00 p.m. (MST) October 20, 2006
Redemption .................................. We 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.
Use of proceeds................................ We plan to use the net proceeds
from the exercise of the options
and warrants, if any, for
general corporate purposes and
working capital.
American Stock Exchange symbols
Common stock................................. NGS
Warrants..................................... NGS.WS
Risk factors................................... Our securities involve a high
degree of risk and immediate
dilution. Warrant holders should
carefully consider all of the
factors set forth herein before
exercising their warrants to
purchase common stock.
- -----------------
(1) There is no trading market for the selling securityholders' options or
warrants and none is expected to develop. The options to purchase our shares of
common stock and warrants cannot be exercised by the selling securityholders
until October 21, 2003.
(2) Assumes all warrants and the selling securityholders' options are exercised.
3
Summary Consolidated Financial Data
The following table summarizes our financial data. You should refer to
the consolidated financial statements included elsewhere in this prospectus for
a more complete description of our financial condition and results of
operations.
Consolidated Statement of For the Six Months
Income and Other Data (1): For the Year Ended December 31. Ended June 30.
------------------------------- -------------------------------
2001 2002 2002 2003
------------- ------------- ------------- -------------
(in thousands except per share data)
Revenue $ 8,762 $ 10,297 $ 5,120 $ 5,565
Total costs of revenue 4,942 5,572 2,806 2,586
------------- ------------- ------------- -------------
Gross profit 3,820 4,725 2,314 2,979
Income from operations 1,199 1,841 932 1,084
Total other expense (503) (471) (313) (329)
------------- ------------- ------------- -------------
Income before provision for income
taxes 696 1,370 619 755
Total income tax expense 314 584 280 322
------------- ------------- ------------- -------------
Net income 382 786 339 433
Preferred dividends 11 107 76 62
------------- ------------- ------------- -------------
Net income available to common
shareholders $ 371 $ 679 $ 263 $ 371
============= ============= ============= =============
Per Common Share Data:
Basic $ .11 $ .19 $ .08 $ .08
============= ============= ============= =============
Diluted $ .11 $ .16 $ .06 $ .07
============= ============= ============= =============
Weighted Average Shares
of Common Stock Outstanding
Basic 3,357,632 3,649,413 3,357,632 4,866,527
Diluted 3,483,987 4,305,053 4,163,710 5,116,332
Consolidated Balance Sheet Data (1):
December 31, 2002 June 30, 2003
----------------- -----------------
(in thousands)
Current assets .............. $ 5,084 $ 4,832
Total assets ................ 23,937 26,990
Current liabilities.......... 2,669 3,840
Shareholders' equity......... 13,001 13,572
4
Consolidated Statement of Cash
Flows:
For the Six Months
For the Year Ended December 31. Ended June 30.
------------------------------- ------------------------------
2001 2002 2002 2003
------------- ------------- ------------- -------------
(in thousands)
Cash flows provided by (used in)
operating activities ........... $ 840 2,206 $ 1,278 $ 536
Cash flow used in investment
activities ..................... (3,087) (3,885) (2,132) (3,850)
Cash flow provided by financing
activities ..................... 2,611 3,886 689 1,576
- ---------------------
(1)The financial information reflects the acquisition by us of the
compression-related assets of Dominion Michigan on March 29, 2001. The purchase
price was $8,000,000, of which $1,000,000 was paid at closing and the net
balance was financed by Dominion Michigan. The operations and assets of Dominion
Michigan that we acquired are included in our consolidated financial statements
commencing on April 1, 2001.
5
RISK FACTORS
To inform investors of our future plans and objectives, this prospectus
(and other reports and statements issued by us and our officers from time to
time) contain certain statements concerning our future performance, intentions,
objectives, plans and expectations that are or may be deemed to be
"forward-looking statements." Our ability to do this has been fostered by the
Private Securities Litigation Reform Act of 1995, which provides a "safe harbor"
for forward-looking statements to encourage companies to provide prospective
information so long as those statements are accompanied by meaningful cautionary
statements identifying important factors that could cause actual results to
differ materially from those discussed in the statement.
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 June 30, 2003, we had an aggregate of approximately $10,365,000
of outstanding indebtedness, not including accounts payable, and accrued
expenses of approximately $973,000. 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:
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 June 30, 2003, our debt service requirements on a monthly,
quarterly and annual basis were $186,803, $560,404 and $2,241,636, 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:
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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
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 80% of our compressor leases are leased for terms of six months or
less and, if terminated, would adversely impact our revenue and our ability to
recover our initial equipment costs.
Approximately 80% 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
a compressor for which a lease is terminated.
7
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. 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 six months ended June 30, 2003, Dominion Exploration &
Production, Inc. accounted for approximately 31% of our consolidated revenue.
During the years ended December 2002 and 2001, Dominion Exploration accounted
for approximately 30% and 26% 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 32% of our compressor components from
two suppliers. We order from these suppliers as needed and we have no long-term
contracts with either supplier. If either 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.
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;
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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 successfully to endure downturns in the oil and gas industry.
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
9
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.
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 wastes 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.
10
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.
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.
11
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 Wayne L.
Vinson, our President and the President of Rotary Gas Systems, Scott W.
Sparkman, our Secretary and the Executive Vice President of NGE Leasing, 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 do not maintain any "key man" life
insurance for any of our officers, except for policies totaling $1,500,000 on
the life of Wayne L. Vinson. We are the beneficiary of these policies.
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 31%,
approximately 30% and approximately 26% of our consolidated revenue during the
six months ended June 30, 2003 and for the years ended December 31, 2002 and
December 31, 2001, 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.
12
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 us through acquiring or controlling blocks of our 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
us. This would make it difficult for other minority shareholders to effect a
change in control or otherwise extend any significant control over our
management. This may adversely affect the market price and interfere with the
voting and other rights of our common stock.
If our common stock does not trade for a certain price per share, our preferred
stock will not automatically convert into our common stock.
Our currently outstanding 343,654 shares of 10% Convertible Series A
Preferred Stock will automatically convert into shares of our common stock if
our common stock trades at or above $6.50 per share for 20 consecutive trading
days. Until such event occurs, we will be required to:
o continue to pay the preferred stock dividend;
o permit the preferred stock holders to vote as a separate class
where required by Colorado law; and
o pay the holders of preferred stock a preference upon our
liquidation.
The same consequences would likely result from any additional preferred
stock that our board of directors may authorize for issuance in the future, as
well as additional rights and preferences that could be included in the terms of
the preferred stock.
We have a comparatively low number of shares of common stock outstanding and,
therefore, our common stock may suffer from limited liquidity and its prices
will likely be volatile and its value may be adversely affected.
Because the number of freely transferable shares of our common stock is
low, the trading price of our common stock will likely be subject to significant
price fluctuations and limited liquidity. This may adversely affect the value of
your investment. In addition, our common stock price could be subject to
fluctuations in response to variations in quarterly operating results, changes
in management, future announcements concerning us, general trends in the
industry and other events or factors as well as those described above.
13
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.
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 under performance 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 independent
valuations in June 2003 and 2002 of our reporting units with goodwill, adoption
of FAS 142 has not had a material adverse effect on us through at least 2003. 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
$2,730,000 as of December 31, 2002, and we expect the carrying value of net
intangible assets will increase significantly if we acquire additional
businesses. Any impairments 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.
14
USE OF PROCEEDS
If all warrants and options were exercised, we would receive about
$11,464,375 million net of legal, accounting, printing and other offering costs.
We intend to use any proceeds received from the exercise of our
warrants and options for general corporate purposes and working capital.
Pending the uses described above, we will invest the proceeds in
short-term, government, government guaranteed or investment grade securities.
15
DIVIDEND POLICY
We have not paid any cash dividends on our common stock. It is our
current policy not to pay cash dividends on our common stock. Any payment of
cash dividends in the future will be dependent upon:
o our financial condition, results of operations, current and
anticipated cash requirements;
o restrictions on the payment of dividends under the terms of
our debt obligations and any future financing arrangements;
o our plans for expansion;
as well as other factors that our Board of Directors deems relevant.
We have 343,654 shares of our 10% Convertible Series A Preferred Stock
outstanding. Holders of that stock are entitled to cash dividends paid quarterly
at a rate equal to 10% per annum or $0.325 per share annually. The 10%
Convertible Series A Preferred stock will automatically convert into our common
stock at any time if our common stock trades for 20 consecutive trading days at
a price of $6.50 or more per share.
16
SELECTED CONSOLIDATED FINANCIAL DATA
The following consolidated selected financial data should be read in
conjunction with our Consolidated Financial Statements and Notes thereto
appearing elsewhere in this prospectus and "Management's Discussion and Analysis
of Financial Condition and Results of Operations." The consolidated statements
of income data for the years ended December 31, 2002 and 2001 and the balance
sheet data as of December 31, 2002 are derived from our consolidated financial
statements which have been audited by Hein + Associates LLP, our independent
auditors, as indicated in their report included herein. The data as of and for
the six months ended June 30, 2002 and 2003 have been derived from our unaudited
financial statements which, in our opinion, contain all normal, recurring
adjustments needed for the fair presentation of results for such periods. With
respect to the unaudited interim consolidated financial information for the six
months ended June 30, 2002 and 2003 included herein, the independent certified
public accountants have not audited such consolidated financial information and
have not expressed an opinion or any other form of assurance with respect to
such consolidated financial information. The selected financial data provided
below is not necessarily indicative of our future results of operations or
financial performance.
17
Consolidated Statement of Income and For the Six Months
Other Data (1): For the Year Ended December 31. Ended June 30.
------------------------------- -------------------------------
2001 2002 2002 2003
------------- ------------- ------------- -------------
(in thousands except per share data)
Revenue $ 8,762 $ 10,297 $ 5,120 $ 5,565
Total costs of revenue 4,942 5,572 2,806 2,586
------------- ------------- ------------- -------------
Gross profit 3,820 4,725 2,314 2,979
Income from operations 1,199 1,841 932 1,084
Total other expense (503) (471) (313) (329)
------------- ------------- ------------- -------------
Income before provision for income
taxes 696 1,370 619 755
Total income tax expense 314 584 280 322
------------- ------------- ------------- -------------
Net income 382 786 339 433
Preferred dividends 11 107 76 62
------------- ------------- ------------- -------------
Net income available to common
shareholders $ 371 $ 679 $ 263 $ 371
============= ============= ============= =============
Per Common Share Data:
Basic $ .11 $ .19 $ .08 $ .08
============= ============= ============= =============
Diluted $ .11 $ .16 $ .06 $ .07
============= ============= ============= =============
Weighted Average Shares
of Common Stock Outstanding
Basic 3,357,632 3,649,413 3,357,632 4,866,527
Diluted 3,483,987 4,305,053 4,163,710 5,116,332
Consolidated Balance Sheet Data (1):
December 31, 2002 June 30, 2003
----------------- -----------------
(in thousands)
Current assets .............. $ 5,084 $ 4,832
Total assets ................ 23,937 26,990
Current liabilities.......... 2,669 3,840
Shareholders' equity......... 13,001 13,572
18
Consolidated Statement of Cash Flows (1):
For the Period
For the Year Ended December 31 Ended June 30
------------------------------ ------------------------------
2001 2002 2002 2003
------------- ------------- ------------- -------------
Cash flow provided by (used in operating activities) $ 840 $ 2,206 $ 1,278 $ 536
Cash flow used in investment activities (3,087) (3,885) (2,132) (3,850)
Cash flow provided by financing activities 2,611 3,886 689 1,576
- -------
(1) The financial information reflects the acquisition by us of the
compression-related assets of Dominion Michigan on March 29, 2001. The purchase
price was $8,000,000, of which $1,000,000 was paid at closing and the net
balance was financed by Dominion Michigan. The operations and assets of Dominion
Michigan that we acquired are included in our consolidated financial statements
commencing on April 1, 2001.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 Prospectus. 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
Prospectus.
Overview
We combine the operations of 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 are the parent company and provide administrative and
management support and, therefore, have expenses associated with that activity.
We acquired the compression related assets of Great Lakes from Dominion
Michigan on March 29, 2001. This acquisition significantly increased the number
of compressor units that we own and service and thereby increased our revenue
and operating income beginning April 1, 2001.
20
Results of Operations
Six Months Ended June 30, 2003. Compared to the Six Months Ended June 30, 2002.
Natural Gas
(in thousands) Rotary NGE Great Lakes Services
Gas Leasing Compression Group Total
----------- ----------- ----------- ----------- -----------
Six Months Ended
June 30, 2003
Revenue $ 1,200 $ 2,070 $ 2,295 $ -- $ 5,565
Inter-segment revenue 2,744 35 8 -- 2,787
Gross margin 479 1,554 946 -- 2,979
Selling, general and
administrative
expense 460 86 135 434 1,115
Depreciation and amortization
expense 70 379 319 12 780
Operating income (loss) (51) 1,089 492 (446) 1,084
Interest expense 3 224 89 13 329
Other income or (expense) -- 9 (9) -- --
Provision for income tax -- -- -- 322 322
----------- ----------- ----------- ----------- -----------
Net Income (loss) $ (54) $ 874 $ 394 $ (781) $ 433
=========== =========== =========== =========== ===========
Six Months Ended
June 30, 2002
Revenue $ 1,571 $ 1,059 $ 2,490 $ -- $ 5,120
Inter-segment revenue 3,046 -- -- -- 3,046
Gross margin 656 761 897 -- 2,314
Selling, general and
administrative
expense 398 80 126 240 844
Depreciation and amortization
expense 59 189 270 20 538
Operating income (loss) 199 492 501 (260) 932
Interest expense 4 186 313 20 523
Equity in earnings from joint
venture -- 208 -- -- 208
Other income or (expense) 1 1 -- -- 2
Provision for income tax -- -- -- 280 280
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 196 $ 515 $ 188 $ (560) $ 339
=========== =========== =========== =========== ===========
- --------------------------------------------------------------------------------
Rotary Gas Systems Operations
Revenue from outside sources decreased 24% or $371,000 for the six
months ended June 30, 2003, as compared to the same period ended June 30, 2002.
Because our products are custom-built, fluctuations in revenue from outside
sources are expected. This decrease was mainly the result of a reduction in the
sale of flare units to third parties.
The gross margin percentage decreased from 42% for the six months ended
June 30, 2002, to 40% for the same period ended June 30, 2003. The cost of
revenue is comprised of expenses associated with service, parts and
manufacturing expenses. This decrease resulted mainly from a change in the
product mix.
Selling, general and administrative expense increased $62,000 or 16%
for the six months ended June 30, 2003, as compared to the same period ended
June 30, 2002. This was mainly the result of the addition of new salesmen in the
Farmington, New Mexico and West Texas areas.
21
Depreciation expense increased 19% or $11,000 for the six months ended
June 30, 2003, as compared to the same period ended June 30, 2002. This increase
was mainly due to the purchase of additional sales vehicles, shop and office
equipment.
There was a decrease of $1,000 in interest expense for the six months
ended June 30, 2003, as compared to the same period ended June 30, 2002, mainly
due to the reduction in loan balances on vehicles.
NGE Leasing Operations
Revenue from our rental of natural gas compressors increased 95% for
the six months ended June 30, 2003, as compared to the same period in 2002. This
increase is the result of units added to our rental fleet. From June 30, 2002,
to June 30, 2003, we added 137 gas compressor units to our rental fleet, which
included the 28 units we purchased from Hy-Bon on March 31, 2003. The operations
from the Joint Venture, which were previously accounted for using the equity
method, have been consolidated beginning January 1, 2003. The earnings from the
units purchased from Hy-Bon is included in our consolidated earnings beginning
April 1, 2003.
