U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2003
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____________ to _____________
Commission file number 1-31398
NATURAL GAS SERVICES GROUP, INC.
(Name of small business issuer in its charter)
COLORADO 75-2811855
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2911 South County Road 1260
Midland, Texas 79706
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (432) 563-3974
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Securities registered under Section 12(b) of the Exchange Act:
Common Stock
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(Title of Class)
Warrants to Purchase Common Stock
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(Title of Class)
Securities registered under Section 12(g) of the Exchange Act:
None
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(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes |X| No
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Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.
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State issuer's revenue for its most recent fiscal year: $12,749,522
The aggregate market value of the voting and non-voting common equity
held by non-affiliates at March 23, 2004, computed by reference to the closing
price of $6.85 per share on the American Stock Exchange, was $16,096,979.
The number of shares outstanding of each of the issuer's classes of
common equity on March 23, 2004, was 5,033,681.
Documents Incorporated by Reference
None
Transitional Small Business Disclosure Format Yes No |X|
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PART 1
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-KSB (this "Report" or this "Form 10-KSB")
contains certain forward-looking statements and information pertaining to us,
our industries and the oil and gas industry that is based on the beliefs of our
management, as well as assumptions made by and information currently available
to our management. All statements, other than statements of historical facts
contained in this Report, including statements regarding our future financial
position, growth strategy, budgets, projected costs, plans and objectives of
management for future operation, are forward-looking statements. Although we
believe our expectations reflected in these forward-looking statements are based
on reasonable assumptions, no assurance can be given that these expectations
will prove to have been correct. Important factors that could cause actual
results to differ materially from the expectations reflected in the
forward-looking statements include, among other things:
o conditions in the gas and oil industry, including the demand
for natural gas and the price of oil and natural gas,
o competition among the various providers of compression
services and products,
o changes in safety, health and environmental regulations
pertaining to the production and transportation of natural
gas,
o changes in economic or political conditions in the markets in
which we operate, and
o introduction of competing technologies by other companies.
In addition, the factors described in "Management's Discussion and
Analysis of Financial Condition and Results of Operation - Risk Factors" could
cause our actual results to differ materially from the expectations reflected in
the forward-looking statements contained herein. These statements relate to
"Description of Business," "Management's Discussion and Analysis of Financial
Condition and Results of Operation" and other sections of this Report. In some
cases, you can identify forward-looking statements by terminology such as "may,"
"will," "should," "expect," "plan," "intend," and "anticipate." The
forward-looking statements in this Report are based largely on our expectations
and are subject to a number of risks and uncertainties, which may be beyond our
control. Actual results may differ materially from the anticipated or implied
results in the forward-looking statements. We do not intend to publicly update
or revise any forward-looking statements, whether as a result of new
information, future events or otherwise. In light of these risks and
uncertainties, we can give no assurances that the forward-looking events and
circumstances included in this Report will occur.
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ITEM 1. DESCRIPTION OF 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 then subsidiary, Great
Lakes Compression, Inc., all of the compression related assets of Dominion
Michigan Petroleum Services, Inc., an unaffiliated company that is a subsidiary
of Dominion Resources, Inc. and that was in the business of manufacturing,
fabricating, selling, leasing and maintaining natural gas compressors. As a part
of the transaction, an affiliate of Dominion Michigan committed to purchase or
to enter into five year leases for compressors totaling five thousand
horsepower. The purchases or leases are to be made by December 31, 2005.
On October 24, 2002, we closed our initial public offering 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.
On January 1, 2004, our wholly-owned subsidiaries were merged into us
except HBRC which will be dissolved in 2004. Thus, all of our assets are owned
by, and our business is conducted through, us.
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
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a clean environment. An ignition system is a pilot light or a spark generator
that assures continuous ignition of the waste gases going through the burner in
the flare tip.
We primarily lease natural gas compressors. As of December 31, 2003, we
had 359 natural gas compressors under lease to third parties.
We also fabricate natural gas compressors for our customers, designing
compressors to meet unique specifications dictated by well pressures, production
characteristics and particular applications for which compression is sought.
We have established an exchange and rebuild program to attempt to help
minimize costs and maximize revenue for our customers. Under the program, we
work with maintenance and operating personnel of a customer to identify
equipment for exchange. When we receive a compressor for exchange because of a
maintenance problem, we deliver to our customer a replacement compressor at full
price. We then rebuild the exchange compressor and credit our customer an amount
based on the value of the rebuilt compressor. We also offer a retrofitting
service by repackaging a customer's compressor with a compressor that meets our
customer's changed conditions.
We design, manufacture, install and service flare stacks and related
ignition and control devices for onshore and offshore burning of gas compounds
such as hydrogen sulfide, carbon dioxide, natural gas and liquefied petroleum
gases.
We have manufacturing and fabrication facilities located in Lewiston,
Michigan, and Midland, Texas, where we manufacture and fabricate natural gas
compressors. We design and manufacture natural gas flare systems, components and
ignition systems in our facility in Midland, Texas, for use in oilfield,
refinery and petrochemical plant applications. We also have service facilities
located in Midland, Texas, Lewiston, Michigan, Bridgeport, Texas and Bloomfield,
New Mexico to provide maintenance inventory and support for our rental
compressor fleet and for third party services.
We currently provide our products and services to a customer base of
oil and gas exploration and production companies operating primarily in
Colorado, Kansas, Louisiana, Michigan, New Mexico, Oklahoma, Texas and Wyoming.
We maintain our principal office at 2911 South County Road 1260,
Midland, Texas 79706 and our telephone number is (432) 563-3974.
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.
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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 well's
production to economically viable levels and enable gas to continue to flow in
the pipeline to its destination. We believe that most producing gas wells in
North America, at some point, will utilize compression. As of December 31, 2002,
the Energy Information Administration reported that there were approximately
386,000 producing gas and gas condensate wells in the United States. The states
where we currently operate, account for approximately 100,000 of these wells.
The Leasing Business
We primarily lease natural gas compressors. As of February 29, 2004, we
had 385 natural gas compressors totaling approximately 43,149 horsepower leased
to 45 third parties, compared to 313 natural gas compressors totaling
approximately 33,240 horsepower leased to 29 third parties at February 28, 2003.
Of the 385 natural gas compressors, 50 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%
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and we owned 50% of HBRC. The non-affiliated company managed HBRC. We split the
expenses of HBRC with the other company. After the payment of expenses, we
received whatever profit is realized by HBRC in proportion to the amount
received by HBRC from the lease of natural gas compressors that are contributed
by us and by the non-affiliated company to HBRC. As of February 28, 2003, we had
contributed 40 compressors and the non-affiliated company had contributed 28
compressors to HBRC.
On March 27, 2003, to be effective January 1, 2003, we purchased and
Hy-Bon sold to us the 28 compressor packages it contributed. In consideration
therefore, we paid Hy-Bon $2,150,000. The $2,150,000 was borrowed by us from our
current lender.
Hy-Bon has withdrawn as a member of HBRC effective as of January 1,
2003. We, as the other member of HBRC, retained all assets of HBRC, which as of
January 1, 2003, had an unaudited aggregate value of approximately $346,000. We
will dissolve HBRC in 2004 and have agreed to not operate using the name Hy-Bon.
In addition to 80 separate written maintenance agreements covering
non-owned compressor units that we had entered into at February 29, 2004, 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, we spent approximately $6,505,500 in 2003
to expand our natural gas compressor inventory, and we intend to spend
approximately $10,200,000 in 2004 on natural gas compressors.
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The size, type and geographic diversity of our rental fleet enables us
to provide our customers with a range of compression units that can serve a wide
variety of applications, and to select the correct equipment for the job, rather
than the customer trying to fit the job to its own equipment. We base our gas
compressor rental rates on several factors, including the cost and size of the
equipment, the type and complexity of service desired by the customer, the
length of contract, and the inclusion of any other services desired, such as
leasing, installation, transportation and daily operation.
Custom Fabrication
We also engineer and fabricate natural gas compressors for our
customers to meet their unique specifications based on well pressure, production
characteristics and the particular applications for which compression is sought.
In order to meet the ongoing needs of our customers for whom we custom
fabricate, we offer a variety of services, including: (i) engineering,
manufacturing and fabrication of the compressors; (ii) installation and testing
of compressors; (iii) ongoing performance review to assess the need for a change
in compression: and (iv) periodic maintenance and parts replacement. We receive
revenue for each service.
Maintenance
Although natural gas compressors generally do not suffer significant
technological obsolescence, they do require routine maintenance and periodic
refurbishing to prolong their useful life. Routine maintenance includes
alignment and compression checks and other parametric checks indicate a change
in the condition of the compressors. In addition, oil and wear-particle analysis
is performed on all compressors. Overhauls are done on a condition-based
interval or a time-based schedule. Based on our past experience, these
maintenance procedures maximize component life and unit availability and
minimize downtime.