The gross margin percentage increased from 72% for the six months ended
June 30, 2002, to 75% for the same period ending 2003. This increase mainly
resulted from a slight reduction in the maintenance expenses associated with the
compressor units and also additional revenue recognized from the sale of our
irrigation pump engines.
Selling, general and administrative expense increased $6,000 or 8% for
the six months ended June 30, 2003, as compared to the same period in 2002. This
was mainly the result of an increase in sales commissions from increased rental
revenue.
Depreciation expense increased 101% or $190,000 for the six months
ended June 30, 2003, as compared to the same period ended June 30, 2002. This
increase was the result of new gas compressor rental units being added to the
rental fleet during the period.
There was an increase in interest expense of 20% from $186,000 for the
six months ended June 30, 2002, to $224,000 for the same period ended June 30,
2003. This is mainly as a result of an increase in bank debt used to purchase
equipment for the rental fleet.
22
Great Lakes Compression
Revenue decreased 8% for the six months ended June 30, 2003, compared
to the same period in 2002. This decrease resulted from a decrease in the sales
of compressor units to third parties. In the period ended June 30, 2002, we had
unit sales of approximately $501,000 to third parties while in the same period
2003 we had no unit sales to third parties. At the same time our rental revenue
increased 5% and our parts sales increased 2%. Because our compressor units are
custom-built, fluctuations in revenue from outside sources are expected.
The gross margin percentage increased from 36% for the six months ended
June 30, 2002, to 41% for the same period in 2003. The cost of revenue is
comprised of expenses associated with the maintenance of the gas compressor
rental activity, service, parts and manufacturing expenses. This increase
resulted mainly from a change in the sales product mix.
Selling, general and administrative expense increased by 7% or $9,000
for the six months ended June 30, 2003, as compared to the same period in 2002.
This is mainly the result of an increase in selling expense.
Depreciation expense increased from $270,000 for the six
months ended June 30, 2002, to $319,000 for the same period ended June 30, 2003.
The increase is the result of equipment that was added to the rental fleet and
the replacement of several service vehicles.
There was a decrease in interest expense of 72% from $313,000 for the
six months ended June 30, 2002, to $89,000 for the six months ended June 30,
2003. This decrease resulted from a reduction of the debt owed to Dominion
Michigan. Part of the proceeds from our initial public offering was used to
reduce debt in the amount of $3,452,464 and our bank financed the remaining
balance of $3,500,000 at a more favorable interest rate.
Natural Gas Services Group
Selling, general and administrative expense increased 81% from $240,000
for the six months ended June 30, 2002, as compared to $434,000 for the same
period ended June 30, 2003. This was mainly the result of the added expense for
being a publicly held company such as legal fees, auditor fees, underwriters and
public relations fees.
Amortization and depreciation expense decreased 40% from $20,000 for
the six months ended June 30, 2002, to $12,000 for the same period ended June
30, 2003. This mainly resulted from vehicles that were moved to our subsidiary,
Great Lakes Compression.
Interest expense decreased 35% from $20,000 for the six months ended
June 30, 2002, to $13,000 for the same period ended June 30, 2003. This decrease
resulted from a reduction in the interest rate and from bank notes for vehicles
moved to our subsidiary.
23
Provision for income tax is accounted for on a consolidated basis.
Therefore, the tax for all companies is included in the provision for income tax
for Natural Gas Services Group Inc. Income tax expense increased $42,000 or 15%,
which is consistent with and pursuant to changes in state and federal tax
statutes and the increase in net taxable income.
Fiscal Year Ended December 31, 2002 Compared to Fiscal Year Ended December 31,
2001 (in thousands)
Great Lakes Natural Gas
Compression Services
Rotary Gas NGE Leasing (1) Group Total
----------- ----------- ----------- ----------- -----------
Twelve Months Ended December 31, 2002
Revenue $ 3,298 $ 2,319 $ 4,680 $ -- $ 10,297
Gross margin 1,329 1,669 1,727 -- 4,725
Selling, general and
administrative
expense 791 161 268 497 1,717
Depreciation 122 439 558 47 1,166
Interest expense 9 392 537 38 976
Other income 4 15 -- -- 19
Equity in earnings from joint
venture -- 485 -- -- 485
----------- ----------- ----------- ----------- -----------
Net income before income taxes $ 411 $ 1,177 $ 364 $ (582) $ 1,370
=========== =========== =========== =========== ===========
Twelve Months Ended December 31, 2001
Revenue $ 3,841 $ 1,519 $ 3,402 $ -- $ 8,762
Gross margin 1,231 1,076 1,513 -- 3,820
Selling, general and
administrative
expense 962 234 297 225 1,718
Depreciation 104 252 423 124 903
Interest expense 4 395 489 36 924
Other income 19 130 3 45 197
Equity in earnings from joint
venture -- 224 -- -- 224
----------- ----------- ----------- ----------- -----------
Net income before income taxes $ 180 $ 549 $ 307 $ (340) $ 696
=========== =========== =========== =========== ===========
- -----------------------------------------
(1) We purchased the compression related assets of Great Lakes from
Dominion Michigan on March 29, 2001. Therefore, the information for the
period ending March 31, 2001, is not included.
Rotary Gas Systems Operations
Revenue from outside sources decreased from $3,841,000 to $3,298,000,
or approximately 16%, for the twelve months ended December 31, 2001 compared to
the same period ended December 31, 2002. Because our products are custom-built,
fluctuations in revenue from outside sources are expected. Our main focus is to
build our rental fleet and associated lease revenue in NGE Leasing, which in the
long term is believed to be more profitable and have a more stable cash flow.
For the year ended December 31, 2002, approximately 76% of our plant output was
used to build gas compressors for NGE Leasing. We feel that our plant capacity
is achievable in the foreseeable future by adding personnel and using the Great
Lakes Compression facility if an overrun occurs.
24
Our gross margin percentage increased to 40% for the year ended
December 31, 2002, from 32% for the same period ended December 31, 2001. The
increase resulted mainly from a change in our product mix. Specifically, a
greater part of sales during the period ending December 31, 2002, included
flares, parts and rebuilds, which normally have a higher margin than gas
compressors and service. It is notable that the margin on our individual
compressors can vary because they are normally custom designed and manufactured.
Selling, general and administrative expense decreased from $962,000, to
$791,000 for the year ended December 31, 2002, as compared to the same period
ended December 31, 2001. This was mainly the result of the reduction of selling
expenses related to the discontinuance of our air compressor line. We
discontinued this air compressor line in the development stage in order to
concentrate on our main product, gas compression.
Depreciation expense increased to $122,000 for the year ended December
31, 2002, compared to $104,000 for the year ended December 31, 2001. This
increase was mainly due to the purchase of additional vehicles, shop and office
equipment.
There was a $5,000 increase in interest expense for the year ended
December 31, 2002 compared to the same period ended December 31, 2001. This
increase was mainly due to financing the purchase of additional vehicles.
NGE Leasing Operations
Revenue from rental of natural gas compressors increased 52% for the
year ended December 31, 2002, compared to the same period in 2001. This increase
is the result of the increase in our rental fleet of which 96 new compressors
were added during the year ended December 31, 2002, as compared to the addition
of 43 during the year ended December 31, 2001. Rotary Gas Systems manufactured
the compressors.
The gross margin percentage increased 1% from 70% for the year ended
December 31, 2001 to 71% for the same period in 2002. The cost of revenue is
comprised mainly of expenses associated with the maintenance of the gas
compressor rental activity.
Selling, general and administrative expense decreased from $234,000 in
the year December 31, 2001 to $161,000 for the year ended December 31, 2002.
This was mainly the result of a decrease in legal and insurance expense.
Depreciation expense increased 74% from $252,000 from the year ended
December to $439,000 for the year ended December 31, 2002. This increase was the
result of new gas compressor rental units being added to the rental fleet during
the period.
There was a decrease in interest expense of $3,000 for the year ended
December 31, 2002 as compared to the same period ended in 2001.
25
Equity in earnings from joint venture increased 116% from $224,000
during the year ended December 31, 2001 to $485,000 during the year ended
December 31, 2002. This joint venture, called Hy-Bon Rotary Compression, LLC,
served a mutual area of interest in which we contributed gas compressor units
for rental. The increase is due to net profits associated with the additional
units leased in 2002 as compared to 2001.
Great Lakes Compression
We acquired the compression-related assets of Great Lakes Compression
from Dominion Michigan as of March 29, 2001. Therefore, there is no historical
comparative data for the year ended December 31, 2001.
Natural Gas Services Group
Selling, general and administrative expense increased to $497,000 for
the year ended December 31, 2002 from $225,000 for the year ended December 31,
2001, an increase of 121%. This was mainly the result of an added expense for
warrants granted to certain officers and directors as consideration for their
guarantee of restructured corporate bank debt, an increase in accrual for
officer bonuses normally paid at year end, and additional cost incurred for our
public offering and for public relations expenses.
Amortization and depreciation expense decreased from $124,000 for the
year ended December 31, 2001 to $47,000 for the year ended December 31, 2002, a
decrease of 62%. This decrease was mainly the result of changes in the
accounting method for amortizing goodwill.
Interest expense increased to $38,000 from $36,000 for the year ended
December 31, 2002 compared to the same period ended December 31, 2001, a 6%
increase. This increase was the result of financing the purchase on three new
service vehicles.
26
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 historically have
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.
27
Service and maintenance revenue is recognized as service is provided or
over the term of the agreement, as applicable.
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 our accounts receivable are
concentrated in approximately three customers at December 31, 2002, 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 likely, 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
28
o significant negative industry or economic trends.
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 initial impairment review
of our goodwill in 2002 and an annual impairment review thereafter. Based upon
valuations we obtained in June 2003 and 2002 of our reporting units with
goodwill, we have not recorded an impairment charge.
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
In June 2001, the Financial Accounting Statement Board, or FASB,
approved for issuance Statement of Accounting Shareholders, or FAS 143, Asset
Retirement Obligations. FAS 143 establishes accounting requirements for
retirement obligations associated with tangible long-lived assets, including 1)
the timing of the liability recognition, 2) initial measurement of the
liability, 3) allocation of asset retirement cost to expense, 4) subsequent
measurement of the liability and 5) financial statement disclosures. FAS 143
requires that an asset retirement cost should be capitalized as part of the cost
of the related long-lived asset and subsequently allocated to expense using a
systematic and rational method. We adopted the statement on January 1, 2003, as
required. The adoption of this statement did not have a material effect on our
financial position, results of operations, or cash flows.
In October 2001, the FASB approved FAS 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. FAS 144 replaces FAS 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of. The new accounting model for long-lived assets to be disposed of
by sale applies to all long-lived assets, including discontinued operations, and
replaces the provisions of Accounting Principles Board Opinion No. 30, Reporting
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, for the disposal of segments of a business. FAS requires that those
long-lived assets be measured at the lower of carrying amount or fair value less
cost to sell, whether reported in continuing operations or in discontinued
operations. Therefore, discontinued operations will no longer be measured at net
29
realizable value or include amounts for operating losses that have not yet
occurred. FAS 144 also broadens the reporting of discontinued operations to
include all components of an entity with operations that can be distinguished
from the rest of the entity and that will be eliminated from the ongoing
operations of the entity in a disposal transaction. The provisions of FAS 144
apply to us effective January 1, 2003. The adoption of this statement did not
have a material effect on our financial position, results of operations, or cash
flows.
In July 2002, the FASB issued Statement of Financial Accounting
Standards No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, or FAS 146. FAS 146 requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than at the date
of a commitment to an exit or disposal plan. Examples of costs covered by FAS
146 include lease termination costs and certain employee severance costs that
are associated with a restructuring, discontinued operation, plant closing, or
other exit or disposal activity. FAS 146 is to be applied prospectively to exit
or disposal activities initiated after December 31, 2002. The adoption of FAS
146 did not have a material effect on our financial position or results of its
operations.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No.148, Accounting for Stock-Based Compensation - Transition and
Disclosure - an Amendment of FASB Statement 123, or FAS 123. For entities that
change their accounting for stock-based compensation from the intrinsic method
to the fair value method under FAS 123, the fair value method is to be applied
prospectively to those awards granted after the beginning of the period of
adoption, the prospective method. The amendment permits two additional
transition methods for adoption of the fair value method. In addition to the
prospective method, the entity can choose to either (i) restate all periods
presented, retroactive restatement method, or (ii) recognize compensation cost
from the beginning of the fiscal year of adoption as if the fair value method
had been used to account for awards, modified prospective method. For fiscal
years beginning December 15, 2003, the prospective method will no longer be
allowed. We currently account for stock-based compensation using the intrinsic
value method as proscribed by Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and plan on continuing using this
method to account for stock options; therefore, we do not intend to adopt the
transition requirements as specified in FAS 148. We adopted the disclosure
requirements as of December 31, 2002.
In May 2003, the FASB issued Statement of Financial Accounting
Standards No 150, Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity, which is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. Statement of Financial Accounting Standards No. 150, establishes standards
of how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. The adoption of this standard is
not expected to have a material effect on our consolidated financial statements.
30
Seasonality and Economic Conditions
Our sales are affected by the timing of planned development and
construction projects by energy industry customers.
We do not believe that inflation had a material impact upon our results
of operations during the six months ended June 30, 2003, or during the years
ended December 31, 2002 and 2001.
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. Proceeds were
primarily used to pay debt and to fund the manufacture and fabrication of
additional units for our rental fleet of gas compressors.
At June 30, 2003, we had cash and cash equivalents of $976,004, working
capital of $992,135 and non-subordinated debt of $8,987,898, of which $2,278,951
was classified as current. We had net cash flow from operating activities of
$536,246 during the first six months of 2003. This was primarily from net income
of $433,035 plus depreciation and amortization of $779,555, an increase in
accounts payable and accrued liabilities of $270,867, an increase in deferred
taxes of $321,573 and an increase in deferred income of $270,446, offset by an
increase in inventory of $746,248 and accounts receivable of $836,812.
On October 24, 2002, we paid off the note of $6,952,464 payable to
Dominion Michigan, used for the acquisition of the compression related assets of
Great Lakes Compression. $3,452,464 of the funds to pay the note came from the
proceeds of our initial public offering, and $3,500,000 came from additional
bank financing to be amortized over 60 months at prime plus 1%.
We entered into a new loan agreement with our bank, dated as of March
26, 2003. This included new borrowing of $2,150,000 in the form of a term loan
with monthly principal payments of $35,833 with interest at 1% over prime but
not less than 5.25% for 60 months. The proceeds from this new borrowing were
used to purchase the 28 gas compressors from Hy-Bon. The new loan agreement also
included the renewal of our line of credit for $750,000 with interest at 1% over
prime for one year. We have not drawn from the line of credit as of June 30,
2003.
Funds from the initial public offering, which closed on October 24,
2002, will permit us to actively pursue adding gas compressors to our rental
fleet. We expect to fund additional rental units through the use of the offering
proceeds, additional bank debt and cash flow from operations.
31
A summary of the use of proceeds from our initial public offering as of
June 30, 2003, is as follows:
o $3,458,464 to reduce indebtedness;
o $2,577,870 for the manufacture of gas compressors placed in
our rental fleet; and
o $492,836 in temporary investments consisting of a bank money
market account.