As of February 29, 2004, we had written maintenance agreements with
third parties relating to 80 compressors. Each written maintenance agreement has
from two to 5 years left on its term and each expires on December 31 in the
expiration year. During our years ended December 31, 2003 and 2002, we received
revenue of approximately $1,073,000 and $1,058,000 (approximately 8% and 10% 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.
Under the program, we work with our customer's maintenance and
operating personnel to identify and quantify equipment for exchange. When we
receive a compressor for exchange due to a problem with the compressor, we
deliver to our customer a replacement compressor at full price. We then rebuild
the exchange compressor and credit our customer with an amount based on the
value of the compressor we rebuild.
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This program enables our customers to obtain replacement compressors
and shorten the time that the customer is unable to realize gas production from
one or more wells because of the lack of a compressor.
During the years ended December 31, 2003 and 2002, we received revenue
of approximately $597,000 and $630,000 (approximately 4.7% and 6% 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.
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During the years ended December 31, 2003 and 2002, we sold 62 and 39
flare systems, respectively, to our customers generating approximately $821,000
and $759,000 (approximately 6% and 7 % of our total consolidated revenue) in
revenue, respectively.
Major Customers
During our year ended December 31, 2003 and 2002, sales to one
customer, Dominion Michigan, amounted to approximately 28% and 30%,
respectively, of our consolidated revenue.
Continuing Product Development
We engage in a continuing effort to improve our compressor and flare
operations. Continuing development activities in this regard include new and
existing product development testing and analysis, process and equipment
development and testing, and product performance improvement. We also focus our
activities on reducing overall costs to the customer, which include the initial
capital cost for equipment, the monthly leasing cost if applicable, and the
operating costs associated with such equipment, including energy consumption,
maintenance costs and environmental emissions.
During our years ended December 31, 2003 and 2002, we did not spend any
material amounts on research and development activities. Rather, product
improvements were made as a part of our normal operating activities.
Sales and Marketing
General. We conduct our operations from four locations. These
locations, with the exception of our executive offices, maintain an inventory
for local customer requirements, trained service technicians, and manufacturing
capabilities to provide quick delivery and service for our customers. Our sales
force also operates out of these locations and focuses on communication with our
customers and potential customers through frequent direct contact, technical
assistance, print literature, direct mail and referrals. Our sales and marketing
is performed by nine employees.
Additionally, our personnel coordinate with each other to develop
relationships with customers who operate in multiple regions. Our sales
personnel maintain intensive contact with our operations personnel in order to
promptly respond to and address customer needs. Our overall sales efforts
concentrate on demonstrating our commitment to enhancing the customer's cash
flow through enhanced product design, fabrication, manufacturing, installation,
customer service and support.
During the years ended December 31, 2003 and 2002, we spent
approximately $46,000 and $49,000, 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.
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Flare Systems Activity. The flare systems marketing program emphasizes
our ability to design, manufacture, install and service flares with the updated
technology.
Competition
Compression Activity. The natural gas compression business is
competitive. We experience competition from companies with greater financial
resources. On a regional basis, we experience competition from several smaller
companies that compete directly with us. We have a number of competitors in the
natural gas compression segment, but we do not have sufficient information to
determine our competitive position within that group. We believe that we compete
effectively on the basis of price, customer service, including the ability to
place personnel in remote locations, flexibility in meeting customer needs and
quality and reliability of our compressors and related services.
Compressor industry participants can achieve significant advantages
through increased size and geographic breadth. As the number of rental
compressors in our rental fleet increases, the number of sales, support, and
maintenance personnel required and the minimum level of inventory does not
increase commensurately. As a result of economies of scale, we believe that we,
with a growing rental fleet, have relatively lower operating costs and higher
margins than smaller companies.
Flare Systems Activity. The flare business is highly competitive. We
have a number of competitors in the flare systems segment, but we do not have
sufficient information to determine our competitive position within that group.
We believe that we are able to compete by our offering products specifically
engineered for the customer's needs.
Employees
As of December 31, 2003, we had 80 total employees of which 79 were
fulltime employees. No employees are represented by a labor union.
Liability and Other Insurance Coverage
Our equipment and services are provided to customers who are subject to
hazards inherent in the oil and gas industry, such as blowouts, explosions,
craterings, fires, and oil spills. We maintain liability insurance that we
believe is customary in the industry. We also maintain insurance with respect to
our facilities. Based on our historical experience, we believe that our
insurance coverage is adequate.
Government Regulation
We are subject to numerous federal, state and local laws and
regulations relating to the storage, handling, emission and discharge of
materials into the environment, including the Comprehensive Environmental
Response, Compensation and Liability Act, the Clean Water Act, the Clean Air Act
and the Resource Conservation and Recovery Act. As a result of our operations,
we generate or manage hazardous wastes, such as solvents, thinner, waste paint,
waste oil, washdown wastes and sandblast material. We currently spend a
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negligible amount each year to dispose of the wastes. Although we attempt to
identify and address contamination before acquiring properties, and although we
attempt to utilize generally accepted operating and disposal practices,
hydrocarbons or other wastes may have been disposed of or released on or under
properties owned, leased, or operated by us or on or under locations where such
wastes have been taken for disposal. These properties and the wastes or remedial
sites where they have been released might have to be remediated at our expense.
We believe that our existing environmental control procedures are
adequate and we have no current plans for substantial operating or capital
expenditures relating to environmental control requirements. We believe that we
are in substantial compliance with environmental laws and regulations and that
the phasing in of emission controls and other known regulatory requirements at
the rate currently contemplated by such laws and regulations will not have a
material adverse affect on our financial condition or operational results. Some
risk of environmental liability and other costs are inherent in the nature of
our business, however, and there can be no assurance that environmental costs
will not rise. Moreover, it is possible that future developments, such as
increasingly strict requirements and environmental laws and enforcement policies
thereunder, could lead to material costs of environmental compliance by us.
While we may be able to pass on the additional cost of complying with such laws
to our customers, there can be no assurance that attempts to do so will be
successful.
Patents, Trademarks and Other Intellectual Property
We believe that the success of our business depends more on the
technical competence, creativity and marketing abilities of our employees than
on any individual patent, trademark, or copyright. Nevertheless, as part of our
ongoing research, development and manufacturing activities, we have a policy of
seeking patents when appropriate on inventions concerning new products and
product improvements. We currently own two United States patents covering
certain flare system technologies, which expire in May 2006 and in January 2010,
respectively. We do not own any foreign patents. Although we continue to use the
patented technology and consider it useful in certain applications, we do not
consider these patents to be material to our business as a whole.
Suppliers and Raw Materials
With respect to our flare system and compressor operations, our raw
materials used consist of cast and forged iron and steel. Such materials are
generally available from a number of suppliers, and accordingly, we are not
dependent on any particular supplier for these new materials. We currently do
not have long-term contracts with our suppliers of raw materials, but believe
our sources of raw materials are reliable and adequate for our needs. We have
not experienced any significant supply problems in the past.
Certain components of our compressors are obtained primarily from four
suppliers. If either one of our current major suppliers should curtail its
operations or be unable to meet our needs, we would encounter delays in
supplying our customers with compressors until an alternative supplier could be
found. We may not be able to find acceptable alternative suppliers.
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ITEM 2. DESCRIPTION OF PROPERTY
We maintain our executive offices in Midland, Texas. This facility is
owned by us and is used for manufacturing, fabrication, remanufacturing,
operations, testing, warehousing and storage, general and administrative
functions and training.
The facility in Midland is an approximately 24,600 square foot building
that provides us with sufficient space to manufacture, fabricate and test our
equipment on site and has land available to expand the building when needed. Our
current facilities in Midland are anticipated to provide us with sufficient
space and capacity for at least the next year and thus there are no current
plans to open new locations, unless they are acquired as a result of any future
acquisitions.
The facilities in Lewiston, Michigan consist of a total of
approximately 15,360 square feet. Approximately 9,360 square feet are used as
offices and a repair shop and approximately 6,000 square feet are used for
manufacturing and fabrication of compressors and storage.
The facility in Bloomfield, New Mexico is an approximately 4,000 square
foot building that is leased at a current rate of $2,650 per month pursuant to a
lease that terminates in May 2008. Approximately 1,000 square feet are used as
office space and approximately 3,000 square feet are used for shop space.
The facility in Bridgeport, Texas is an approximately 4,500 square foot
building that is leased at a current rate of $1,500 per month pursuant to a
lease that terminates in August 2006. Approximately 4,000 square feet is used as
office space and approximately 500 square feet is used as shop space.
We also own an approximately 4,100 square foot building in Midland that
is leased at a current rate of $1,050 per month to an unaffiliated party
pursuant to a lease that terminates in May 2005. This facility previously
contained our executive offices and manufacturing and fabrication operations.
We believe that our properties are generally well maintained and in
good condition.
ITEM 3. LEGAL PROCEEDINGS
There are no pending legal proceedings against our properties or us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit anything to a vote of our security holders during the
fourth quarter of our fiscal year ended December 31, 2003.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS
ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock and warrants are quoted on the American Stock Exchange under
the symbols NGS and NGS.WS, respectively. The following table sets forth for the
periods indicated the high and low sales prices for our common stock and
warrants as reported by the American Stock Exchange. Our common stock and
warrants began trading on October 21, 2002.
----------------------------------- ---------------------- ---------------------
Common Stock Warrants
----------------------------------- ---------------------- ---------------------
High Low High Low
----------------------------------- ---------- ----------- ---------- ----------
Oct. 21, 2002 through Dec. 31, 2002 $4.25 $3.35 $0.90 $0.25
----------------------------------- ---------- ----------- ---------- ----------
2003
----------------------------------- ---------- ----------- ---------- ----------
First Quarter $4.30 $3.70 $0.80 $0.63
----------------------------------- ---------- ----------- ---------- ----------
Second Quarter $7.25 $3.65 $1.55 $0.55
----------------------------------- ---------- ----------- ---------- ----------
Third Quarter $6.75 $5.45 $1.65 $1.06
----------------------------------- ---------- ----------- ---------- ----------
Fourth Quarter $6.24 $5.25 $1.70 $1.25
----------------------------------- ---------- ----------- ---------- ----------
As of December 31, 2003, there were approximately 25 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.
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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 after April 24, 2003, if our common stock trades for 20
consecutive trading days after the six-month period at a price of $6.50 or more
per share.
The following is a table with information regarding our equity
compensation plans as of December 31, 2003:
---------------------- ---------------------- ----------------------- ------------------------
Plan category Number of securities Weighted-average Number of securities
to be issued upon exercise price of remaining available for
exercise of outstanding options, future issuance under
outstanding options, warrants and rights equity compensation
warrants and rights plans (excluding s
ecurities reflected in
column (a))
(a) (c)
(b)
---------------------- ---------------------- ----------------------- ------------------------
Equity compensation
plans approved by
security holders 80,000 $3.92 70,000
---------------------- ---------------------- ----------------------- ------------------------
Equity compensation
plans not approved by
security holders - - -
---------------------- ---------------------- ----------------------- ------------------------
Total 80,000 $3.92 70,000
---------------------- ---------------------- ----------------------- ------------------------
Sales of Unregistered Securities During the Year Ended December 31, 2003
During the three months ended June 30, 2003, holders of 24,000 shares
of our outstanding 10% Convertible Series A Preferred Stock converted the shares
into 24,000 shares of our common stock. There was no underwriter involved in the
transactions. The shares of our common stock were all issued in reliance upon
the exemption contained in Section 4(2) of the Securities Act of 1933, as
amended, because all of the persons were accredited investors and appropriate
restrictive legends were place on the certificates unless the shares were sold
pursuant to the provisions of Rule 144.
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
14
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.
During the three months ended September 30, 2003, holders of 14,000
shares of our outstanding 10% Convertible Series A Preferred Stock converted the
shares into 14,000 shares of our common stock. There was no underwriter involved
in the transactions. The shares of our common stock were all issued in reliance
upon the exemption contained in Section 4(2) of the Securities Act of 1933, as
amended, because all of the persons were accredited investors and appropriate
restrictive legends were placed on the certificates unless the shares were sold
pursuant to the provisions of Rule 144.
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 nor 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.
In October 2003, we issued 3,000 shares of our common stock at $3.25
per share upon the exercise of a warrant by a holder thereof. The shares were
issued in a transaction not involving a public offering and were issued in
reliance upon the exemption from registration provided by Section 4(2) of the
Securities Act of 1933. The 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 the issuance of the 3,000 shares.
On December 3, 2003 and on December 31, 2003, we granted options to
purchase in the aggregate 15,000 shares of our common stock and 12,500 shares of
our common stock, respectively, to three employees (an option to purchase 15,000
shares) and to five of our independent directors (options to purchase an
aggregate of 12,500 shares). We do not consider grants of these options to
constitute sales.
On December 9, 2003, we issued 6,000 shares of our common stock at
$2.00 per share upon the exercise of options by a holder thereof. The shares
were issued in a transaction not involving a public offering and were issued in
reliance upon the exemption from registration provided by Section 4(2) of the
Securities Act of 1933. The person to whom the shares were issued had access to
full information concerning us.
No repurchases of our securities were made by on our behalf of us or
any "affiliated purchaser" as defined in Rule 10b - 18(a)(3) during the fourth
quarter of the year ended December 31, 2003.
15
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion should be read in conjunction with the
consolidated financial statements and attached notes thereto and the other
financial information included elsewhere in this Report. This discussion
contains forward-looking statements that involve risks and uncertainties. Our
actual results could differ materially from those anticipated in these forward
looking statements as a result of any number of factors, including those set
forth under the section entitled "Risk Factors" and elsewhere in this Report.
Overview
We have combined the operations of our wholly-owned subsidiaries:
Rotary Gas Systems, NGE Leasing and Great Lakes Compression. These entities
provide products and services to the oil and gas industry and are engaged in (1)
the manufacture, sale and rental of natural gas compressors to enhance the
productivity of oil and gas wells, and (2) the manufacture, sale and rental of
flares and flare ignition systems for plant and production facilities. We have
been the parent company and provide administrative and management support and,
therefore, have expenses associated with that activity. On January 1, 2004, we
merged our subsidiaries into us.
We acquired the compression related assets of Great Lakes from Dominion
Michigan on March 27, 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 and continuing through December 31,
2003.
Results of Operations
Fiscal Year Ended December 31, 2003 Compared to Fiscal Year Ended December 31,
2002.
Natural Gas
Great Lakes Services
Rotary Gas NGE Leasing Compression Group Total
----------- ----------- ----------- ----------- -----------
Twelve Months Ended December 31, 2003
Revenue $ 2,884 $ 4,803 $ 5,062 $ -- $ 12,749
Gross margin 1,255 3,418 2,020 -- 6,693
Selling, general and administrative expense 924 174 317 878 2,293
Depreciation 150 888 662 25 1,725
Interest expense 7 475 162 23 667
Other income (expense) (4) (11) 11 -- (4)
Equity in earnings from joint venture -- -- -- --
----------- ----------- ----------- ----------- -----------
Income before income taxes $ 170 $ 1,870 $ 890 $ (926) $ 2,004
=========== =========== =========== =========== ===========
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 (expense) 4 15 -- -- 19
Equity in earnings from joint venture -- 485 -- -- 485
----------- ----------- ----------- ----------- -----------
Income before income taxes $ 411 $ 1,177 $ 364 $ (582) $ 1,370
=========== =========== =========== =========== ===========
16
Rotary Gas Systems Operations
Revenue from outside sources decreased 13% or $414,000 for the twelve
months ended December 31, 2003, as compared to the same period ended December
31, 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 compressor units to third parties.
The gross margin percentage increased from 40% for the twelve months
ended December 31, 2002, to 44% for the same period ended December 31, 2003. The
cost of revenue is comprised of expenses associated with service, parts and
manufacturing expenses. This increase resulted mainly from a change in the
product mix.
Selling, general and administrative expense increased $133,000 or 17%
for the twelve months ended December 31, 2003, as compared to the same period
ended December 31, 2002. This was mainly the result of the addition of new
salesmen in the Farmington, New Mexico and West Texas areas.
Depreciation expense increased 23% or $28,000 for the twelve months
ended December 31, 2003, as compared to the same period ended December 31, 2002.
This increase was mainly due to the purchase of additional sales vehicles, shop
and office equipment.
NGE Leasing Operations
Revenue from our rental of natural gas compressors increased $2,484,000
or 107% for the twelve months ended December 31, 2003, as compared to the same
period in 2002. This increase is the result of units added to our rental fleet.
From December 31, 2002, to December 31, 2003, we added 95 gas compressor units
to our rental fleet, which included the 28 units we purchased from Hy-Bon on
March 31, 2003. The revenue from the Joint Venture, which was previously
accounted for using the equity method, has been consolidated beginning January
1, 2003. The profit earned on the units purchased from Hy-Bon is included in our
consolidated earnings beginning April 1, 2003.
The gross margin percentage decreased from 72% for the twelve months
ended December 31, 2002 to 71% for the same period ending 2003. This decrease
mainly resulted from a slight increase in maintenance expenses associated with
rental compressor units.