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.
BUSINESS
History and Organization
We were incorporated 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 now operate as Rotary Gas Systems, Inc. Effective March 31, 2000, we
sold CNG.
On March 29, 2001, we acquired, through our 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 pursuant to
a registration statement 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 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.
32
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
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 June 30, 2003, we had
354 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 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.
33
We maintain our principal office at 2911 South County Road 1260,
Midland, Texas 79706 and our telephone number is (915) 563-3974.
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 is 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 the
production of a well 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, 2001, the Energy Information Administration reported that there were
approximately 367,000 producing gas and gas condensate wells in the United
States. The states where we currently operate accounts for approximately 194,000
of these wells.
34
The Leasing Business
We primarily lease natural gas compressors. As of June 30, 2003, we had
312 natural gas compressors totaling approximately 38,000 horsepower leased to
29 third parties, compared to 240 natural gas compressors totaling approximately
32,000 horsepower leased to 24 third parties at June 30, 2002. Of the 312
natural gas compressors, 46 were leased to Dominion Michigan and its affiliates.
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 appointed a majority of the
persons who serve as managers of HBRC.
On March 27, 2003, to be effective January 1, 2003, we purchased and
Hy-Bon sold to us 28 of Hy-Bon's compressor packages. In consideration therefor,
we paid Hy-Bon $2,150,000.00. The $2,150,000.00 was borrowed by us from our
current lender.
Hy-Bon withdrew as a member of HBRC effective as of January 1, 2003.
We, as the other member of HBRC, will retain all assets of HBRC which as of
December 31, 2002, had an unaudited aggregate value of $346,511. We plan to
dissolve HBRC and we have agreed not to operate using the name Hy-Bon.
In addition to 81 separate written maintenance agreements covering
non-owned compressor units that we had entered into at June 30, 2003, 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. 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
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, and intend to expand our fleet by spending
approximately $5,700,000 on natural gas compressors over the next 12 months.
35
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 June 30, 2003, we had written maintenance agreements with third
parties relating to 81 compressors. Each written maintenance agreement expires
on December 31, 2005. During our six months ended June 30, 2003, and the years
ended December 31, 2002 and 2001, we received revenue of approximately $534,000,
$1,058,000 and $704,000 (approximately 11%, 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.
36
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 core
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 six months ended June 30, 2003, and years ended December 31,
2002 and 2001, we received revenue of approximately $292,000, $630,000 and
$402,000 (approximately 6%, 6% and 5% 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
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.
37
During the six months ended June 30, 2003, and during the years ended
December 31, 2002 and 2001, we sold 30, 39 and 54 flare systems, respectively,
to our customers generating approximately $309,000, $759,000 and $703,000
(approximately 6%, 7 % and 8% of our total consolidated revenue) in revenue,
respectively.
Major Customers
During the six months ended June 30, 2003, sales to one customer,
Dominion Michigan, amounted to approximately 31%; during our year ended December
31, 2002, sales to one customer, Dominion Michigan, amounted to approximately
30% and during our year ended December 31, 2001, sales to one customer, Dominion
Michigan, amounted to approximately 26% of our consolidated revenue. No other
single customer accounted for more than 10% of our revenue in any of those
periods.
Backlog
We had a backlog of approximately $383,000 as of June 30, 2003, as
compared to approximately $692,000 as of the same date in 2002. The reduced
backlog at June 30, 2003 results from us having more compressors being built for
leasing rather than for sale. Backlog consists of firm customer orders for which
a purchase order has been received, satisfactory credit or a financing
arrangement exists, and delivery is scheduled. Our backlog at June 30, 2003
includes only sales to outside third parties and does not include the backlog
that we may receive from the lease or sale of compressors over the next three
years to Dominion Exploration.
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 the six months ended June 30, 2003, and during our years ended
December 31, 2002 and December 31, 2001, 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.
38
Sales and Marketing
General. We conduct our operations from three locations. These
locations, with 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 seven 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
respond promptly 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 six months ended June 30, 2003, and during the years ended
December 31, 2002 and 2001, we spent approximately $33,000, $49,000 and $56,000,
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.
39
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 June 30, 2003, we had 72 full time employees and 1 part-time
employee. No employees are represented by labor unions and we believe that our
relations with our employees are satisfactory.
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,
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 to 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 effect 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.
40
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.
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 of our components of our compressors are obtained primarily
from four suppliers. If 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.
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 future
acquisitions.
We also own facilities in Lewiston, Michigan that 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.
41
We also own an approximate 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.
42
LEGAL PROCEEDINGS
There are no pending or, to our knowledge, threatened claims against
us. However, from time to time, we expect to be subject to various legal
proceedings, all of which are of an ordinary or routine nature and incidental to
our operations. Such proceedings have not in the past, and we do not expect they
will in the future have, a material impact on our results of operations or
financial condition.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission a
registration statement on Form SB-2 under the Securities Act for the common
stock sold in this offering. This prospectus does not contain all of the
information set forth in the registration statement and the accompanying
exhibits and schedules. For further information about us and our common stock,
we refer you to the registration statement and the accompanying exhibits and
schedules. Statements contained in this prospectus regarding the contents of any
contract or any other document to which we refer are not necessarily complete.
In each instance, reference is made to the copy of the contract or document
filed as an exhibit to the registration statement, and each statement is
qualified in all respects by that reference. Copies of the registration
statement and the accompanying exhibits and schedules may be inspected without
charge at the public reference facilities maintained by the Securities and
Exchange Commission at room 1024, 450 Fifth Street, N.W., Washington, D.C.
20549, and at the regional offices of the Securities and Exchange Commission
located at 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies
of these materials may be obtained at prescribed rates from the public reference
room of the Securities and Exchange Commission at room 1024, 450 Fifth Street,
N.W., Washington, D.C. 20549. You may obtain information on the operation of the
public reference room by calling the Securities and Exchange Commission at
1-800-SEC-0330. The Securities and Exchange Commission maintains a web site that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Securities and Exchange
Commission. The address of the site is http://www.sec.gov.
We are subject to the reporting requirements of the Securities Exchange
Act of 1934, and we file annual, quarterly and special reports, proxy statements
and other information with the Securities and Exchange Commission. You may read
and copy any document that we file at the Securities and Exchange Commission's
public reference rooms in Washington, D.C., New York, New York, and Chicago,
Illinois. Please call the Securities Exchange Commission at 1-800-SEC-0330 for
further information on the public reference rooms. Our SEC filings are also
available to you free of charge at the Securities Exchange Commission's web site
at http://www.sec.gov.
43
MARKET FOR OUR SECURITIES AND
RELATED STOCKHOLDER MATTERS
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
from October 21, 2002, (the first day of trading) through December 31, 2002, and
for the first and second quarters of 2003, the high and low sales prices for our
common stock and warrants as reported by the American Stock Exchange.
Common Stock Warrants
------------------- -------------------
High Low High Low
-------- -------- -------- --------
Fourth Quarter 2002 (from October 21) $ 4.25 $ 3.35 $ 0.90 $ 0.25
First Quarter 2003 4.28 3.75 0.80 0.27
Second Quarter 2003 7.25 3.65 1.55 0.22
As of June 30, 2003, there were approximately 22 holders of record of
our common stock and 2 holders of record of our warrants. The number of holders
of record does not include holders whose securities are held in street name.
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.
We have 343,654 shares of our 10% Convertible Series A Preferred Stock
outstanding. Holders of that stock are entitled to cash dividends paid quarterly
at a rate equal to 10% per annum or $0.325 per share annually. The 10%
Convertible Series A Preferred Stock will automatically convert into our common
stock if our common stock trades for 20 consecutive trading days at a price of
$6.50 or more per share. As of June 30, 2003, we have issued 38,000 shares of
common stock as a result of the conversion of 38,000 shares of our 10%
Convertible Series A Preferred Stock.
44
MANAGEMENT
Executive Officers and Directors
The table below contains information about our executive officers and
directors:
Name Age Position
Wallace O. Sellers(1)(2) 73 Director, Chairman
Wayne L. Vinson 44 Director, President and Chief
Executive Officer
Charles G. Curtis(1)(2) 70 Director
James T. Grigsby(1)(2) 55 Director
Wallace C. Sparkman 73 Director
Gene A. Strasheim(1)(2) 62 Director
Richard L. Yadon(1)(2) 45 Director
S. Craig Rogers 41 Vice President
Earl R. Wait 59 Chief Financial Officer and
Treasurer
Scott W. Sparkman 41 Secretary
---------------------
(1) Member of our audit committee
(2) Member of our compensation committee
The Board of Directors has been divided into three classes with
directors serving staggered three-year terms. With respect to the existing Board
of Directors, the terms of Messrs. Sparkman, Vinson and Yadon will expire in
2004, the terms of Messrs. Curtis, Sellers and Strasheim will expire in 2005,
and the term of Mr. Grigsby will expire in 2006. All officers serve at the
discretion of the Board of Directors.
The following sets forth biographical information for at least the past
five years for our directors and executive officers.
Wallace O. Sellers is one of our founders and has served as a director
and the Chairman of our Board of Directors since December 17, 1998, and as the
Chairman of the Board of Directors of Great Lakes Compression since February
2001. 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. Mr. Sellers serves as a director of Danielson Holding Corp., an
insurance holding company which is a reporting company under the Securities
Exchange Act of 1934. 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.
45
Wayne L. Vinson has served as one of our directors since April 2000, as
our President and Chief Executive Officer since July 2001, as our Executive Vice
President from October 31, 2000 to July 2001, as the President of Rotary (and
its predecessor, Hi-Tech) since February 1994, as a director of NGE between 1996
and 1998 and as Executive Vice President of Great Lakes Compression since
February 2001. He also served as our Vice President from April 2000 to October
2000. From January 1990 to June 1995, Mr. Vinson served as Vice President and
since June 1995 he has served as President of Vinson Operating Company, an oil
and gas well operator. Mr. Vinson has more than 22 years of experience in the
energy services industry.
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.
James T. Grigsby has served as one of our directors since 1999 and as
one of the directors of Great Lakes Compression since February 2001. Since 1996,
Mr. Grigsby has been a director of and a consultant to Blue River Paint Co., a
development stage environmental friendly coatings technology company. From 1996
to 1997, Mr. Grigsby was a consultant to Outlook Window Partnership, a regional
wood window manufacturer. From 1989 to 1996, Mr. Grigsby was President and Chief
Executive Officer of Seal Right Windows, Inc. and Chief Executive Officer of
Oldach Window Corp., manufacturers of wood, wood-clad and vinyl windows and
doors. Mr. Grigsby received a BS degree from the University of Michigan and an
MBA degree from Stanford University.
Wallace C. Sparkman is one of our founders, has served as one of our
directors since 2003, has been the President of NGE since July 2001, a director
of NGE since February 1996, and the President of Rotary (and its predecessor,
Flare King) from April 1993 to April 1997. Mr. Sparkman served as our President
from May 2000 to July 2001 and as the President of Great Lakes Compression from
February 2001 to July 2001. Mr. Sparkman was Vice President of NGE from February
1996 to November 1999. Since December 1998, Mr. Sparkman has acted as a
consultant to our Board of Directors. From 1985 to 1998, 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 34 years of experience in the
energy service industry.
46
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 and since December 1994, 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.
S. Craig Rogers age 41, has been our Vice President since June 2003. He
has served as Operations Mangers for Rotary since 1995 and Vice President of
Rotary from April 2002. From March 1987 to January 1995, Mr. Rogers was the Shop
Manager for CSI, a major manufacture of natural gas compressors.
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 has been the Chief Financial Officer and
Secretary/Treasurer of Flare King and then Rotary since April 1993, the
Assistant Secretary/Treasurer for Hi-Tech since June 1996, the Controller and
Assistant Secretary/Treasurer for Hi-Tech from 1994 to 1999, a director of NGE
since July 1999 and the Chief Accounting Officer and Treasurer of Great Lakes
Compression since February 2001. Mr. Wait is a certified public accountant with
an MBA in management and has more than 25 years of experience in the energy
industry.
Scott W. Sparkman has served as Executive Vice-President of NGE since
July 2001, has served as a director since December 1998 and as Secretary and
Treasurer of NGE since March 1999 and has served as the Secretary of Great Lakes
Compression since February 2001. 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 pursued personal business interests from May 1996 to May
1997. From February 1991 to May 1996, Mr. Sparkman served as Vice President and
Director, later as President and Director, of Diamond S Safety Services, Inc., a
seller and servicer of hydrogen sulfide monitoring equipment. Mr. Sparkman filed
47
for personal bankruptcy in 1998 as a result of personal debt created when there
was a decline in the need for the oilfield services that were provided by a
company that was owned by Mr. Sparkman. He received a BBA degree from Texas A&M
University.
The following sets forth biographical information for at least the past
five years for one of our employees whom we consider to be a key employee.
Ronald D. Bingham, age 58, has served as the President of Great Lakes
Compression since 2001. 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.
All of the officers and key employees devote substantially all of their
working time to our business.
48
Executive Compensation
The following table sets forth information regarding the compensation
paid during the years ended December 31, 2002, 2001 and 2000 by us to Wayne L.
Vinson and Earl R. Wait, our only executive officers during those years whose
combined salary and bonuses exceeded $100,000 during the year ended December 31,
2002.
Long Term
Annual Compensation Compensation Awards
------------------- -------------------
Name and Securities Underlying
Principal Position Year Salary Bonus Options
- ------------------ ---- ------ ----- -------
Wayne L. Vinson 2002 $ 120,000(1) $ 39,452 -0- (2)
President and Chief
Executive Officer 2001 $ 102,692(1) $ 25,583 -0-
2000 74,423(1) 25,604 -0-
Earl R. Wait 2002 $ 90,000 $ 29,589 15,000
Chief Financial Officer 2001 85,385 23,164 -0-
2000 80,088 7,416 -0-
- --------------------------
(1) Does not include any compensation paid to the wife of Wayne L. Vinson
for her services as our accounts payable and payroll clerk for 2002,
2001 and 2000, respectively.
(2) CAV-RDV, Ltd., a Texas limited partnership for the benefit of the
children of Wayne L. Vinson, was issued a five year warrant to purchase
15,756 shares of our common stock at $2.50 per share in consideration
for CAV-RDV, Ltd. guaranteeing a portion of our debt. The children are
eighteen years old or older and Mr. Vinson is not a partner in CAV-RDV,
Ltd. and disclaims beneficial ownership of the warrants.
We have established a bonus program for our officers. At the end of
each of our fiscal years, our Board of Directors 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 allocated. The Board of
Directors may discontinue the bonus program at any time.
49
Option Grants in Last Fiscal Year
The following table sets forth information pertaining to option grants
to Wayne L. Vinson and Earl R. Wait, our only executive officers during the year
ended December 31, 2002, whose combined salary and bonuses exceeded $100,000
during that year:
% of Total
Number of Options
Securities Granted to
Underlying Employees in
Name Options Fiscal Year Exercise Price Expiration Date
- ---- ------- ----------- -------------- ---------------
Wayne L. Vinson 0 0% N/A N/A
Earl R. Wait 15,000 35% $3.25 4/23/2012
Aggregate Option Exercises in Last Fiscal Year and Fiscal Year End Option Values
The following table sets forth information pertaining to option
exercises to Wayne L. Vinson and Earl R. Wait, our only executive officers
during the year ended December 31, 2002, whose combined salary and bonuses
exceeded $100,000 during that year:
50
Fiscal Year End Option Values
-----------------------------
Number of Securities Value of Unexercised
Shares Underlying Unexercised In-the-Money Options
Acquired Value Options at Fiscal Year End at Fiscal Year End
Name on Exercise Realized Exercisable/Unexercisable Exercisable/Unexercisable
- ---- ----------- -------- ------------------------- -------------------------
Wayne L. Vinson 0 0 0/0 0/0
Earl R. Wait 0 0 0/15,000 0/$9,750
Compensation of Directors
Our directors who are not employees are paid $1,000 per quarter and at
December 31 of each year will be issued a five year option to purchase 2,500
shares of our common stock at the then market value. We also reimburse our
directors for accountable expenses incurred on our behalf.