17
Selling, general and administrative expense increased $13,000 or 8% for
the twelve months ended December 31, 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 102% or $449,000 for the twelve months
ended December 31, 2003, as compared to the same period 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 an increase in interest expense of 21% from $392,000 for the
twelve months ended December 31, 2002, to $475,000 for the same period ended
December 31, 2003. This is mainly as a result of an increase in bank debt used
to purchase equipment for the rental fleet and service vehicles.
Great Lakes Compression
Revenue increased 8% for the twelve months ended December 31, 2003,
compared to the same period in 2002. This increase resulted from a decrease in
the sales of compressor units to third parties offset by increases in parts and
labor sales. Because our compressor units are custom-built, fluctuations in
revenue from outside sources are expected.
The gross margin percentage increased from 37% for the twelve months
ended December 31, 2002 to 40% 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 an increase in service and parts revenues.
Selling, general and administrative expense increased by 18% or $49,000
for the twelve months ended December 31, 2003, as compared to the same period in
2002. This is mainly the result of an increase in advertising and promotional
expenses.
Depreciation expense increased from $558,000 for the twelve months
ended December 31, 2002, to $662,000 for the same period ended December 31,
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 70% from $537,000 for the
twelve months ended December 31, 2002 to $162,000 for the twelve months ended
December 31, 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.
18
Natural Gas Services Group
Selling, general and administrative expense increased 77% from $497,000
for the twelve months ended December 31, 2002, as compared to $878,000 for the
same period ended December 31, 2003. This was mainly the result of the added
expense associated with being a publicly held company such as legal fees,
auditor fees, underwriters and public relations fees.
Amortization and depreciation expense decreased 47% from $47,000 for
the twelve months ended December 31, 2002, to $25,000 for the same period ended
December 31, 2003. This mainly resulted from vehicles that were moved to our
then subsidiary, Great Lakes Compression.
Interest expense decreased 39% from $38,000 for the twelve months ended
December 31, 2002, to $23,000 for the same period ended December 31, 2003. This
decrease resulted from a reduction in the interest rate and from bank notes for
vehicles moved to our then subsidiary.
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 us. Income tax expense increased $113,000, or 19%, primarily due to the
increase in net taxable income.
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
19
Revenue recognition
We recognize revenue from sales of compressors or flare systems at the
time of shipment and passage of title when collectability is reasonably assured.
We also offer certain of our customers the right to return products that do not
function properly within a limited time after delivery. We continuously monitor
and track such product returns and we record a provision for the estimated
amount of such future returns, based on historical experience and any
notification we receive of pending returns. While such returns have historically
been within our expectations and the provisions established, we cannot guarantee
that we will continue to experience the same return rates that we have in the
past. Any significant increase in product failure rates and the resulting credit
returns could have a material adverse impact on our operating results for the
period or periods in which such returns occur.
When product is billed to customers based on contractual agreements,
but has not yet been shipped, payments are recorded as deferred revenue, pending
shipment.
Rental and lease revenue are recognized over the terms of the
respective lease agreements based upon the classification of the lease.
Service and maintenance revenue is recognized as the service is
provided or over the term of the agreement, as applicable.
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 38% of our accounts receivable
are concentrated in approximately two customers at December 31, 2003, 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
20
likelihood that our deferred tax assets will be recovered from future taxable
income and to the extent we believe that recovery is not probable, we must
establish a valuation allowance. To the extent we establish a valuation
allowance or increase this allowance in a period, we must include an expense in
the tax provision in the statement of operations.
Significant management judgment is required in determining our
provision for income taxes, our deferred tax assets and liabilities and any
valuation allowance recorded against our net deferred tax assets.
Valuation of long-lived and intangible assets and goodwill
We assess the impairment of identifiable intangibles, long-lived assets
and related goodwill whenever events or changes in circumstances indicate that
the carrying value may not be recoverable. Factors we consider important which
could trigger an impairment review include the following:
o significant underperformance relative to expected historical
or projected future operating results;
o significant changes in the manner of our use of the acquired
assets or the strategy for our overall business; and
o significant negative industry or economic trends;
When we determine that the carrying value of intangibles, long-lived
assets and related goodwill may not be recoverable based upon the existence of
one or more of the above indicators of impairment, we measure any impairment
based on a projected discounted cash flow method using a discount rate
determined by our management to be commensurate with the risk inherent in our
current business model.
In 2002, Statement of Financial Accounting Standards ("FAS") No. 142,
"Goodwill and Other Intangible Assets" became effective and as a result, we
ceased to amortize approximately $2.6 million of goodwill as of January 1, 2002.
In lieu of amortization, we are required to perform an annual impairment review
of our goodwill. Based upon valuations in July 2002 and June 2003, of our
reporting units with goodwill, we did not record an impairment charge during
either year.
Inventories
We value our inventory at the lower of the actual cost to purchase
and/or manufacture the inventory or the current estimated market value of the
inventory. We regularly review inventory quantities on hand and record a
provision for excess and obsolete inventory based primarily on our estimated
forecast of product demand and production requirements.
21
Recently Issued Accounting Pronouncements
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 148. 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 of FAS 148 as of December 31, 2002.
In June 2003, the FASB approved SFAS 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS
150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. This
statement is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise was effective at the beginning of the Company's
third quarter of fiscal 2003. Implementation of SFAS 150 did not affect the
Company's financial position.
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 year ended December 31, 2003, or during the year ended
December 31, 2002.
Liquidity and Capital Resources
We have funded our operations through public and private offerings of
our common and preferred stock, subordinated debt, and bank debt. At December
31, 2003, we had cash and cash equivalents of approximately $176,000, a working
capital deficit of approximately $288,000 and debt of approximately $9,014,000
of which approximately $2,364,000 was classified as current. We had
approximately $3,024,000 of net cash flow from operating activities during the
twelve months ending December 31, 2003. This was primarily from net income of
approximately $1,307,000 plus depreciation and amortization of approximately
$1,726,000 and increases in deferred taxes of approximately $672,000, and
decrease in accounts receivable of approximately $391,000.
22
Market Risk
We significantly rely upon debt financing provided by various financial
institutions. Most of these instruments contain interest provisions that are at
least a percentage point above the published prime rate. This creates a
vulnerability to us relative to the movement of the prime rate. Should the prime
rate increase, our cost of funds will increase and affect our ability to obtain
additional debt. We have not engaged in any hedging activities to offset such
risks.
Risk Factors
You should carefully consider the following risks. The risks and
uncertainties described below are not the only ones facing us. Additional risks
and uncertainties that are not presently known to us or that we currently deem
immaterial may also impair our business.
If any of the events described in the following risks actually occur,
our business, financial condition and results of operations could be materially
adversely affected. In such case, the trading prices of our common stock or
warrants could decline and you could lose all or part of your investment.
Our current debt is large and may negatively impact our current and future
financial stability.
As of December 31, 2003 we had an aggregate of approximately $9,014,000
of outstanding indebtedness not including accounts payable and accrued expenses
of approximately $1,071,000. 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 December 31, 2003, our debt service requirements on a monthly,
quarterly and annual basis were approximately $223,000, $670,000, and
$2,681,000, respectively. It is possible that our business will not generate
sufficient cash flow from operations to meet our debt service requirements and
the payment of principal when due. If this were to occur, we may be forced to:
23
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 70% of our compressor leases are leased for terms of six months or
less that, if terminated, would adversely impact our revenue and our ability to
recover our initial equipment costs.
Approximately 70% of our compressor leases are for terms of up to six
months. There is a possibility that these leases could be terminated by lessees
within short periods of time and that we may not be able to recover the cost of
the compressor for which a lease is terminated.
The anticipated revenue from the affiliate of Dominion Michigan cannot be
guaranteed.
24
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 years ended December 2003 and 2002, Dominion Exploration &
Production, Inc. accounted for approximately 28% and 30% 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 23% of our compressor components from
two suppliers. We order from these suppliers as needed and we have no long-term
contracts with any of these suppliers. If any of these of these suppliers should
curtail its operations or be unable to meet our needs, we would encounter delays
in supplying our customers with compressors until an alternative supplier, if
any, could be found. Such delays in our manufacturing process could reduce our
revenue and negatively impact our relationships with customers.
Decreased oil and gas industry expenditure levels would adversely affect our
revenue.
Our revenue is derived from expenditures in the oil and gas industry
which, in turn, are based on budgets to explore for, develop and produce oil and
natural gas. If these expenditures decline, our revenue will suffer. The
industry's willingness to explore, develop and produce depends largely upon the
prevailing view of future oil and gas prices. Many factors affect the supply and
demand for oil and gas and, therefore, influence product prices including:
o the level of oil and gas production;
o the levels of oil and gas inventories;
o the expected cost of developing new reserves;
o the cost of producing oil and gas;
o the level of drilling activity;
o inclement weather;
25
o worldwide economic activity;
o regulatory and other federal and state requirements in the
United States;
o the ability of the Organization of Petroleum Exporting
Countries to set and maintain production levels and prices for
oil;
o terrorist activities in the United States and elsewhere;
o the cost of developing alternate energy sources;
o environmental regulation; and
o tax policies.