1998 Stock Option Plan
We have adopted the 1998 Stock Option Plan which 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 or 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. Options to purchase 12,000
shares of our common stock at an exercise price of $2.00 per share, options to
purchase 33,000 shares of our common stock at an exercise price of $3.25 per
share, and options to purchase 7,500 shares of our common stock at an exercise
price of $3.88 per share have been granted under the plan and are outstanding.
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 us and our shareholders.
51
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.
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 from October 21, 2002, until December 31, 2002, 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 except that Charles G.
Curtis filed an amendment to his Form 3 to add 10% Convertible Series A
Preferred Stock he owned, filed an amendment to a Form 4 to include common stock
and warrants that were not previously reported and was late in filing a Form 4
to report the granting of an option to him; Diamond S DGT Trust was late in
filing its Form 3; James T. Grigsby filed an amendment to his Form 4 to report
warrants that were previously not included on his Form 4 and was late in filing
a Form 4 to report the granting of an option to him; Alan P. Kurus filed
amendments to his Form 3 to change the nature of his ownership of common stock
and to report a stock option that he owned; Sharon Renee Pipes was late in
filing her Form 3; Wallace O. Sellers was late in filing a Form 4 to report the
granting of an option to him; and Earl R. Wait filed an amendment to his Form 3
to report a stock option that he owned.
52
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of September 22, 2003, 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.
Percent
Shares of Common Stock Beneficially
Name and Address Beneficially Owned Owned
- ---------------- ------------------ ------------
Wallace O. and Naudain Sellers 698,159(1) 13.8%
P.O. Box 106, 6539 Upper York Road
Solebury, PA 18963-0106
Wayne L. Vinson 0(2) 0.0%
4404 Lennox Drive
Midland, TX 79707
Charles G. Curtis 65,500(3) 1.3%
1 Penrose Lane
Colorado Springs, CO 80906
James T. Grigsby 81,700(4) 1.6%
3345 Grimsby Lane
Lincoln, NE 68502
Wallace C. Sparkman 167,691(5) 3.3%
4906 Oakwood Court
Midland, TX 79707
53
Gene A. Strasheim 0 0.0%
165 Huntington Place
Colorado Springs, CO 80906
Richard L. Yadon 294,183(6) 5.8%
P.O. Box 8715
Midland, TX 79708-8715
S. Craig Rogers 14,250(7) .3%
14732 Bluestem Ave
Gardendale, TX 79758
Earl R. Wait 75,000(8) 1.5%
109 Seco
Portland, TX 78374
Scott W. Sparkman 516,467(9) 10.2%
1604 Ventura Avenue
Midland, TX 79705
All directors and executive
officers as a group 1,912,950(10) 36.8%
(nine persons)
CAV-RDV, Ltd. 488,128(2) 9.7%
1541 Shannon Drive
Lewisville, TX 75077
RWG Investments LLC 424,000(11) 8.2%
5980 Wildwood Drive
Rapid City, SD 57902
- -----------------------------------
(1) Includes 238,720 shares of common stock owned by the Wallace Sellers,
July 11, 2002 GRAT, warrants to purchase 21,936 shares of common stock,
9,032 shares of common stock and 5,000 shares of common stock at $ 2.50
per share, at $3.25 per share and at $6.25 per share, respectively,
owned by Wallace Sellers, an option to purchase 2,500 shares of common
stock at $3.88 per share owned by Wallace Sellers, 95,971 shares of
common stock owned by Naudain Sellers, and 238,720 shares of common
stock owned by the Naudain Sellers, July 11, 2002 GRAT. Wallace and
Naudain Sellers are husband and wife. Wallace Sellers is the trustee of
his wife's trust and his wife is the trustee of his trust. The
beneficiaries of the trusts are two trusts. The beneficiaries of one
trust are Naudain Sellers and their three children and the
beneficiaries of the other trust are their three children.
(2) CAV-RDV, Ltd., a Texas limited partnership for the benefit of the
children of Wayne L. Vinson, owns 470,250 shares of common stock and
warrants to purchase 15,756 shares of common stock at $2.50 per share
and 2,122 shares of common stock at $3.25 per share, respectively. Both
children are 18 years old or older and Mr. Vinson is not a partner in
CAV-RDV, Ltd. Mr. Vinson disclaims beneficial ownership of any of the
shares of common stock.
(3) Represents warrants to purchase 40,000 shares of common stock at $3.25
per share, an option to purchase 2,500 shares of common stock at $3.88
per share and 18,000 shares of common stock which may be obtained upon
conversion of shares of our 10% Convertible Series A Preferred Stock.
(4) Includes warrants to purchase 9,600 shares at $6.25 per share and an
option to purchase 2,500 shares at $3.88 per share.
(5) Includes 105,691 shares owned by Diamente Investments, LLP, a Texas
limited partnership of which Mr. Sparkman is a general and limited
partner.
(6) Includes warrants to purchase 14,683 shares of common stock at $2.50
per share.
(7) 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.
(8) Includes an option to purchase 15,000 shares of common stock at $3.25
per share that began to vest in April 2003.
54
(9) Includes 20,000 shares of common stock owned by Scott W. Sparkman 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 for
which Mr. Sparkman is a co-trustee and co-beneficiary with his sister.
(10) Includes the shares of common stock set forth in (1) through (9) above
issuable upon the exercise of options and warrants and the conversion
of shares of our 10% Convertible Series A Preferred Stock.
(11) Includes warrants to purchase 32,000 shares of common stock at $3.25
per share, warrants to purchase 15,000 shares of common stock at $6.25
per share and 12,000 shares of common stock which may be obtained upon
conversion of shares of our 10% Convertible Series A Preferred Stock.
RWG Investments LLC is a limited liability company the beneficial owner
of which is Roland W. Gentner, 5980 Wildwood Drive, Rapid City, South
Dakota 57902.
55
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In March 2001, we issued warrants that will expire on December 31,
2006, to purchase shares of our common stock at $2.50 per share to the following
persons for guaranteeing the amount of our debt indicated:
Number of Shares Amount of
Name Underlying Warrants Debt Guaranteed
---- ------------------- ---------------
Wallace O. Sellers 21,936 $ 548,399
Wallace C. Sparkman(1) 21,467 536,671
CAV-RDV, Ltd.(2) 15,756 393,902
Richard L. Yadon 9,365 234,121
- ---------------------------
(1) Wallace C. Sparkman subsequently transferred his warrants for 21,467
shares to Diamond S DGT, a trust of which Scott W. Sparkman is the
trustee and a beneficiary. Wallace C. Sparkman has represented to us
that he has no beneficial interest in Diamond S DGT.
(2) CAV-RDV, Ltd., is a Texas limited partnership for the benefit of the
children of Wayne L. Vinson. Both children are eighteen years old or
older and Mr. Vinson is not a partner in CAV-RDV, Ltd. Mr. Vinson
disclaims beneficial ownership of the warrants.
None of the guaranties is still in effect.
In April 2002, we issued five year warrants to purchase shares of our
common stock at $3.25 per share to the following persons for guaranteeing our
restructured bank debt indicated:
Number of Shares Amount of Additional
Name Underlying Warrants Debt Guaranteed
---- ------------------- ---------------
Wallace O. Sellers 9,032 $ 451,601
CAV-RDV, Ltd.(1) 2,122 106,098
Richard L. Yadon 5,318 265,879
- ---------------------------
(1) CAV-RDV, Ltd., is a Texas limited partnership for the benefit of the
children of Wayne L. Vinson. Both children are eighteen years old or
older and Mr. Vinson is not a partner in CAV-RDV, Ltd. Mr. Vinson
disclaims beneficial ownership of the warrants.
None of the guaranties is still in effect.
Wayne L. Vinson, Earl R. Wait and Wallace C. Sparkman have also
guaranteed approximately $197,000, $84,000 and $92,000, respectively, of
additional 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 June 30, 2003:
56
Balance at Interest Maturity
Guarantor June 30, 2003 Rate Date
--------- ------------- --------- -----------
Earl Wait $10,000 1.90% 3/26/2004
Earl Wait 35,525 10.50% 10/10/2005
Wallace Sparkman 76,492 10% 10/15/2010
Wayne Vinson 443 Prime + 1.0% 7/15/2003
Wayne Vinson 8,928 1.90% 4/22/2004
Wayne Vinson 6,436 7.50% 6/21/2004
None of the guarantees is still in effect.
In October, 1999, RWG Investments, LLC was granted a five year option
to purchase 100,000 shares of our common stock at $2.00 per share in
consideration of one of its members serving as an advisor to us. In June 2003,
RWG Investments LLC exercised the option.
Hunter Wise Financial Group LLC served as our investment banker and
advisor in connection with our acquisition of the compression related assets of
Dominion Michigan for which we paid Hunter Wise a total fee of $440,000. James
T. Grigsby, one of our directors, has a 1% interest in Hunter Wise.
Charles G. Curtis, one of our directors, Alan P. Kurus, one of our
former officers, and RWG Investments, LLC, a beneficial owner of more than 5% of
our outstanding stock, purchased our notes and five year warrants to purchase
common stock in a private offering that commenced in October 2000 and concluded
in May 2001. Mr. Curtis purchased $100,000 of the notes and warrants, Mr. Kurus
purchased approximately $79,000 of the notes and warrants and RWG Investments,
LLC purchased $80,000 of the notes and warrants. The notes and warrants
purchased by Mr. Curtis, Mr. Kurus and RWG Investments, LLC were on the same
terms and conditions as sales to non-affiliated purchasers in the private
offering.
Charles G. Curtis, one of our directors, and RWG Investments, LLC, a
beneficial owner of more than 5% of our outstanding stock, purchased 18,000
shares and 12,000 shares, respectively, or $58,500 and $39,000, respectively, of
our 10% Convertible Series A Preferred Stock in a private offering that
commenced in July 2001. The shares purchased by Mr. Curtis and RWG Investments,
LLC were on the same terms and conditions as sales to non-affiliated purchasers
in the private offering.
Wallace O. Sellers, Charles G. Curtis and James T. Grigsby, three of
our independent directors, were each paid $1,000 and were each issued an option
to purchase 2,500 shares of our common stock at $3.88 per share for serving as
our directors during the year ended December 31, 2002.
57
SELLING SECURITYHOLDERS
The following table sets forth information regarding the beneficial
ownership of our securities by the selling securityholders. All information
contained in the table below is based upon beneficial ownership as of June 30,
2003.
The selling securityholders received their securities from the
underwriter of our initial public offering completed in October 2002. As part of
its compensation in the offering, the underwriter received an option to
purchase:
o 150,000 shares of our common stock at $6.25 per share; and
o warrants to purchase 150,000 shares of our common stock at
$7.8125 per share.
We agreed to register the shares of common stock in order to permit the
selling securityholders to sell these shares from time to time in the public
market or in privately-negotiated transactions. We have also agreed to pay for
all expenses of this offering other than underwriting discounts and commissions
and brokerage commissions and fees.
This table assumes that all shares owned by the selling securityholders
as being sold. The selling securityholders may offer and sell less than the
number of shares indicated. The selling securityholders are not making any
representation that any shares will or will not be offered for sale.
Shares Shares
Name and Address Beneficially Owned Shares Offered Beneficially Owned
of Selling Securityholder Prior to the Offering Hereby After the Offering
- ------------------------- -------------------------------------------- -------------- ------------------
Underlying Options Underlying Warrants
------------------ -------------------
Number Percent Number Percent
------ ------- ------ -------
Charles C. Bruner 30,000 20% 30,000 20% all -0-
1675 Larimer Street, Suite 300
Denver, Colorado 80203
Zenas N. Gurley 15,000 10% 15,000 10% all -0-
102 South Tejon Street, Suite 1100
Colorado Springs, Colorado 80903
Eugene Neidiger 30,000 20% 30,000 20% all -0-
1675 Larimer Street, Suite 300
Denver, Colorado 80203
Robert L. Parish 11,000 7.3% 11,000 7.3% all -0-
1675 Larimer Street, Suite 300
Denver, Colorado 80203
58
Anthony B. Petrelli 40,000 26.7% 40,000 26.7% all -0-
1675 Larimer Street, Suite 300
Denver, Colorado 80203
Regina L. Roesner 15,000 10% 15,000 10% all -0-
1675 Larimer Street, Suite 300
Denver, Colorado 80203
John R. Turk 9,000 6% 9,000 6% all -0-
1675 Larimer Street, Suite 300
Denver, Colorado 80203
PLAN OF DISTRIBUTION
This offering is self-underwritten; we have not employed an underwriter
for the issuance of common stock upon the exercise of the warrants and we will
bear all expenses of the offering.
The warrants may be exercised by the delivery to Computershare Investor
Services, Inc., 350 Indiana Street, Suite 800, Golden, Colorado 80401 of your
warrant certificate accompanied by an election of exercise and payment of the
warrant exercise price for each share of your common stock purchased in
accordance with the terms of the warrant. Payment must be made in the form of
cash or a cashier's or certified check payable to the order of Natural Gas
Services Group, Inc. Delivery of the certificates representing the common stock
will be made upon receipt of the warrant certificate duly executed for transfer
together with payment for the exercise price and our acceptance of your tender
for exercise. If you exercise fewer than all of your warrants, a new warrant
certificate evidencing warrants remaining unexercised will be issued to you.
DESCRIPTION OF SECURITIES
The following describes the attributes of our authorized and our
outstanding securities.
Common Stock
We are authorized to issue up to 30,000,000 shares of our common stock,
$.01 par value. There are 5,022,181 shares of our common stock issued and
outstanding as of the date of this prospectus. All shares of our common stock
have equal voting rights and, when validly issued and outstanding, have one vote
per share in all matters to be voted upon by shareholders. The shares of common
stock have no preemptive, subscription, conversion or redemption rights and may
be issued only as fully paid and non-assessable shares. Cumulative voting in the
election of directors is not allowed, which means that the holders of a majority
of the outstanding shares represented at any meeting at which a quorum is
present will be able to elect all of the directors if they choose to do so and,
in such event, the holders of the remaining shares will not be able to elect any
directors. On liquidation, each common shareholder is entitled to receive a pro
rata share of the assets available for distribution to holders of common stock.
We have no stock option plan or similar plan which may result in the
issuance of stock options, stock purchase warrants, or stock bonuses other than
our 1998 Stock Option Plan pursuant to which an aggregate of 150,000 shares of
59
common stock have been reserved for issuance. Options to purchase 12,000 shares
of common stock with an average exercise price of $2.00 per share, and options
to purchase 33,000 shares of our common stock at an exercise price of $3.25 per
share and options to purchase 7,500 shares of common stock at an exercise price
of $3.88 per share have been granted and are outstanding under the plan.
Preferred Stock
We are authorized to issue up to a total of 5,000,000 shares of
preferred stock, $.01 par value. The shares of preferred stock may be issued in
one or more series from time to time with such designations, rights, preferences
and limitations as our Board of Directors may determine without the approval of
our shareholders. The rights, preferences and limitations of separate series of
preferred stock may differ with respect to such matters as may be determined by
our Board of Directors, including without limitation, the rate of dividends,
method or nature or prepayment of dividends, terms of redemption, amounts
payable on liquidation, sinking fund provisions, conversion rights and voting
rights. The ability of our Board of Directors to issue preferred stock could
also be used by it as a means for resisting a change in our control and can
therefore be considered an "anti-takeover" device. We currently have no plans to
issue any additional shares of preferred stock.
We designated 1,177,000, shares of our preferred stock as 10%
Convertible Series A Preferred Stock. In 2001 and 2002, 381,654 of these shares
were sold in a private offering. 38,000 of these shares have been converted into
38,000 shares of common stock. At our 2003 Annual Meeting of Shareholders, we
reduced the number of designated shares of Preferred Stock to 381,654 shares of
Preferred Stock actually sold. The Preferred Stock has a cumulative annual
dividend rate of 10% in cash. The annual dividend rate is payable 30 days after
the end of each quarter beginning with the quarter ended September 30, 2001,
when and if declared by our Board of Directors. Each share of Preferred Stock
will be entitled to one vote per share with the holders of our outstanding
common stock on any matter voted on at a meeting of our shareholders and to vote
as a class on any matter required to be voted on by classes under Colorado law.
The Preferred Stock initially is convertible into common stock on a one for one
basis. The Conversion Price will be adjusted if at any time we complete an
offering of our common stock at a price equivalent to less than 150% of the then
Conversion Price of the Preferred Stock. The Conversion Price will also be
adjusted if any investment is made in us at a price equivalent to less than the
then Conversion Price of the Preferred Stock. The Conversion Price may also be
adjusted for stock splits, stock dividends, certain reorganizations and certain
reclassifications. The Preferred Stock will automatically convert into our
common stock at any time if our common stock trades for 20 consecutive trading
days at a price equivalent to 200% of the then Conversion Price (initially 200%
is $6.50 per share).
The Preferred Stock has a per share liquidation preference of $3.25
plus accrued and unpaid dividends over our common stock.
60
Series A 10% Subordinated Notes due December 31, 2006 and Outstanding Options
and Warrants
At the present time, we have outstanding $1,539,260 of Series A 10%
Subordinated Notes due December 31, 2006. NGE, one of our subsidiaries, is the
primary obligor on the notes and we are the guarantor. Interest only on the
notes is payable annually on December 31. In addition, in conjunction with the
issuance of the notes, we issued five year warrants to purchase 615,704 shares
of our common stock at $3.25 per share. In addition, we issued five year
warrants to purchase 61,570 shares of our common stock at $3.25 per share to the
selling agent of the Series A 10% Subordinated Notes due December 31, 2006. Of
the warrants to purchase 61,570 shares, there are warrants to purchase 13,471
shares still outstanding. In addition to those warrants, we have outstanding
options to purchase 12,000 shares of our common stock at $2.00 per share,
outstanding options to purchase 33,000 shares of our common stock at $3.25 per
share, outstanding options to purchase 7,500 shares of our common stock at $3.88
per share, outstanding warrants to purchase 68,524 shares of our common stock at
$2.50 per share and outstanding warrants to purchase 16,472 shares of our common
stock at $3.25 per share.
Warrants
One warrant entitles the holder to purchase one share of our common
stock at an exercise price of $6.25 until 5:00 p.m. (MST) October 20, 2006,
subject to our redemption rights described below. The warrants were issued
pursuant to the terms of a warrant agreement between us and Computershare Trust
Company, Inc.
The warrant exercise price and the number of shares of common stock
purchasable upon exercise of the warrants are subject to adjustment in the event
of, among other events, a stock dividend on, or a subdivision, recapitalization
or reorganization of, the common stock, or if we merge or consolidate with or
into another corporation or business entity.
We may, in our discretion redeem outstanding warrants, in whole but not
in part, upon not less than 30 days' notice, at a price of $0.25 per warrant,
provided that the closing bid price of our common stock equals or exceeds
$10.9375 (175% of the warrant exercise price) for 20 consecutive trading days.
The redemption notice must be provided not more than five business days after
conclusion of the 20 consecutive trading days in which the closing bid price of
our common stock equals or exceeds $10.9375 per share. In the event we exercise
our right to redeem the warrants, the warrants will be exercisable until the
close of business on the date fixed for redemption in such notice. If any
warrant called for redemption is not exercised by such time, it will cease to be
exercisable and the holder will be entitled only to the redemption price of
$0.05 per warrant.
We must have on file a current registration statement with the
Securities and Exchange Commission pertaining to the common stock underlying the
warrants in order for a holder to exercise the warrants or in order for us to
redeem the warrants. This prospectus is part of a current registration statement
we have filed with the Commission.
61
Underwriter's Options
In connection with our October 2002 initial public offering, we issued
options to our underwriter who then transferred them to the selling
securityholders. The options give the selling securityholders the right to
acquire:
o 150,000 shares of our common stock for $6.25 per share at any
time prior to October 20, 2006.
o 150,000 warrants to acquire 150,000 shares of our common stock
for $7.8125 per share at any time prior to October 20, 2006.
These are substantially similar to the public warrants
described above, except that they provide for cashless
exercise, they cannot be redeemed by us and their exercise
price is $7.8125 per share.
We may grant options in the future in connection with capital formation
activities.
Listing
Our common stock and warrants trade on the American Stock Exchange
under the symbols NGS and NGS.WS. There is no market for the selling
securityholders' options or warrants and none is expected to develop.
Transfer Agent, Warrant Agent and Registrar
Our transfer agent, warrant agent and registrar for our common stock
and warrants is Computershare Trust Company, Inc., 350 Indiana Street, Suite
800, Golden, Colorado 80401.
62
EXPERTS
Our consolidated balance sheet at December 31, 2002, and the
consolidated statements of income, shareholders' equity and cash flows for each
of the two years ended December 31, 2002 and 2001 included in this prospectus
have been included herein in reliance on the report of HEIN + ASSOCIATES LLP,
independent certified public accountants, given on the authority of that firm as
experts in accounting and auditing. With respect to the unaudited interim
consolidated financial information for the six months ended June 30, 2003 and
2002 included herein, the independent certified public accountants have not
audited such consolidated financial information and have not expressed an
opinion or any other form of assurance with respect to such consolidated
financial information.
63
Natural Gas Services Group, Inc.
Consolidated Balance Sheet
(unaudited)
June 30, 2003
ASSETS
Current Assets:
Cash and cash equivalents $ 976,004
Accounts receivable - trade 1,482,762
Inventory 2,292,196
Prepaid expenses 81,156
-----------
Total current assets 4,832,118
Lease equipment, net 16,709,633
Other property, plant and equipment, net 2,616,661
Goodwill, net 2,589,655
Patents, net 127,684
Other assets 114,605
-----------
Total assets $26,990,356
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long term debt and capital lease $ 2,278,951
Accounts payable and accrued liabilities 973,025
Unearned Income 588,007
-----------
Total current liabilities 3,839,983
Long term debt and capital lease, less current portion 6,708,947
Subordinated notes, net 1,376,865
Deferred income tax payable 1,492,573
-----------
Total liabilities 13,418,368
SHAREHOLDERS' EQUITY
Preferred stock 3,577
Common stock 49,816
Paid in capital 11,167,733
Retained earnings 2,350,862
-----------
Total shareholders' equity 13,571,988
-----------
Total liabilities and shareholders' equity $26,990,356
===========
The accompanying notes are an integral part of the consolidated balance sheet.
F-1
Natural Gas Services Group, Inc.
Consolidated Income Statements
(unaudited)
Six months ended June 30
2003 2002
----------- -----------
Revenue:
Sales $ 1,505,110 $ 2,311,269
Service and maintenance 893,883 752,020
Leasing income 3,165,567 2,056,267
----------- -----------
5,564,560 5,119,556
Cost of revenue:
Cost of sales 1,146,797 1,561,452
Cost of service and maintenance 671,229 658,049
Cost of leasing 767,784 586,299
----------- -----------
2,585,810 2,805,800
----------- -----------
Gross Margin 2,978,750 2,313,756
Operating Cost:
Selling expense 324,551 243,670
General and administrative expense 791,004 600,487
Amortization and depreciation 779,555 537,600
----------- -----------
1,895,110 1,381,757
----------- -----------
Operating income 1,083,640 931,999
Interest expense (329,789) (522,840)
Equity in earnings of joint venture -- 207,603
Other income 787 1,910
----------- -----------
Income before income taxes 754,638 618,672
Income tax expense 321,603 279,563
----------- -----------
Net income 433,035 339,109
Preferred dividends 62,020 75,614
----------- -----------
Net income available to common shareholders
$ 371,015 $ 263,495
=========== ===========
Earnings per share:
Basic $ 0.08 $ 0.08
Diluted $ 0.07 $ 0.06
Weighted average shares:
Basic 4,866,527 3,357,632
Diluted 5,116,332 4,163,710
The accompanying notes are an integral part of the consolidated income
statements.
F-2
Six Months Six Months
Ended Ended
June 30, 2003 June 30, 2002
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 433,035 $ 339,109
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization 779,555 537,600
Deferred taxes 321,573 279,563
Amortization of debt issuance costs 32,478 32,477
Warrants Issued for debt guarantee -- 42,025
Equity in earnings of joint venture -- (207,603)
Gain on disposal of assets 10,547 --
Changes in operating assets and liabilities:
Trade and other receivables (836,812) (174,984)
Inventory and work in progress (746,248) (247,991)
Prepaid expenses and other 92,146 (23,513)
Accounts payable and accrued liabilities 270,867 276,419
Unearned income 270,446 449,065
Other (91,341) (23,760)
------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 536,246 1,278,407
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (4,465,223) (2,296,033)
Acquisition of remaining interest in joint venture, net of cash acquired 242,753 --
Proceeds from sale of property and equipment 112,500 --
Decrease in lease receivable 210,512 40,954
Distribution from equity method investee 49,090 123,353
------------- -------------
NET CASH USED IN INVESTING ACTIVITIES (3,850,368) (2,131,726)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from bank loans and line of credit 2,438,997 1,353,386
Repayments of long term debt (1,000,489) (449,123)
Deferred offering costs -- (152,326)
Proceeds from stock offering, net of offering cost -- 12,724
Dividends paid on preferred stock (62,020) (75,614)
Proceeds from exercise of warrants 200,000 --
------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,576,488 689,047
------------- -------------
NET CHANGE IN CASH AND CASH EQUVALENTS (1,737,634) (164,272)
CASH AT BEGINNING OF PERIOD 2,713,638 506,669
------------- -------------
CASH AT END OF PERIOD $ 976,004 $ 342,397
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 329,789 $ 470,697
Income taxes paid $ -- $ --
The accompanying notes are an integral part of the consolidated
statements of cash flows.
F-3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation
The accompanying unaudited financial statements present the
consolidated results of our company and its wholly-owned subsidiaries taken from
our books and records. In our opinion, such information includes all
adjustments, consisting of only normal recurring adjustments, which are
necessary to make our financial position at June 30, 2003 and the results of our
operations for the six months periods ended June 30, 2003 and 2002 not
misleading. As permitted by the rules and regulations of the Securities and
Exchange Commission (SEC) the accompanying financial statements do not include
all disclosures normally required by accounting principles generally accepted in
the United States of America. These financial statements should be read in
conjunction with the financial statements included in our Annual Report on Form
10-KSB on file with the SEC. Investments in joint ventures in which our company
does not have majority voting control are accounted for by the equity method.
All intercompany balances and transactions have been eliminated in
consolidation. In our opinion , the consolidated financial statements are a fair
presentation of the financial position, results of operations and cash flows for
the periods presented.
The results of operations for the six months ended June 30, 2003 are
not necessarily indicative of the results of operations to be expected for the
full fiscal year ending December 31, 2003
(2) Stock-based Compensation
Statement of Financial Accounting Standards No. 123, ("SFAS 123")
"Accounting for Stock-Based Compensation," encourages, but does not require, the
adoption of a fair value-based method of accounting for employee stock-based
compensation transactions. We have elected to apply the provisions of Accounting
Principles Board Opinion No. 25 ("Opinion 25"), "Accounting for Stock Issued to
Employees," and related interpretations, in accounting for our employee
stock-based compensation plans. Under Opinion 25, compensation cost is measured
as the excess, if any, of the quoted market price of our stock at the date of
the grant above the amount an employee must pay to acquire the stock.
Had compensation costs for options granted to our employees been
determined based on the fair value at the grant dates consistent with the method
prescribed by SFAS No. 123, our pro forma net income and earnings per share
would have been reduced to the pro forma amounts listed below:
Six Months Ended
June 30
2003 2002
----------- -----------
Pro forma impact of fair value method
Income applicable to common shares, as
reported $ 371,015 $ 263,495
Pro-forma stock-based compensation costs
under the fair value method, net of related tax (15,365) (14,010)
----------- -----------
Pro-forma income applicable to common shares $ 355,650 $ 249,485
under the fair-value method
F-4
Earnings per common share
Basic earnings per share reported $ 0.08 $ 0.08
Diluted earnings per share reported $ 0.07 $ 0.06
Pro-forma basic earnings per share under the
fair Value method $ 0.07 $ 0.07
Pro-forma diluted earnings per share under the
fair value method $ 0.07 $ 0.06
Weighted average Black-Scholes fair value
assumptions:
Risk free rate 4.0%-5.2%
Expected life 5-10 yrs
Expected volatility 50.0 %
Expected dividend yield 0.0%
(3) Acquisitions
On March 31, 2003 we acquired 28 gas compressor packages from Hy-Bon
Engineering Company, Inc. ("Hy-Bon"). The adjusted purchase price amounted to
approximately $2,140,000. 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. We, as the other member of Hy-Bon Rotary
Compression, L.L.C., retained all assets of Hy-Bon Rotary Compression, L.L.C.
that as of December 31, 2002 had an unaudited aggregate value of $346,511. We
plan to dissolve Hy-Bon Rotary Compression, L.L.C. and have agreed not to
operate under the name Hy-Bon. We have consolidated the operations of the Joint
Venture beginning January 1, 2003 and then began recording our share of the
profit of the acquired interest beginning April 1, 2003.
(4) Long Term Debt
We entered into a new loan agreement with our bank, as of March 26,
2003 that included new borrowing of $2,150,000 in the form of a term loan with
monthly principal payments of $35,833 with interest at 1% over prime but not
less than 5.25% for 60 months. The proceeds from this new borrowing were used to
purchase the 28 gas compressors from Hy-Bon Engineering Company, Inc. The new
loan agreement also included the renewal of our line of credit for $750,000 with
interest at 1% over prime but not less than 5.25% for one year.
F-5
(5) Segment Information
FAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, establishes standards for public companies relating to the
reporting of 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.