If the demand for oil and gas decreases, then demand for our
compressors likely will decrease.
The intense competition in our industry could result in reduced profitability
and loss of market share for us.
We sell or lease our products and sell our services in competitive
markets. In most of our business segments, we compete with the oil and gas
industry's largest equipment and service providers who have greater name
recognition than we do. These companies also have substantially greater
financial resources, larger operations and greater budgets for marketing,
research and development than we do. They may be better able to compete in
making equipment available quickly and more efficiently, meeting delivery
schedules or reducing prices. As a result, we could lose customers and market
share to those competitors. These companies may also be better positioned than
us to successfully endure down turns in the oil and gas industry.
Our operations may be adversely affected if our current competitors or
new market entrants introduce new products or services with better prices,
features, performance or other competitive characteristics than our products and
services. Competitive pressures or other factors also may result in significant
price competition that could harm our revenue and our business.
We might be unable to employ adequate technical personnel, which could hamper
our plans for expansion or increase our costs.
Many of the compressors that we sell or lease are technically complex
and often must perform in harsh conditions. We believe that our success depends
upon our ability to employ and retain a sufficient number of technical personnel
who have the ability to design, utilize, enhance and maintain these compressors.
Our ability to expand our operations depends in part on our ability to increase
our skilled labor force. The demand for skilled workers is high and supply is
limited. A significant increase in the wages paid by competing employers could
result in a reduction of our skilled labor force or cause an increase in the
wage rates that we must pay or both. If either of these events were to occur,
our cost structure could increase and our operations and growth potential could
be impaired.
26
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 waste on these properties may be subject to federal or state
environmental laws that could require us to remove the wastes or remediate sites
where they have been released. We could be exposed to liability for cleanup
costs, natural resource and other damages as a result of our conduct or the
conduct of, or conditions caused by, prior operators or other third parties.
Environmental laws and regulations have changed in the past, and they are likely
to change in the future. If existing regulatory requirements or enforcement
policies change, we may be required to make significant unanticipated capital
and operating expenditures.
27
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.
28
Loss of key members of our management could adversely affect our business while
we attempt to find their replacements.
We depend on the continued employment and performance of Wallace C.
Sparkman, our interim President since the death of Wayne Vinson, Earl R. Wait,
our Treasurer and Chief Financial Officer, and other key members of our
management. If any of our key managers resigns or becomes unable to continue in
his present role and is not adequately replaced, our business operations could
be materially adversely affected.
We are reliant on our current customers for future cash flows and the loss of
one or more of our current customers could adversely affect our results of
operations.
Our business is dependent not only on securing new customers but also
on maintaining current customers. Dominion Exploration & Production, Inc., an
affiliate of Dominion Resources, Inc., accounted for approximately 28% and
approximately 35% of our consolidated revenue during the year ended December 31,
2003 and the year ended December 31, 2002, respectively. The loss of one or more
of our significant customers would have an adverse effect on our revenue and
results of operations.
Provisions contained in our governing documents could hinder a change in our
control.
Our articles of incorporation and bylaws contain provisions that may
discourage acquisition bids and may limit the price investors are willing to pay
for our common stock and warrants. Our articles of incorporation and bylaws
provide that:
o directors will be elected for three-year terms, with
approximately one-third of the board of directors standing for
election each year;
o cumulative voting is not allowed which limits the ability of
minority shareholders to elect any directors;
o the unanimous vote of the board of directors or the
affirmative vote of the holders of not less than 80% of the
votes entitled to be cast by the holders of all shares
entitled to vote in the election of directors is required to
change the size of the board of directors; and
o directors may only be removed for cause by holders of not less
than 80% of the votes entitled to be cast on the matter.
Our board of directors has the authority to issue up to five million
shares of preferred stock. The board of directors can fix the terms of the
preferred stock without any action on the part of our shareholders. The issuance
of shares of preferred stock may delay or prevent a change in control
transaction. In addition, preferred stock could be used in connection with the
29
board of director's adoption of a shareholders' rights plan (also known as a
poison pill), which would make it much more difficult to effect a change in
control of our company through acquiring or controlling blocks of stock. Also,
after completion of this offering, our directors and officers as a group will
continue to beneficially own stock. Although this is not a majority of our
stock, it confers substantial voting power in the election of directors and
management of our company. This would make it difficult for other minority
shareholders, such as the investors in this offering, to effect a change in
control or otherwise extend any significant control over the management of our
company. This may adversely affect the market price and interfere with the
voting and other rights of our common stock.
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. As of February 29, 2004, our common stock has not traded at
the required threshold in order to trigger the automatic conversion of the
preferred stock.
We will have a comparatively low number of shares of common stock and warrants
outstanding and, therefore, our common stock and warrants may suffer from
limited liquidity and their prices will likely be volatile and their value may
be adversely affected.
Because the number of freely transferable shares of our common stock
and number of our warrants will be low, the trading prices of our common stock
and warrants 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 and warrants 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.
30
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 underperformance relative to expected historical
or projected future operating results;
o significant changes in the manner of our use of the acquired
assets or the strategy for our overall business;
o significant negative industry or economic trends;
o significant decline in our stock price for a sustained period;
and
o our market capitalization relative to net book value.
We adopted FAS 142 as of January 1, 2002. Based on an independent
valuation in July 2002 and June 2003 of our reporting units with goodwill,
adoption of FAS 142 did not have a material adverse effect on us in 2002 or
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 $2,704,000 as of December 31, 2003, 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.
Item 7. FINANCIAL STATEMENTS
See Financial Statements beginning on page F-1.
31
Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
We did not change our principal independent accountant for the years
ended December 31, 2003 or December 31, 2002.
Item 8A. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our chief executive officer and our principal accounting officer, we
have evaluated the effectiveness of our disclosure controls and procedures as of
December 31, 2003. They have concluded that these disclosure controls provide
reasonable assurance that we can collect process and disclose, within the time
periods specified in the Commission's rules and forms, the information required
to be disclosed in our periodic Exchange Act reports.
There have been no significant changes in our internal controls or in
other factors that could significantly affect our internal controls subsequent
to the date of their most recent evaluation.
32
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT.
Executive Officers and Directors
The table below contains information about our executive officers and
directors:
Name Age Position
---- --- --------
Wallace O. Sellers(1)(2)(3) 74 Director, Chairman
Wallace C. Sparkman(5) 73 Director, Interim President
and Chief Executive Officer
Charles G. Curtis(1)(2) (3) 71 Director
William F. Hughes, Jr. (1)(2) (3) 51 Director
Gene A. Strasheim(1)(2)(3)(4) 62 Director
Richard L. Yadon(1)(2)(3) 45 Director
Earl R. Wait 60 Chief Financial Officer and
Treasurer
Ronald D. Bingham 59 Vice President
S. Craig Rogers 41 Vice President
Scott W. Sparkman(5) 42 Secretary
---------------------
(1) Member of our audit committee
(2) Member of our compensation committee
(3) Member of our nominating committee
(4) Gene A. Strasheim has been determined by our Board of Directors to
be the financial expert on our audit committee. Mr. Strasheim is
independent as that term is used in Item 7 (d)(3)(iv) of Schedule A
of the Exchange Act.
(5) Wallace C. Sparkman is the father of Scott W. Sparkman.
The Board of Directors has been divided into three classes with
directors serving staggered three-year terms. With respect to the existing Board
of Directors, the terms of Messrs. Hughes (who replaced James T. Grigsby on the
Board of Directors), Sparkman (who replaced Scott W. Sparkman on the Board of
Directors), and Yadon will expire in 2004 and the terms of Messrs. Curtis,
Sellers and Strasheim will expire in 2005. 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. Mr. Sellers
was the Chairman of the Board of Directors of Great Lakes Compression from
February 2001 to December 31, 2003. Although Mr. Sellers retired in December
1994, he served as Vice-Chairman of the Board and Chairman of the Executive
Committee of Enhance Financial Services, Inc., a financial guaranty reinsurer,
from January 1995 to 2001. From November 1986 to December 1991 he was President
and Chief Executive Officer of Enhance. From 1951 to 1986 Mr. Sellers was
33
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.
Wallace C. Sparkman is one of our founders and has served as a director
since 2003. He was appointed Interim President and Chief Executive Officer
following the death of Wayne Vinson in March 2004 until our Board of Directors
appoints a new President and Chief Executive Officer. Mr. Sparkman was the
President of NGE from July 2001 to December 31, 2003, a director of NGE from
February 1996 to December 31, 2003, 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. From December 1998 to 2003, Mr.
Sparkman was 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.
Charles G. Curtis has been one of our directors since April 2001. Since
1992, Mr. Curtis has been the President and Chief Executive Officer of Curtis
One, Inc. d/b/a/ Roll Stair, a manufacturer of aluminum and steel mobile stools
and mobile ladders. From 1988 to 1992, Mr. Curtis was the President and Chief
Executive Officer of Cramer, Inc. a manufacturer of office furniture. Mr. Curtis
has a B.S. degree from the United States Naval Academy and a MSAE degree from
the University of Southern California.
William F. Hughes, Jr. has been one of our directors since December
2003. Since 1983, Mr. Hughes has been co-owner of The Whole Wheatery, LLC, a
natural foods store located in Lancaster, California. Mr. Hughes holds a
Bachelor of Science degree in Civil Engineering from the U.S. Air Force Academy
and a Masters of Science in Engineering from UCLA.
34
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.
Earl R. Wait has served as our Chief Financial Officer since May 2000
and our Treasurer since 1998. Mr. Wait was our Chief Accounting Officer from
1998 to May 2000. Mr. Wait was the Chief Financial Officer and
Secretary/Treasurer of Flare King and then Rotary from April 1993 to December
31, 2003, the Controller and Assistant Secretary/Treasurer for Hi-Tech from 1994
to 1999, a director of NGE and Rotary from July 1999 to April 2001 and the Chief
Accounting Officer and Treasurer of Great Lakes Compression from February 2001
to December 31, 2003. Mr. Wait is a certified public accountant with an MBA in
management and has more than 25 years of experience in the energy industry.
Ronald D. Bingham has served as one of our Vice Presidents since
December 2003 and was the President of Great Lakes Compression from 2001 to
December 31, 2003. From March 2001 to July 2001, Mr. Bingham was the General
Manager of Great Lakes Compression. From January 1989 to March 2001, Mr. Bingham
was the District Manager for Waukesha Pearce Industries, Inc., a distributor of
Waukesha natural gas engines. Mr. Bingham is a member of the Michigan Oil and
Gas Association and received a bachelors degree in Graphic Arts from Sam Houston
State University.
S. Craig Rogers has served as one of our Vice Presidents since June
2003. He served as Operations Manager for Rotary from 1995 to December 31, 2003,
and Vice President of Rotary from April 2002 to December 31, 2003. From March
1987 to January 1995, Mr. Rogers was the Shop Manager for CSI, a major
manufacturer of natural gas compressors.
Scott W. Sparkman has served as our Secretary since December 1998. Mr.
Sparkman was Executive Vice-President of NGE from July 2001 to December 31,
2003, was a director of NGE from December 1998 to December 31, 2003, was
Secretary and Treasurer of NGE from March 1999 to December 31, 2003 and was the
Secretary of Great Lakes Compression from February 2001 to December 31, 2003.
Mr. Sparkman was one of our directors from 1998 to 2003. Mr. Sparkman served as
35
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 received a BBA
degree from Texas A&M University
All of the officers devote substantially all of their working time to
our business.
Section 16(A) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our
officers and directors and persons who beneficially own more than 10% of our
outstanding common stock to file reports of beneficial ownership with the
Securities and Exchange Commission and to furnish us with copies of the reports.
Based solely on a review of the Forms 3, 4 and 5 and amendments thereto
furnished to us for 2003 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:
o Ronald D. Bingham was late in filing his Form 3;
o S. Craig Rogers was late in filing his Form 3;
o Charles G. Curtis was late in filing a Form 4 to report two
acquisitions of warrants, was late in filing a Form 4 to
report the grant of a nonqualified option to him which Charles
G. Curtis reported on a Form 5 and filed amendments to Forms 4
he previously filed;
o William F. Hughes, Jr. was late in filing a Form 4 to report
the grant of a nonqualified option to him which William F.
Hughes reported on a Form 5;
o Wallace O. Sellers was late in filing a Form 4 to report two
transactions and was late in filing a Form 4 to report the
grant of a nonqualified option to him which Wallace O. Sellers
reported on a Form 5;
o Gene A. Strasheim was late in filing a Form 4 to report the
grant of a nonqualified option to him which Gene A. Strasheim
reported on a Form 5; and
o Richard L. Yadon was late in filing a Form 4 to repot the
grant of a nonqualified option to him which Richard L. Yadon
reported on a Form 5.
36
Code of Ethics
Our Board of Directors has adopted a Code of Business Conduct and
Ethics ("Code"), which we intend to post on our web site located at
WWW.NGSGI.COM. You may also obtain a copy of our Code by requesting a copy in
writing at 2911 SCR 1260, Midland, TX 79706 or by calling us at (432) 563-3974.
Our Code provides general statements of our expectations regarding
ethical standards that we expect our directors, officers and employees to adhere
to while acting on our behalf. Among other things, the Code provides that:
o We will comply with all laws, rules and regulations;
o Our directors, officers and employees are to avoid conflicts
of interest and are prohibited from competing with us or
personally exploiting our corporate opportunities;
o Our directors, officers and employees are to protect our
assets and maintain our confidentiality;
o We are committed to promoting values of integrity and fair
dealing; and
o We are committed to accurately maintaining our accounting
records under generally accepted accounting principles and
timely filing our periodic reports.
Our Code also contains procedures for our employees to report,
anonymously or otherwise, violations of the Code.
ITEM 10. EXECUTIVE COMPENSATION
Executive Compensation
The following table sets forth information regarding the compensation
paid during the years ended December 31, 2003, 2002 and 2001 by us to Wayne L.
Vinson, Earl R. Wait and Craig Rogers our only officers whose combined salary
and bonuses exceeded $100,000 during the year ended December 31, 2003.
Long-Term
Annual Compensation Compensation Awards
------------------- --------------------
Name
Securities Underlying
Principal Position Year Salary Bonus Options
------------------ ---- ------ ----- -----------------------
Wayne L. Vinson 2003 $ 120,000(1) $ 48,000 -0-
Executive Vice President 2002 $ 120,000(1) $ 39,452 -0-(2)
until 7/25/01 2001 $ 102,692(1) $ 25,583 -0-
President from7/25/01 until
3/15/04
Earl R. Wait 2003 $ 90,000 $ 41,256 -0-
Chief Financial Officer 2002 $ 90,000 $ 29,589 15,000
2001 $ 85,385 $ 23,164 -0-
37
S. Craig Rogers 2003 $ 88,500 $ 37,669 -0-
Vice President 2002 $ 80,000 $ 26,301 12,000
Since June 2003 2001 $ 64,615 $ 20,957 -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 2003,
2002 and 2001, 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 was not a partner in
CAV-RDV, Ltd. and disclaimed 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 paid to our officers.
The Board of Directors may discontinue the bonus program at any time.
Option Grants in Last Fiscal Year
We did not grant any options to Wayne L. Vinson, Earl R. Wait or S.
Craig Rogers, our officers whose combined salary and bonuses exceeded $100,000
during our year ended December 31, 2003.
Aggregate Option Exercises in Last Fiscal Year and Fiscal Year End Option Values
The following table sets forth information pertaining to option
exercises by, and fiscal year end option values of options held by, Wayne L.
Vinson, Earl R. Wait, and S. Craig Rogers, our only executive officers whose
combined salary and bonuses exceeded $100,000 during the year ended December 31,
2003:
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 Received Exercisable/Unexercisable Exercisable/Unexercisable
---- ----------- -------- --------------------------- -----------------------------
Wayne L. Vinson 0 0 0/0 0/0
Earl R. Wait 0 0 10,000/15,000 $23,000/$34,500
S. Craig Rogers 0 0 8,000/12,000 $18,400/$27,600
38
Compensation of Directors
Our directors who are not employees are paid $1,000 per quarter and at
December 31 of each year are issued a five year option to purchase 2,500 shares
of our common stock at the then market value. On December 31, 2003, we granted
an option to each of our five non-employee directors to purchase 2,500 shares of
our common stock at $5.55 per share. 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. The following options to
purchase our common stock have been granted under the plan and are outstanding:
o 12,000 shares at an exercise price of $2.00 per share,
o 33,000 shares at an exercise price of $3.25 per share,
o 7,500 shares at an exercise price of $3.88 per share, and
o 18,500 shares at an exercise price of $5.55 per share.
Limitations on Directors' and Officers' Liability
Our Articles of Incorporation provide our officers and directors with
certain limitations on liability to us or any of our shareholders for damages
for breach of fiduciary duty as a director or officer involving certain acts or
omissions of any such director or officer.
This limitation on liability may have the effect of reducing the
likelihood of derivative litigation against directors and officers and may
discourage or deter shareholders or management from bringing a lawsuit against
directors and officers for breach of their duty of care even though such an
action, if successful, might otherwise have benefited our shareholders and us.