Our segment information is set forth in the following table:
Natural Gas
(in thousands) Rotary NGE Great Lakes Services
Gas Leasing Compression Group Total
Six Months Ended ----------- ----------- ----------- ----------- -----------
June 30, 2003
Revenue $ 1,200 $ 2,070 $ 2,295 $ -- $ 5,565
Inter-segment revenue 2,744 35 8 -- 2,787
Net Income (loss) (54) 874 394 (781) 433
Segment Assets 4,323 12,986 9,195 486 26,990
Natural Gas
(in thousands) Rotary NGE Great Lakes Services
Gas Leasing Compression Group Total
Six Months Ended ----------- ----------- ----------- ----------- -----------
June 30, 2002
Revenue $ 1,571 $ 1,059 $ 2,490 $ -- $ 5,120
Inter-segment revenue 3,046 -- -- -- 3,046
Net Income (loss) 196 515 188 (560) 339
Segment Assets 4,504 6,711 9,160 695 21,070
F-6
(6) Earnings per common share
The following table reconciles the numerators and denominators of the basic and
diluted earnings per share computation.
Six Months Ended
June 30,
2003 2002
--------------------------
Basic earnings per share Numerator:
Net income $ 433,035 $ 339,109
Less: dividends on preferred shares (62,020) (75,614)
--------------------------
Net income available to common shareholders $ 371,015 $ 263,495
==========================
Denominator -
Weighted average common shares outstanding 4,866,527 3,357,632
==========================
Basic earnings per share $ 0.08 $ 0.08
==========================
Diluted earnings per share Numerator:
Net income $ 433,035 $ 339,109
Less: dividends on preferred shares (1) (62,020) (75,614)
--------------------------
Net income available to common shareholders $ 371,015 $ 263,495
==========================
Denominator :
Weighted average common shares outstanding 4,866,527 3,357,632
Common stock options and warrants 249,805 806,078
Conversion of preferred shares (1) -- --
--------------------------
5,116,332 4,163,710
==========================
Diluted earnings per share $ 0.07 $ 0.06
==========================
(1) Preferred shares were anti-dilutive for the six months ended June 30,
2003 and 2002.
F-7
INDEPENDENT AUDITOR'S REPORT
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, 2002,
and the related consolidated statements of income, stockholders' equity and cash
flows for the years ended December 31, 2002 and 2001. 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 auditing standards generally accepted
in the United States of America. 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, 2002, and the results of its operations and its cash flows for the
years ended December 31, 2002 and 2001 in conformity with accounting principles
generally accepted in the United States of America.
HEIN + ASSOCIATES LLP
Dallas, Texas
February 21, 2003
F-8
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2002
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 2,713,638
Trade accounts receivable, no allowance for doubtful accounts considered necessary 709,122
Lease receivable, net of unearned interest of $23,723 97,813
Inventory 1,475,794
Prepaid expenses and other 87,643
-----------
Total current assets 5,084,010
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,209,512 15,694,946
GOODWILL, net of accumulated amortization of $325,192 2,589,654
PATENTS, net of accumulated amortization of $109,939 141,426
LEASE RECEIVABLE, net of unearned interest of $8,837 112,699
INVESTMENT IN JOINT VENTURE 198,313
OTHER ASSETS 116,039
-----------
Total assets $23,937,087
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Current portion of long-term debt and capital lease $ 1,750,223
Accounts payable and accrued liabilities 600,762
Deferred income 317,561
-----------
Total current liabilities 2,668,546
LONG-TERM DEBT AND CAPITAL LEASE, less current portion 5,752,181
SUBORDINATED NOTES, net of discount of $194,874 1,344,387
DEFERRED TAX LIABILITY 1,171,000
COMMITMENT (Note 12)
STOCKHOLDERS' EQUITY:
Preferred stock, 5,000,000 shares authorized, par value $0.01:
10 % Convertible Series A: 1,177,000 shares authorized 381,654 shares outstanding; 10%
cumulative, liquidation preference of $1,240,376 3,817
Common stock, 30,000,000 shares authorized, par value $0.01; 4,857,632 shares issued and
outstanding 48,576
Additional paid-in capital 10,968,733
Retained earnings 1,979,847
-----------
Total stockholders' equity 13,000,973
-----------
Total liabilities and stockholders' equity $23,937,087
===========
F-9
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------
2002 2001
------------ ------------
REVENUE:
Sales, net $ 4,335,721 $ 4,506,190
Service and maintenance income 1,562,650 1,160,916
Leasing income and interest 4,398,170 3,095,001
------------ ------------
Total revenue 10,296,541 8,762,107
COSTS OF REVENUE:
Cost of sales 3,078,429 3,046,067
Cost of service 1,326,572 986,779
Cost of leasing 1,166,530 909,299
------------ ------------
Total costs of revenue 5,571,531 4,942,145
------------ ------------
GROSS PROFIT 4,725,010 3,819,962
OPERATING EXPENSES:
Selling expenses 499,721 612,670
General and administrative 1,218,513 1,105,290
Depreciation and amortization 1,166,004 903,166
------------ ------------
Total operating expenses 2,884,238 2,621,126
------------ ------------
INCOME FROM OPERATIONS 1,840,772 1,198,836
OTHER INCOME (EXPENSE):
Interest expense (975,719) (924,382)
Equity in earnings of joint venture 485,109 224,231
Other income 19,386 197,208
------------ ------------
Total other income (expense) (471,224) (502,943)
------------ ------------
INCOME BEFORE PROVISION FOR INCOME TAXES 1,369,548 695,893
PROVISION FOR INCOME TAXES:
Current 25,900 9,100
Deferred 557,563 304,800
------------ ------------
Total income tax expense 583,463 313,900
------------ ------------
NET INCOME 786,085 381,993
PREFERRED DIVIDENDS 106,624 10,908
------------ ------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 679,461 $ 371,085
============ ============
NET INCOME PER COMMON SHARE:
Basic $ 0.19 $ 0.11
============ ============
Diluted $ 0.16 $ 0.11
============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic 3,649,413 3,357,632
Diluted 4,305,053 3,483,987
F-10
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
PREFERRED STOCK COMMON STOCK
--------------------------- ---------------------------
SHARES AMOUNT SHARES AMOUNT
------------ ------------ ------------ ------------
BALANCES, January 1, 2001 -- $ -- 3,357,632 $ 33,576
Issuance of preferred stock 377,154 3,772 -- --
Warrants issued in connection with
subordinated notes -- -- -- --
Warrants issued for debt guaranty -- -- -- --
Dividends on preferred stock -- -- -- --
Net income -- -- -- --
------------ ------------ ------------ ------------
BALANCES, January 1, 2002 377,154 3,772 3,357,632 33,576
Issuance of preferred stock 4,500 45 -- --
Issuance of common stock and warrants -- -- 1,500,000 15,000
Warrants issued for debt guaranty -- -- -- --
Repurchase of warrants -- -- -- --
Dividends on preferred stock -- -- -- --
Net income -- -- -- --
------------ ------------ ------------ ------------
BALANCES, December 31, 2002 381,654 $ 3,817 4,857,632 $ 48,576
============ ============ ============ ============
ADDITIONAL TOTAL
PAID-IN RETAINED STOCKHOLDERS'
CAPITAL EARNINGS EQUITY
------------ ------------ ------------
BALANCES, January 1, 2001 $ 3,423,854 $ 929,301 $ 4,386,731
Issuance of preferred stock 899,461 -- 903,233
Warrants issued in connection with
subordinated notes 96,364 -- 96,364
Warrants issued for debt guaranty 23,137 -- 23,137
Dividends on preferred stock -- (10,908) (10,908)
Net income -- 381,993 381,993
------------ ------------ ------------
BALANCES, January 1, 2002 4,442,816 1,300,386 5,780,550
Issuance of preferred stock 12,722 -- 12,767
Issuance of common stock and warrants 6,514,170 -- 6,529,170
Warrants issued for debt guaranty 42,025 -- 42,025
Repurchase of warrants (43,000) -- (43,000)
Dividends on preferred stock -- (106,624) (106,624)
Net income -- 786,085 786,085
------------ ------------ ------------
BALANCES, December 31, 2002 $ 10,968,733 $ 1,979,847 $ 13,000,973
============ ============ ============
F-11
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2002 2001
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 786,085 $ 381,993
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 1,166,004 903,166
Deferred taxes 557,563 304,800
Amortization of debt issuance costs 70,369 64,956
Gain on disposal of assets (15,066) (117,387)
Warrants issued for debt guarantee 42,025 23,137
Equity in earnings of joint venture (485,109) (224,231)
Changes in current assets:
Trade and other receivables 276,588 (360,868)
Inventory 139,614 (593,403)
Prepaid expenses and other (11,888) 25,190
Changes in current liabilities:
Accounts payable and accrued liabilities (348,549) 472,779
Deferred income 134,187 (9,826)
Other changes (105,870) (30,551)
-------------- --------------
Net cash provided by operating activities 2,205,953 839,755
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (4,414,952) (2,220,110)
Proceeds from sale of property and equipment 40,000 328,500
Decrease in lease receivable 84,908 73,711
Distributions from joint venture 405,466 124,353
Cash paid for acquisition -- (1,393,113)
-------------- --------------
Net cash used in investing activities (3,884,578) (3,086,659)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from lines of credit 1,956,893 750,000
Proceeds from long-term debt -- 249,761
Repayments of long-term debt (4,463,612) (592,258)
Dividends on preferred stock (106,624) (10,908)
Net proceeds from sale of common stock 6,529,170 --
Net proceeds from preferred stock 12,767 903,233
Proceeds from note offering, net of offering costs -- 1,310,839
Purchase warrants from underwriter (43,000) --
-------------- --------------
Net cash provided by financing activities 3,885,594 2,610,667
NET INCREASE IN CASH 2,206,969 363,763
CASH, beginning of year 506,669 142,906
-------------- --------------
CASH, end of year $ 2,713,638 $ 506,669
============== ==============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 975,719 $ 872,239
============== ==============
Income taxes paid $ 4,110 $ 2,566
============== ==============
Purchase of property and equipment for note payable $ 1,956,893 $ 7,148,949
============== ==============
F-12
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.
NGSG currently conducts its operations through the following wholly-owned
subsidiaries:
|X| Rotary Gas Systems, Inc. ("RGS") (a Texas corporation) is 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) is 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.
The accompanying financial statements present the consolidated results of the
Company and its wholly-owned subsidiaries. Investments in joint ventures in
which the Company does not have majority voting control are accounted for by the
equity method. All intercompany balances and transactions have been eliminated
in consolidation.
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.
Inventory
- ---------
Inventory is valued at the lower of cost or market. The cost of inventories are
determined by the first-in, first-out method. At December 31, 2002, inventory
consisted of the following:
Raw materials $ 1,303,785
Work in process 172,009
------------
$ 1,475,794
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.
F-13
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, 2002 and 2001. Amortization expense for each of the next five 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 various acquisitions and was being amortized on a
straight-line basis over 20 years. Amortization expense of $124,425 was
recognized for the year ended December 31, 2001. The Company ceased amortization
of goodwill effective January 1, 2002 in accordance with Statement of Financial
Accounting Standards ("FAS") No. 142. See Note 14.
FAS 142 requires that goodwill be tested for impairment at least annually. The
Company completed its initial test for goodwill impairment during the second
quarter 2002, 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, including patents and 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, 2002.
Advertising Costs
- -----------------
Advertising costs are expensed as incurred. Total advertising expense was
$49,720 in 2002 and $56,335 in 2001.
Revenue Recognition
- -------------------
Revenue from the sales of custom and fabricated and rebuilt 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. Operating lease revenue is recognized over
the term of the agreements. Maintenance agreement revenue is recognized as
services are rendered. Deferred income represents items that have been billed to
customers based on contractual agreements, but have not yet been shipped. Rental
and lease revenue is recognized over the terms of the respective lease
agreements based upon the classification of the lease.
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 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, and FAS No. 148,
Accounting for Stock-Based Compensation - Transition and Disclosure - an
Amendment of FASB Statement No. 123, 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
F-14
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 2002 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 50%; risk free interest rate 5.2% and 4.0%
and no dividends during the expected term as the Company does not have a history
of paying cash dividends. There were no options issued in 2001.
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:
YEAR ENDED
DECEMBER 31,
2002
------------
Net income, as reported $ 786,085
Add: Stock-based employee compensation included in reported net
income --
Deduct: Total stock-based employee compensation expense
determined under fair value method for all awards (39,000)
------------
Net income, pro forma $ 747,085
------------
Net income per share:
Basic, as reported $ 0.19
============
Basic, pro forma $ 0.18
============
Diluted, as reported $ 0.16
============
Diluted, pro forma $ 0.15
============
Weighted average fair value of options granted during the year $ 2.24
============
Description of Leasing Arrangements
- -----------------------------------
The Company's leasing operations principally consist of the leasing of natural
gas compressor packages and flare stacks. The Company has one seven-year lease
of natural gas irrigation engines to an agricultural entity that is classified
as a sales-type lease. The remaining leases are all classified as operating
leases. See Note 5.
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 carryforwards. 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
F-15
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
- -----------------------------------------
In June 2001, the Financial Accounting Standards Board ("FASB") approved for
issuance FAS 143, Asset Retirement Obligations. FAS 143 establishes accounting
requirements for retirement obligations associated with tangible long-lived
assets, including 1) the timing of the liability recognition, 2) initial
measurement of the liability, 3) allocation of asset retirement cost to expense,
4) subsequent measurement of the liability and 5) financial statement
disclosures. FAS 143 requires that an asset retirement cost should be
capitalized as part of the cost of the related long-lived asset and subsequently
allocated to expense using a systematic and rational method. The Company will
adopt the statement effective on January 1, 2003, as required. The transition
adjustment resulting from the adoption of FAS 143 will be reported as a
cumulative effect of a change in accounting principle. The Company does not
believe that the adoption of this statement will have a material effect on its
financial position, results of operations, or cash flows.
In October 2001, the FASB approved for issuance FAS 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. FAS 144 replaces SFAS 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of. The new accounting model for long-lived assets to be disposed of
by sale applies to all long-lived assets, including discontinued operations, and
replaces the provisions of APB Opinion No. 30, Reporting Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, for the
disposal of segments of a business. FAS 144 requires that those long-lived
assets be measured at the lower of carrying amount or fair value less cost to
sell, whether reported in continuing operations or in discontinued operations.
Therefore, discontinued operations will no longer be measured at net realizable
value or include amounts for operating losses that have not yet occurred. FAS
144 also broadens the reporting of discontinued operations to include all
components of an entity with operations that can be distinguished from the rest
of the entity and that will be eliminated from the ongoing operations of the
entity in a disposal transaction. The provisions of FAS 144 applied to the
Company beginning January 1, 2002 and did not have a material effect on its
financial position, results of operations, or cash flows.
In July 2002, the FASB issued FAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. FAS 146 requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. Examples of costs
covered by FAS 146 include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. FAS 146 is to be
applied prospectively to exit or disposal activities initiated after December
31, 2002. The adoption of FAS 146 is not expected to have a material effect on
the Company's financial position or results of its operations.
In December 2002, the FASB issued FAS No.148, Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement 123.
For entities that change their accounting for stock-based compensation from the
intrinsic method to the fair value method under FAS 123, the fair value method
is to be applied prospectively to those awards granted after the beginning of
the period of adoption (the prospective method). The amendment permits two
additional transition methods for adoption of the fair value method. In addition
to the prospective method, the entity can choose to either (i) restate all
periods presented (retroactive restatement method) or (ii) recognize
compensation cost from the beginning of the fiscal year of adoption as if the
fair value method had been used to account for awards (modified prospective
method). For fiscal years beginning December 15, 2003, the prospective method
will no longer be allowed. The Company currently accounts for its stock-based
compensation using the intrinsic value method as proscribed by APB Opinion No.