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
39
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.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table sets forth, as of March 18, 2004, the beneficial
ownership of our common stock and our 10% convertible series preferred 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 and
benefically own more than five percent of our 10% convertible series preferred
stock.
Shares of
Shares of Convertible Series
Common Stock Percent A Preferred Stock Percent
Beneficially Beneficially Beneficially Beneficially
Name and Address Owned Owned Owned Owned
---------------- ------------ ------------ ------------------ ------------
Wallace O. and Naudain Sellers 700,659(1) 14% -0- -0-
P.O. Box 106
6539 Upper York Road
Solebury, PA 18963-0106
Charles G. Curtis 68,000(2) 1.3% 18,000 5.2%
1 Penrose Lane
Colorado Springs, CO 80906
William F. Hughes 244,500(3) 4.8% 12,000 3.5%
42921 Normandy Lane
Lancaster, CA 93536
Wallace C. Sparkman 167,691(4) 3.3% -0- -0-
4906 Oakwood Court
Midland, TX 79707
40
Gene A. Strasheim 2,500 .05% -0- -0-
165 Huntington Place
Colorado Springs, CO 80906
Richard L. Yadon 296,683(5) 5.9% -0- -0-
P.O. Box 8715
Midland, TX 79708-8715
S. Craig Rogers 14,250 (6) .3% -0- -0-
14732 Bluestem Ave
Gardendale, TX 79758
Earl R. Wait 75,000(7) 1.5% -0- -0-
109 Seco
Portland, TX 78374
Scott W. Sparkman 516,467(8) 10.2% -0- -0-
1604 Ventura Avenue
Midland, TX 79705
All directors and executive 2,085,750 (9) 39.5% 30,000 8.7%
officers as a group
(nine persons)
CAV-RDV, Ltd. 488,128(10) 9.7% -0- -0-
1541 Shannon Drive
Lewisville, TX 75077
RWG Investments LLC 424,000(11) 8.3% 12,000 3.5%
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, options to purchase 2,500
shares of common stock at $3.88 per share and 2,500 shares of common
stock at $5.55 per share, respectively, 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) Represents warrants to purchase 40,000 shares of common stock at $3.25
per share, options to purchase 2,500 shares of common stock at $3.88
per share and 2,500 shares of common stock at $5.55 per share,
respectively, and 18,000 shares of common stock which may be obtained
upon conversion of shares of our 10% Convertible Series A Preferred
Stock.
(3) Includes 168,500 shares of common stock owned by the William and
Cheryl Hughes Family Trust, a warrant to purchase 60,000 shares of
common stock at $3.25 per share, on option to purchase 2,500 shares of
common stock at $5.55 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.
(4) Includes 105,691 shares owned by Diamente Investments, LLP, a Texas
limited partnership of which Mr. Sparkman is a general and limited
partner.
(5) Includes warrants to purchase 14,683 shares of common stock at $2.50
per share and an option to purchase 2,500 shares if common stock at
$5.55 per share.
41
(6) 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.
(7) Includes an option to purchase 15,000 shares of common stock at $3.25
per share that began to vest in April 2003.
(8) 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.
(9) Includes the shares of common stock set forth in (1) through (10)
above issuable upon the exercise of options and warrants and the
conversion of shares of our 10% Convertible Series A Preferred Stock.
(10) Includes 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. CAV-RDV is a Texas Limited Partnership for the benefit
of Ryan and Candice Vinson.
(10) 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.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
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 February 29, 2004:
Balance at Interest Maturity
Guarantor February 29, 2004 Rate Date
--------- ----------------- --------- -----------
Earl Wait $1,162 1.90% 3/26/2004
Earl Wait 26,594 10.50% 10/10/2005
Wallace Sparkman 69,908 10% 10/15/2010
Wayne Vinson 1,008 1.90% 4/22/2004
Wayne Vinson 2,660 7.50% 6/21/2004
None of the guarantees is still in effect.
42
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 former directors, has a 1% interest in Hunter Wise.
All 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 $5.55 per share
for serving as our directors during the year ended December 31, 2003 and at
$3.88 for serving as our directors during the year ended December 31, 2002.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
The following is a list of all exhibits filed as part of this Form
10-KSB:
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)
3.2 Amendment to articles of incorporation dated March 31, 1999,
and filed on May 25, 1999.(3)
3.3 Amendment to articles of incorporation dated July 25, 2001,
and filed on July 30, 2001.(3)
3.4 Amendment to articles of incorporation dated June 18, 2003,
and filed on June 19, 2003.(3)
3.5 Articles of Merger filed on December 30, 2003 to be effective
January 1, 2004 merging NGE Leasing, Inc into Natural Gas
Services Group, Inc.(1)
3.6 Articles of Merger filed on December 30, 2003 to be effective
January 1, 2004 merging Rotary Gas Systems, Inc. into Natural
Gas Services Group, Inc.(1)
3.7 Articles of Merger filed on December 30, 2003 to be effective
January 1, 2004 merging Great Lakes Compression, Inc. into
Natural Gas Services Group, Inc.(1)
3.8 Bylaws.(3)
4.1 Form of warrant certificate.(3)
4.2 Form of warrant agent agreement.(3)
43
Exhibit No. Description and Method of Filing
----------- --------------------------------
4.3 Form of lock-up agreement.(3)
4.4 Form of representative's option for the purchase of common
stock.(3)
4.5 Form of representative's option for the purchase of
warrants.(3)
10.1 1998 Stock Option Plan.(3)
10.2 Asset Purchase Agreement between Natural Gas Acquisition
Corporation and Great Lakes Compression, Inc. dated January
1, 2001.(3)
10.3 Amendment to Guaranty Agreement between Natural Gas Services
Group, Inc. and Dominion Michigan Production Services,
Inc.(3)
10.4 Form of Series A 10% Subordinated Notes due December 31,
2006.(3)
10.5 Form of Five-Year Warrants to Purchase Common Stock.(3)
10.6 Warrants issued to Berry-Shino Securities, Inc.(3)
10.7 Warrants issued to Neidiger, Tucker, Bruner, Inc.(3)
10.8 Form of warrant issued in March 2001 for guaranteeing
debt.(3)
10.9 Form of warrant issued in April 2002 for guaranteeing
debt.(3)
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.(3)
10.11 Articles of Organization of Hy-Bon Rotary Compression, L.L.C.
dated April 17, 2000 and filed on April 20, 2001.(3)
10.12 Regulations of Hy-Bon Rotary Compression, L.L.C.(3)
10.13 First Amended and Restated Loan Agreement between Natural Gas
Services Group, Inc. and Western National Bank(4)
10.14 Termination of Employment Agreement Letter relating to the
Employment Agreement of Alan Kurus(5)
10.15 Termination of Employment Agreement Letter relating to the
Employment Agreement of Wayne Vinson(5)
10.16 Termination of Employment Agreement Letter relating to the
Employment Agreement of Earl R. Wait(5)
10.17 Lease Agreement dated June 1, 2003 with Steven J. & Katherina
L. Winer(1)
10.18 Lease Agreement dated June 19, 2003 with Wise Commercial
Properties(1)
23.1 Consent of HEIN + ASSOCIATES LLP.(1)
31.1 Certification of Chief Executive Officer required by Section
302 of the Sarbanes-Oxley Act of 2002. (1)
44
Exhibit No. Description and Method of Filing
----------- --------------------------------
31.2 Certification of Chief Financial Officer required by Section
302 of the Sarbanes-Oxley Act of 2002. (1)
32.1 Certification required by Section 906 of the Sarbanes-Oxley
Act of 2002. (1)
32.2 Certification required by Section 906 of the Sarbanes-Oxley
Act of 2002. (1)
-------------------
(1) Filed herewith.
(2) Exhibit 2.1 is incorporated by reference to Exhibit 2.1 filed as an
exhibit to our Current Report on Form 8-K dated February 28, 2003
(3) Exhibits 3.1 through 3.4 and 3.8 through 10.12 are incorporated by
reference to the exhibits filed as exhibits to our Registration
Statement No. 333-88314
(4) Exhibit 10.13 is incorporated by reference to our Current Report on Form
8-K filed on April 14, 2003
(5) Exhibits 10.14, 10.15 and 10.16 are incorporated by reference to
exhibits 10.25, 10.26 and 10.27 to our Annual Report on Form 10-KSB for
the year ended December 31, 2002
(b) Reports on Form 8-K
On November 11, 2003, we filed a Current Report on Form 8-K in which we
described our earnings release for the third quarter of 2003 under Item 12 and
filed a copy of the release as an exhibit under Item 7.
45
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Our principal accountant for the fiscal years ended December 31, 2003
and 2002 was HEIN + ASSOCIATES LLP.