25, Accounting for Stock Issued to Employees, and plans on continuing using this
method to account for stock options; therefore, it does not intend to adopt the
transition requirements as specified in FAS 148. The Company has adopted the new
FAS 148 disclosure requirements with these financial statements.
F-16
2. ACQUISITION
-----------
In March 2001, the Company acquired the assets, primarily compressors, office
furniture and fixtures, building and land, of Dominion Michigan Production
Services, Inc. ("Dominion") for a total purchase price of $8 million, subject to
adjustment. $1 million of the purchase price was paid in cash with the remainder
financed by the seller (see Note 7). The transaction was accounted for under the
purchase method of accounting and the purchase price was allocated to the net
assets acquired based on their estimated fair values. The excess of cost over
the fair value of net assets acquired totaled approximately $741,000 and was
recorded as goodwill as of the acquisition date. The operating results of the
acquired business have been included in the Company's financial statements
beginning April 1, 2001. The following unaudited pro forma information has been
prepared as if the acquisition of the assets of Dominion had occurred at the
beginning of the year ended December 31, 2001. Such information is not
necessarily reflective of the actual results that would have occurred had the
acquisition occurred on that date.
Net sales $9,563,146
Net income $429,276
Net income per common share $0.13
Net income per common share, assuming dilution $0.12
In connection with the acquisition, a total fee of $440,000 was paid to the
investment banker/advisor. A director of the Company has a 1% interest in the
investment banker/advisor.
3. PROPERTY AND EQUIPMENT
----------------------
Property and equipment consists of the following at December 31, 2002:
Land and building $ 1,345,740
Leasehold improvements 124,902
Equipment and furniture 604,134
Rental equipment 15,092,994
Vehicles 736,688
------------
17,904,458
Less accumulated depreciation (2,209,512)
------------
$ 15,694,946
============
Depreciation expense for property and equipment of $1,137,520 and $751,257 was
recognized for the years ended December 31, 2002 and 2001, respectively.
4. INVESTMENT IN JOINT VENTURE
---------------------------
The Company owns a non-controlling 50% interest in a joint venture, Hy-Bon
Rotary Compression, LLC ("Hy-Bon"). Hy-Bon leases natural gas compressors
provided by each party and provides the related service and maintenance to the
customers. Income is split between the parties based on the revenue of their
respective compressors on lease. The Company's investment is accounted for on
the equity method, in which the Company recognizes its share of the earnings or
loss of the joint venture determined in accordance with the Hy-Bon operating
F-17
agreement. The Company's total equity method investment in Hy-Bon at December
31, 2002 totaled $198,313. The Company's equity in the earnings of Hy-Bon was
$485,109 and $224,231 in 2002 and 2001, respectively. Summarized financial
information of Hy-Bon follows:
December 31,
2002
--------------
BALANCE SHEET:
ASSETS:
Current assets $ 393,271
Equipment, net 65,857
--------------
Total assets $ 459,128
==============
LIABILITIES:
Current liabilities $ 84,666
Notes payable 27,951
Members' capital 346,511
--------------
Total liabilities and equity $ 459,128
==============
For the Years Ended December 31,
--------------------------------
2002 2001
-------------- --------------
STATEMENT OF OPERATIONS:
Total revenue $ 1,296,728 $ 644,170
Total expenses 388,483 193,756
-------------- --------------
Net income $ 908,245 $ 450,414
============== ==============
Subsequent to December 31, 2002, the Company agreed to purchase the compressors
owned by the other party that are used in the joint venture for $2,150,000.
5. LEASING ACTIVITY
----------------
The following lists the components of the net investment in the Company's
sales-type lease as of December 31, 2002:
Total minimum lease payments receivable $ 243,072
Less unearned income (32,560)
--------------
$ 210,512
==============
Future minimum lease payments are approximately $122,000 per year until the
lease expiration in December 2004.
The Company leases natural gas compressor packages to entities in the petroleum
industry. These leases are classified as operating leases and generally have
original lease terms of one 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, 2002 are as follows:
Year Ended December 31,
2003 $ 799,831
2004 828,085
2005 861,208
2006 245,743
--------------
Total $ 2,734,867
==============
6. 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% (5.25% at
December 31, 2002) and requires monthly interest payments with principal due at
F-18
maturity on March 15, 2003. The line of credit is collateralized by
substantially all of the assets of the Company. At December 31, 2002, there was
no outstanding balance on this line of credit.
The line of credit and first three notes listed in Note 7 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
except the cash flow ratio at December 31, 2002. The bank granted the Company a
waiver until June 30, 2003 for its non-compliance with the cash flow ratio.
F-19
7. LONG-TERM DEBT
--------------
Long-term debt at December 31, 2002 consisted of the following:
Notepayable to a bank, interest at bank's prime rate plus 1.0% (5.25% at
December 31, 2002), monthly payments of principal of $58,333 plus interest,
until maturity in October 15, 2007. The note is collateralized by substantially
all of the assets of the Company. See Note 6 regarding loan covenants $ 3,383,334
Note payable to a bank, interest at prime rate plus 1% (5.25% at December 31,
2002), monthly payments of principal of $30,889 plus interest until maturity
on November 15, 2007. The note is collateralized by substantially all of the
assets of the Company. See Note 6 regarding loan covenants 1,853,340
Note payable to a bank, interest at prime rate plus 1% (5.25% at December 31, 2002),
monthly payments of principal of $45,746 plus interest until maturity on March 15,
2006. The note is collateralized by substantially all of the assets of the
Company. See Note 6 regarding loan covenants 1,734,947
Notepayable to a bank, interest at 11%, monthly payments of principal and
interest totaling $2,614, until maturity in September 2010,
collateralized by a building
214,321
Note payable to an individual, interest at 10%, monthly payments of principal
and interest totaling $1,255 until maturity in August 2010. This note is
collateralized by a building 80,443
Various notes payable to a bank, interest rates ranging from prime plus 1%
(5.25% at December 31, 2002) to 7.75%, monthly payments ofprincipal and
interest until maturity dates ranging from July 2003 to July 2004. These notes
are collateralized by various vehicles 60,545
Capital lease 43,540
Other notes payable, various terms 131,934
-----------
Total 7,502,404
-----------
Less current portion (1,750,223)
-----------
$ 5,752,181
===========
F-20
Maturities of long-term debt based on contractual requirements for the years
ending December 31 are as follows:
2003 $ 1,750,223
2004 1,720,683
2005 1,675,968
2006 1,180,057
2007 977,654
Thereafter 197,819
--------------
$ 7,502,404
==============
8. SUBORDINATED NOTES
------------------
On October 31, 2000, the Company initiated a private placement of subordinated
debt units. 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. The warrants were valued at their estimated fair
market value resulting in a discount relating to the warrants of $87,128.
Proceeds from this offering totaled $1,539,260. Under the terms of the offering,
all proceeds from the notes must be used for the operations of NGE Leasing. In
connection with the offering, a placement agent was paid a 10% cash commission
and 3% non-accountable expense allowance totaling $200,104, and was issued
warrants in the same form as those issued in the offering for a total of 61,570
shares. The warrants were valued at their estimated fair market value of $9,236.
Total debt issuance costs of $237,658 are recorded as a debt discount and the
total debt discount of $324,786 is being amortized using the effective interest
rate method over the life of the notes. The balance of the subordinated debt,
net of unamortized discount of $194,874, is $1,344,387 at December 31, 2002.
Certain stockholders, officers and directors purchased units in this 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.
9. INCOME TAXES
------------
The provision for income taxes consists of the following:
2002 2001
---------- ----------
Current provision:
Federal $ -- $ --
State 25,900 9,100
---------- ----------
25,900 9,100
Deferred provision:
Federal 491,363 269,100
State 66,200 35,700
---------- ----------
557,563 304,800
---------- ----------
$ 583,463 $ 313,900
========== ==========
F-21
The income tax effects of temporary differences that give rise to
significant portions of deferred income tax assets and (liabilities) are as
follows:
2002
-----------
Deferred income tax assets:
Net operating loss $ 892,000
Other 48,000
-----------
Total deferred income tax assets 940,000
-----------
Deferred income tax liabilities:
Property and equipment (1,962,000)
Goodwill and other intangible assets (149,000)
-----------
Total deferred income tax liabilities (2,111,000)
-----------
Net deferred income tax liabilities $(1,171,000)
===========
The effective tax rate differs from the statutory rate as follows:
2002 2001
----------- -----------
Statutory rate 34% 34%
State and local taxes 7% 6%
Non-deductible goodwill amortization -- 14%
Other non-deductible expenses 2% --
Other -- (9%)
----------- -----------
Effective rate 43% 45%
=========== ===========
At December 31, 2002, the Company had available federal net operating loss
("NOL") carryforwards of approximately $2,420,000, which may be used to reduce
future taxable income and begin to expire in 2020 through 2022.
10. 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 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 to purchase 150,000 shares at $0.3125 per share.
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.
F-22
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. Of the preferred
shares, 1,177,000 shares are designated 10% Convertible Series A Preferred
Stock. The Series A shares have 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 are entitled to one vote per share and the Series A shares
are 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 will automatically be converted to common stock on
a one-for-one basis if or when the Company's common stock trades on a public
exchange at a price of $6.50 per share or greater for twenty consecutive days.
The Series A shares have a liquidation preference of $3.25 per share plus
accrued and unpaid dividends over common stock. The Company initiated a private
placement of its Series A shares in July 2001. Under the terms of the placement
agreement, the Company offered a maximum of 770,000 Series A shares at a price
of $3.25 per share. As of December 31, 2001, the Company had received gross
proceeds of $1,225,751 from the offering, net of $322,518 of offering costs, for
377,154 Series A shares. Included in the offering costs, are a 10% commission
and 3% non-accountable expense allowance paid to the placement agent. In 2002,
additional proceeds of $14,625 were received representing 4,500 additional
Series A shares issued. Total Series A shares outstanding at December 31, 2002
were 381,654. A total of 18,000 and 12,000 Series A shares were issued in the
offering to a director and a stockholder, respectively, on the same terms and
conditions as those sold to non-affiliated purchasers in the private offering.
11. 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.
In September 1999, the Company granted 27,000 non-qualified stock options to
certain employees to purchase the Company's common stock at $2.00 per share. The
options vest over three years and expire in 2009.
In April 2002, the Company granted 42,000 non-qualified stock options to certain
employees to purchase the Company's common stock at $3.25 per share. The options
vest over three years and expire in April 2012. Also, in December 2002, the
Company granted 7,500 non-qualified stock options to the three outside directors
to purchase the Company's common stock at $3.88 per share any time through
December 2012.
In September 1999, the Company granted 100,000 non-qualified stock options to an
advisory director to purchase the Company's common stock at $2.00 per share
anytime through September 30, 2004. These options were not granted pursuant to
the Plan described above.
F-23
The following is a summary of activity for the stock options outstanding for the
years ended December 31, 2002 and 2001:
DECEMBER 31, 2002 DECEMBER 31, 2001
--------------------- ---------------------
Weighted Weighted
Number Average Number Average
Of Exercise Of Exercise
Shares Price Shares Price
--------- --------- --------- ---------
Outstanding, beginning of year 112,000 $ 2.00 112,000 $ 2.00
Canceled or expired -- -- -- --
Granted 49,500 3.35 -- --
Exercised -- -- -- --
--------- --------- --------- ---------
Outstanding, end of year 161,500 $ 2.41 112,000 $ 2.00
========= ========= ========= =========
Exercisable, end of year 128,800 $ 2.21 112,000 $ 2.00
========= ========= ========= =========
12. COMMITMENT
----------
401(k) Plan
- -----------
Effective January 1, 2001, the Company offered a 401(k) Plan (the "Plan") to all
employees that had reached the age of eighteen and had 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 $50,233 to the Plan in 2002.
13. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK
------------------------------------------------
Sales to one customer in the year ended December 31, 2002 and one customer in
the year ended December 31, 2001 amounted to a total of 30% and 26% of
consolidated revenue, respectively. No other single customer accounted for more
than 10% of the Company's sales in 2002 or 2001. At December 31, 2002, the
Company had one customer that accounted for 12% 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. The Company performs
periodic credit evaluations on its customers' financial condition and believes
that no allowance for doubtful accounts for trade receivables is necessary at
December 31, 2002.
14. GOODWILL - ADOPTION OF STATEMENT 142
------------------------------------
The Company adopted FAS 142 on January 1, 2002, at which time it ceased the
amortization of goodwill. At December 31, 2002, the Company's goodwill had a
carrying value of $2,589,654. Pursuant to FAS 142, the Company completed its
initial test for goodwill impairment in 2002 and no impairment was indicated.
The following table sets forth the effect of the adoption of FAS 142 on the 2001
financial statements as if it had been adopted on January 1, 2001.
F-24
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEAR
ENDED
DECEMBER 31,
2001
------------
Reported net income $ 381,993
Add back: Goodwill amortization, net of
tax effect 124,425
------------
Adjusted net income $ 506,418
============
Basic earnings per share:
Reported net income $ .11
Goodwill amortization .04
------------
Adjusted net income $ .15
============
Diluted earnings per share:
Reported net income $ .11
Goodwill amortization .03
------------
Adjusted net income $ .14
============
15. 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 on its subsidiary entities. The Company's reportable operating
segments have been determined as separately identifiable business units. The
Company measures segment earnings as income before income taxes. The following
amounts are expressed in thousands:
RGS NGE GLC NGSG Elim. Total
--------- --------- --------- --------- --------- ---------
For the year ended December 31,
2002:
Revenue from external customers $ 3,298 $ 2,319 $ 4,680 $ -- $ -- $ 10,297
Inter-segment revenue 5,756 45 20 -- (5,821) --
Gross profit 1,329 1,669 1,727 -- -- 4,725
Depreciation and amortization 122 439 558 47 -- 1,166
Interest expense 9 392 537 38 -- 976
Other income 4 15 -- -- -- 19
Equity in the net income of investee
accounted for by the equity method -- 485 -- -- -- 485
Income taxes -- -- -- 583 -- 583
Net income 411 1,177 364 (1,166) -- 786
As of December 31, 2002:
Segment assets 3,779 10,905 8,587 666 -- 23,937
Goodwill 1,873 -- 717 -- -- 2,590
For the year ended December 31,
2001:
Revenue from external customers $ 3,841 $ 1,519 $ 3,402 $ -- $ -- $ 8,762
Inter-segment revenue 2,691 -- -- -- (2,691) --
Gross profit 1,231 1,076 1,513 -- -- 3,820
Depreciation and amortization 104 252 423 124 -- 903
Interest expense 4 395 489 36 -- 924
Other income 19 130 3 45 -- 197
Equity in the net income of investee
accounted for by the equity method -- 224 -- -- -- 224
Income taxes -- -- -- 314 -- 314
Net income 180 549 307 (654) -- 382
As of December 31, 2001:
Segment assets 1,200 6,107 9,181 2,322 -- 18,810
Goodwill 1,873 -- 717 -- -- 2,590
F-26
- --------------------------------------------
We have not authorized any dealer,
salesperson or other person to give any
information or to make any representation
not contained in this prospectus. This
prospectus does not constitute an offer to
sell, or a solicitation of an offer to buy,
any offer or solicitation by anyone in any
jurisdiction not authorized, or in which the
person making such an offer or solicitation
is not qualified to do so or to any person
to whom it is unlawful to make such an offer
or solicitation. By delivery of this
prospectus we do not imply that there has
been no change in our affairs or that the
information in this prospectus is correct as
of any time subsequent to its date.
- -------------------------------------------
NATURAL GAS SERVICES
GROUP, INC.
TABLE OF CONTENTS
Page
About Natural Gas Services, Inc............. 2
Summary of the Offering..................... 3
Risk Factors................................ 6
Use of Proceeds............................. 15 ________________
Dividend Policy............................. 16
Selected Consolidated Financial Data........ 17 PROSPECTUS
Management's Discussion and ________________
Analysis of Financial Condition
and Results of Operations................. 20
Business ................................... 32
Legal Proceedings........................... 43
Where You Can Find Additional
Information............................... 43
Market for Our Securities and
Related Stockholder Matters................. 43
Management................................ 45
Security Ownership of Certain
Beneficial Owners and Management.......... 53 __________, 2003
Certain Relationships and Related
Transactions.............................. 55
Selling Securityholders..................... 57
Plan of Distribution........................ 58
Description of Securities................... 58
Experts..................................... 62
Index to Financial Statements............... F-1
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24. Indemnification of Directors and Officers.
Section 7-109-102 of the Colorado Business Corporation Act permits a
Colorado corporation to indemnify any director against liability if such person
acted in good faith and, in the case of conduct in an official capacity with the
corporation, that the director's conduct was in the corporation's best interests
and, in all other cases, that the director's conduct was at least not opposed to
the best interests of the corporation or, with regard to criminal proceedings,
the director had no reasonable cause to believe the director's conduct was
unlawful.
Section 7-109-103 of the Colorado Business Corporation Act provides
that, unless limited by its articles of incorporation, a Colorado corporation
shall indemnify a person who was wholly successful, on the merits or otherwise,
in the defense of any proceeding to which the person was a party because the
person is or was a director, against reasonable expenses incurred by him or her
in connection with the proceeding.
Section 3 of Article IX of our articles of incorporation, filed as
Exhibit 3.1 hereto, provides that we shall indemnify, to the maximum extent
permitted by law in effect from time to time, any person who is or was a
director, officer, agent, fiduciary or employee of ours against any claim,
liability or expense arising against or incurred by such person made party to a
proceeding because such person is or was a director, officer, agent, fiduciary
or employee of ours or because such person is or was serving another entity as a
director, officer, partner, trustee, employee, fiduciary or agent at our
request. We further have the authority to the maximum extent permitted by law to
purchase and maintain insurance providing such indemnification.
Article VI of our bylaws, filed as Exhibit 3.4 hereto, provides for the
indemnification of certain persons.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 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 of 1933 and is,
therefore, unenforceable.
II-1
Item 25. Other Expenses of Issuance and Distribution.
Expenses payable by us in connection with the issuance and distribution
of the securities being registered hereby are as follows:
SEC Registration Fee(1) $ --
NASD Filing Fee -0-
American Stock Exchange Listing Fee -0-
Accounting Fees and Expenses 5,000*
Legal Fees and Expenses 10,000*
Printing 2,000*
Transfer Agent Fee 2,000
Miscellaneous 1,000
-----------
Total $ 20,000
===========
(1) Paid in connection with the initial filing of this Registration
Statement.
(23) Estimated
Item 26. Recent Sales of Unregistered Securities.
Beginning in October 2000, we issued 62 units comprised of Series A 10%
Subordinated Notes and Five Year Warrants to Purchase Common Stock to 34
investors. The units were issued in transactions 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. A Form D relating to the offering
was filed with the Securities and Exchange Commission. The persons to whom the
units were issued had access to full information concerning us and represented
that they acquire the shares for their own account and not for the purpose of
distribution. The certificates for the securities contain a restrictive legend
advising that the securities 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 1933 Act. The underwriter involved
in this offering was Barry-Shino Securities, Inc. which received a commission of
$153,926, a nonaccountable expense allowance of $46,178 and warrants to purchase
61,570 shares of our common stock at $3.25 per share.
In March 2001, we issued five year warrants to purchase 68,524 shares
of our common stock at $2.50 per share in exchange for persons guaranteeing
approximately $1,749,000 of our debt. The warrants 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 warrants were issued had access to full information
concerning us. The certificates for the warrants contain a restrictive legend
advising that the warrants and underlying 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 1933 Act. There
was no underwriter involved in the exchange of the warrants for the guaranteeing
of the debt.
II-2
Beginning in July 2001, we issued 381,654 shares of our 10% Convertible
Series A Preferred Stock to 35 investors. The shares were issued in transactions
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. A Form
D relating to the offering was filed with the Securities and Exchange
Commission. The persons to whom the shares were issued had access to full
information concerning us and represented that they acquired the shares for
their own account and not for the purpose of distribution. The certificates for
the shares contain a restrictive legend 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 1933 Act. The underwriter of this offering was Neidiger, Tucker,
Bruner, Inc. which received a commission of $124,037 a nonaccountable expense
allowance of $37,211 and warrants to purchase 38,165 shares of our 10%
Convertible Series A Preferred Stock.
In April 2002, we issued five year warrants to purchase 16,472 shares
of our common stock at $3.25 per share in exchange for three persons
guaranteeing approximately $824,000 of our debt. The warrants 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 1933 Act. The
persons to whom the warrants were issued had access to full information
concerning us. The certificates for the warrants contain a restrictive legend
advising that the warrants and underlying 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 1933 Act. There
was no underwriter involved in the exchange of the warrants for the guaranteeing
of the debt.
In June 2003 we issued 100,000 shares of our common stock to one person
upon the exercise of an option that the person owned. 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 1933 Act. The
person to whom the shares were issued had access to full information concerning
us. The certificate for the shares contains a restrictive legend 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 1933 Act. There was no underwriter involved in this
offering.
In September 2003, we issued 26,549 shares of our common stock to one
person and one company upon the exercise of outstanding warrants. The shares
were issued in transactions not involving a public offering and were issued in
reliance upon the exemption from registration provided by Section 4(2) of the
1933 Act. The persons to whom the shares were issued had access to full
information concerning us. The certificates for the shares contain a restrictive
legend 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 1933 Act. There was no underwriter
involved in these offerings.
II-3
Item 27. Exhibits.
--------
The following is a list of all exhibits filed as part of this Registration
Statement:
Exhibit No. Description and Method of Filing
- ----------- --------------------------------
2.1 Purchase and Sale Agreement by and between Hy-Bon Engineering
Company, Inc. and NGE Leasing, Inc. (2)
3.1 Articles of incorporation.*
3.2 Amendment to articles of incorporation dated March 31, 1999, and
filed on May 25, 1999.*
3.3 Amendment to articles of incorporation dated July 25, 2001, and
filed on July 30, 2001.*
3.4 Amendment to articles of incorporation adopted on June 18, 2003,
and filed on June 19, 2003. (1)
3.5 Bylaws.*
4.1 Form of warrant certificate.*
4.2 Form of warrant agent agreement.*
4.3 Form of lock-up agreement.*
4.4 Form of representative's option for the purchase of common
stock.*
4.5 Form of representative's option for the purchase of warrants.*
4.6 Form of consulting agreement between Natural Gas Services Group,
Inc. and the representative.*
10.1 1998 Stock Option Plan.*
10.2 Asset Purchase Agreement between Natural Gas Acquisition
Corporation and Great Lakes Compression, Inc. dated January 1,
2001.*
10.3 Amendment to Guaranty Agreement between Natural Gas Services
Group, Inc. and Dominion Michigan Production Services, Inc.*
10.4 Form of Series A 10% Subordinated Notes due December 31, 2006.*
10.5 Form of Five-Year Warrants to Purchase Common Stock.*
10.6 Warrants issued to Berry-Shino Securities, Inc.*
10.7 Warrants issued to Neidiger, Tucker, Bruner, Inc.*
10.8 Form of warrant issued in March 2001 for guaranteeing debt.*
II-4
Exhibit No. Description and Method of Filing
- ----------- --------------------------------
10.9 Form of warrant issued in April 2002 for guaranteeing debt.*
10.10 Exhibits 3(C)(1), 3(C)(2), 3(C)(3), 3(1)(4), 13(d)(1), 13(d)(2)
and 13(d)(3) to Asset Purchase Agreement between Natural Gas
Acquisition Corporation and Great Lakes Compression, Inc. dated
January 1, 2001.*
10.11 Articles of Organization of Hy-Bon Rotary Compression, L.L.C.
dated April 17, 2000 and filed on April 20, 2001.*
10.12 Regulations of Hy-Bon Rotary Compression, L.L.C.*
10.13 First Amended and Restated Loan Agreement between Natural Gas
Services Group, Inc. and Western National Bank (3)
10.14 Termination of Employment Agreement Letter relating to the
Employment Agreement of Alan Kurus. (4)
10.15 Termination of Employment Agreement Letter relating to the
Employment Agreement of Wayne L. Vinson. (4)
10.27 Termination of Employment Agreement Letter relating to the
Employment Agreement of Earl R. Wait. (4)
21 Subsidiaries of the registrant.*
23.1 Consent of HEIN + ASSOCIATES LLP. (1)
*Previously filed as Exhibits to this Registration Statement.
(1) Filed herewith
(2) Filed as exhibit 2.1 to the Registrant's Current Report on Form 8-K filed on
March 6, 2003 and incorporated herein by reference.
(3) Filed as exhibit 10.1 to the Registrant's Current Report on Form 8-K filed
on April 14, 2003 and incorporated herein by reference.
(4) Filed as exhibits 10.25, 10.26 and 10.27 to Registrant's Annual Report on
Form 10-KSB for the year ended December 31, 2002 and incorporated herein by
reference
Item 28. Undertakings.
------------
The undersigned will:
(1) File, during any period in which it offers or sells securities, a
post-effective amendment to this registration statement to:
(i) include any prospectus required by section 10(a)(3) of the
Securities Act;
(ii) reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in the
information in the registration statement; and
II-5
(iii) include any additional or changed material information
on the plan of distribution.
(2) For determining liability under the Securities Act, treat each
post-effective amendment as a new registration statement of the securities
offered, and the offering of the securities at that time to be the initial bona
fide offering.
(3) File a post-effective amendment to remove from registration any of the
securities that remain unsold at the end of the offering.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
undersigned pursuant to the foregoing provisions, or otherwise, the undersigned
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the undersigned of expenses incurred
or paid by a director, officer or controlling person of the undersigned in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the undersigned will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
II-6
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements of filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned, in the City of Midland,
State of Texas on September 30, 2003.
NATURAL GAS SERVICES GROUP, INC.
/s/ Wayne L. Vinson
----------------------------------------
Wayne L. Vinson, President and Principal
Executive Officer
/s/ Earl R. Wait
----------------------------------------
Earl R. Wait, Principal Financial and
Accounting Officer
In accordance with the requirements of the Securities Act of 1933, this
registration statement was signed by the following persons in the capacities and
on the dates stated:
Signature Title Date
- --------- ----- ----
/s/ Wallace O. Sellers Director September 30, 2003
- --------------------------
Wallace O. Sellers
/s/ Wayne L. Vinson Director September 30, 2003
- --------------------------
Wayne L. Vinson
/s/ Scott W. Sparkman Director September 30, 2003
- --------------------------
Scott W. Sparkman
/s/ Charles G. Curtis Director September 30, 2003
- --------------------------
Charles G. Curtis
/s/ James T. Grigsby Director September 30, 2003
- --------------------------
James T. Grigsby
/s/ Gene A. Strasheim Director September 30, 2003
- --------------------------
Gene A. Strasheim
/s/ Richard L. Yadon Director September 30, 2003
- --------------------------
Richard L. Yadon
II-7
EXHIBIT INDEX
Exhibit Description and Method of Filing
- -------- --------------------------------
No.
- ---
2.1 Purchase and Sale Agreement by and between Hy-Bon Engineering
Company, Inc. and NGE Leasing, Inc. (2)
3.1 Articles of incorporation.*
3.2 Amendment to articles of incorporation dated March 31, 1999, and
filed on May 25, 1999.*
3.3 Amendment to articles of incorporation dated July 25, 2001, and
filed on July 30, 2001.*
3.4 Amendment to articles of incorporation adopted on June 18, 2003,
and filed on June 19, 2003. (1)
3.5 Bylaws.*
4.1 Form of warrant certificate.*
4.2 Form of warrant agent agreement.*
4.3 Form of lock-up agreement.*
4.4 Form of representative's option for the purchase of common
stock.*
4.5 Form of representative's option for the purchase of warrants.*
4.6 Form of consulting agreement between Natural Gas Services Group,
Inc. and the representative.*
10.1 1998 Stock Option Plan.*
10.2 Asset Purchase Agreement between Natural Gas Acquisition
Corporation and Great Lakes Compression, Inc. dated January 1,
2001.*
10.3 Amendment to Guaranty Agreement between Natural Gas Services
Group, Inc. and Dominion Michigan Production Services, Inc.*
10.4 Form of Series A 10% Subordinated Notes due December 31, 2006.*
10.5 Form of Five-Year Warrants to Purchase Common Stock.*
10.6 Warrants issued to Berry-Shino Securities, Inc.*
10.7 Warrants issued to Neidiger, Tucker, Bruner, Inc.*
II-8
Exhibit No. Description and Method of Filing
- ----------- --------------------------------
10.8 Form of warrant issued in March 2001 for guaranteeing debt.*
10.9 Form of warrant issued in April 2002 for guaranteeing debt.*
10.10 Exhibits 3(C)(1), 3(C)(2), 3(C)(3), 3(1)(4), 13(d)(1), 13(d)(2)
and 13(d)(3) to Asset Purchase Agreement between Natural Gas
Acquisition Corporation and Great Lakes Compression, Inc. dated
January 1, 2001.*
10.11 Articles of Organization of Hy-Bon Rotary Compression, L.L.C.
dated April 17, 2000 and filed on April 20, 2001.*
10.12 Regulations of Hy-Bon Rotary Compression, L.L.C.*
10.13 First Amended and Restated Loan Agreement between Natural Gas
Services Group, Inc. and Western National Bank (3)
10.14 Termination of Employment Agreement Letter relating to the
Employment Agreement of Alan Kurus. (4)
10.15 Termination of Employment Agreement Letter relating to the
Employment Agreement of Wayne L. Vinson. (4)
10.27 Termination of Employment Agreement Letter relating to the
Employment Agreement of Earl R. Wait. (4)
21 Subsidiaries of the registrant.*
23.1 Consent of HEIN + ASSOCIATES LLP. (1)
*Previously filed as Exhibits to this Registration Statement.
(1) Filed herewith
(2) Filed as exhibit 2.1 to the Registrant's Current Report on Form 8-K filed on
March 6, 2003 and incorporated herein by reference.
(3) Filed as exhibit 10.1 to the Registrant's Current Report on Form 8-K filed
on April 14, 2003 and incorporated herein by reference.
(4) Filed as exhibits 10.25, 10.26 and 10.27 to Registrant's Annual Report on
Form 10-KSB for the year ended December 31, 2002 and incorporated herein by
reference
II-9
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the use in the Registration Statement (Post-Effective
Amendment No. 2 to Form SB-2) and Prospectus of Natural Gas Services Group, Inc.
of our report dated February 21, 2003 accompanying the consolidated financial
statements of Natural Gas Services Group, Inc. contained in such Registration
Statement, and to the use of our name and the statements with respect to us, as
appearing under the heading "Experts" in the Prospectus.
HEIN + ASSOCIATES LLP
Dallas, Texas
September 26, 2003