Audit Fees
The aggregate fees billed for professional services rendered by HEIN +
ASSOCIATES LLP for the audit of our financial statements for our fiscal year
ended December 31, 2003 and 2002 and the review of the financial statements in
our Forms 10-QSB for the fiscal quarters in such fiscal years were $75,749 and
$43,691, respectively.
Audit Related Fees
No fees were billed by HEIN + ASSOCIATES LLP during our fiscal years
ended December 31, 2003 and 2002 for assurance and related services.
Tax Fees
The aggregate fees billed for professional services rendered by HEIN +
ASSOCIATES LLP for the compliance, tax advice and tax planning were $18,391 and
$15,468 respectively.
Audit Committees Pre-Approval Policies and Procedures
In accordance with Section 10A(i) of the Exchange Act, our audit
committee approves the engagement of our principal accountant prior to the
accountant rendering audit or non-audit services.
46
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Date: March 25, 2004 NATURAL GAS SERVICES GROUP, INC.
/s/ Wallace C. Sparkman
-----------------------
Wallace C. Sparkman, President and Principal
Executive Officer
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated:
Signature Title Date
--------- ----- ----
/s/Charles G. Curtis Director March 25, 2004
----------------------------
Charles G. Curtis
/s/William F. Hughes, Jr Director March 25, 2004
----------------------------
William F. Hughes, Jr.
/s/Wallace O. Sellers Director March 25, 2004
----------------------------
Wallace O. Sellers
/s/Wallace C. Sparkman Director March 25, 2004
----------------------------
Wallace C. Sparkman
/s/ Gene A. Strasheim Director March 25, 2004
----------------------------
Gene A. Strasheim
/s/Richard L. Yadon Director March 25, 2004
----------------------------
Richard L. Yadon
47
INDEX OF EXHIBITS
The following is a list of all exhibits filed as part of this Form
10-KSB:
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)
3.2 Amendment to articles of incorporation dated March 31, 1999,
and filed on May 25, 1999.(3)
3.3 Amendment to articles of incorporation dated July 25, 2001,
and filed on July 30, 2001.(3)
3.4 Amendment to articles of incorporation dated June 18, 2003,
and filed on June 19, 2003.(3)
3.5 Articles of Merger filed on December 30, 2003 to be effective
January 1, 2004 merging NGE Leasing, Inc into Natural Gas
Services Group, Inc.(1)
3.6 Articles of Merger filed on December 30, 2003 to be effective
January 1, 2004 merging Rotary Gas Systems, Inc. into Natural
Gas Services Group, Inc.(1)
3.7 Articles of Merger filed on December 30, 2003 to be effective
January 1, 2004 merging Great Lakes Compression, Inc. into
Natural Gas Services Group, Inc.(1)
3.8 Bylaws.(3)
4.1 Form of warrant certificate.(3)
4.2 Form of warrant agent agreement.(3)
4.3 Form of lock-up agreement.(3)
4.4 Form of representative's option for the purchase of common
stock.(3)
4.5 Form of representative's option for the purchase of
warrants.(3)
10.1 1998 Stock Option Plan.(3)
10.2 Asset Purchase Agreement between Natural Gas Acquisition
Corporation and Great Lakes Compression, Inc. dated January
1, 2001.(3)
10.3 Amendment to Guaranty Agreement between Natural Gas Services
Group, Inc. and Dominion Michigan Production Services,
Inc.(3)
10.4 Form of Series A 10% Subordinated Notes due December 31,
2006.(3)
10.5 Form of Five-Year Warrants to Purchase Common Stock.(3)
10.6 Warrants issued to Berry-Shino Securities, Inc.(3)
10.7 Warrants issued to Neidiger, Tucker, Bruner, Inc.(3)
48
Exhibit No. Description and Method of Filing
----------- --------------------------------
10.8 Form of warrant issued in March 2001 for guaranteeing
debt.(3)
10.9 Form of warrant issued in April 2002 for guaranteeing
debt.(3)
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.(3)
10.11 Articles of Organization of Hy-Bon Rotary Compression, L.L.C.
dated April 17, 2000 and filed on April 20, 2001.(3)
10.12 Regulations of Hy-Bon Rotary Compression, L.L.C.(3)
10.13 First Amended and Restated Loan Agreement between Natural Gas
Services Group, Inc. and Western National Bank(4)
10.14 Termination of Employment Agreement Letter relating to the
Employment Agreement of Alan Kurus(5)
10.15 Termination of Employment Agreement Letter relating to the
Employment Agreement of Wayne Vinson(5)
10.16 Termination of Employment Agreement Letter relating to the
Employment Agreement of Earl R. Wait(5)
10.17 Lease Agreement dated June 1, 2003 with Steven J. & Katherina
L. Winer(1)
10.18 Lease Agreement dated June 19, 2003 with Wise Commercial
Properties(1)
23.1 Consent of HEIN + ASSOCIATES LLP.(1)
31.1 Certification of Chief Executive Officer required by Section
302 of the Sarbanes-Oxley Act of 2002. (1)
31.2 Certification of Chief Financial Officer required by Section
302 of the Sarbanes-Oxley Act of 2002. (1)
32.1 Certification required by Section 906 of the Sarbanes-Oxley
Act of 2002. (1)
32.2 Certification required by Section 906 of the Sarbanes-Oxley
Act of 2002. (1)
49
(1) Filed herewith.
(2) Exhibit 2.1 is incorporated by reference to Exhibit 2.1 filed as an
exhibit to our Current Report on Form 8-K dated February 28, 2003
(3) Exhibits 3.1 through 3.4 and 3.8 through 10.12 are incorporated by
reference to the exhibits filed as exhibits to our Registration
Statement No. 333-88314
(4) Exhibit 10.13 is incorporated by reference to our Current Report on Form
8-K filed on April 14, 2003
(5) Exhibits 10.14, 10.15 and 10.16 are incorporated by reference to
exhibits 10.25, 10.26 and 10.27 to our Annual Report on Form 10-KSB for
the year ended December 31, 2002
50
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, 2003,
and the related consolidated statements of income, stockholders' equity and cash
flows for the years ended December 31, 2003 and 2002. 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, 2003, and the results of its operations and its cash flows for the
years ended December 31, 2003 and 2002 in conformity with accounting principles
generally accepted in the United States of America.
HEIN & ASSOCIATES LLP
Dallas, Texas
February 13, 2004
F-1
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2003
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 176,202
Trade accounts receivable, net of doubtful accounts of $5,000 816,596
Inventory 2,554,239
Prepaid expenses and other 107,030
-----------
Total current assets 3,654,067
LEASE EQUIPMENT, net of accumulated depreciation of $2,978,848 18,986,190
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $906,736 2,818,438
GOODWILL, net of accumulated amortization of $325,192 2,589,655
PATENTS, net of accumulated amortization of $137,423 113,941
OTHER ASSETS 107,900
-----------
Total assets $28,270,191
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Current portion of long-term debt and capital lease $ 2,363,927
Line of credit 300,000
Accounts payable and accrued liabilities 1,070,652
Deferred income 207,215
-----------
Total current liabilities 3,941,794
LONG-TERM DEBT AND CAPITAL LEASE, less current portion 6,650,486
SUBORDINATED NOTES, net of discount of $129,918 1,409,343
DEFERRED TAX LIABILITY 1,843,406
COMMITMENT (Note 11)
STOCKHOLDERS' EQUITY:
Preferred stock, 5,000,000 shares authorized, par value $0.01:
10 % Convertible Series A: 381,654 shares authorized, 343,654 shares
outstanding;10% cumulative, liquidation preference of $1,116,876 3,437
Common stock, 30,000,000 shares authorized, par value $0.01; 5,031,181 shares
issued and outstanding 50,311
Additional paid-in capital 11,205,375
Retained earnings 3,166,039
-----------
Total stockholders' equity 14,425,162
-----------
Total liabilities and stockholders' equity $28,270,191
===========
See accompanying notes to these consolidated financial statements.
F-2
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------
2003 2002
------------ ------------
REVENUE:
Sales, net $ 3,865,045 $ 4,335,721
Service and maintenance income 1,773,256 1,562,650
Leasing income and interest 7,111,221 4,398,170
------------ ------------
Total revenue 12,749,522 10,296,541
COSTS OF REVENUE:
Cost of sales 2,859,572 3,078,429
Cost of service 1,243,499 1,326,572
Cost of leasing 1,953,525 1,166,530
------------ ------------
Total costs of revenue 6,056,596 5,571,531
------------ ------------
GROSS PROFIT 6,692,926 4,725,010
OPERATING EXPENSES:
Selling expenses 678,777 499,721
General and administrative 1,613,076 1,218,513
Depreciation and amortization 1,725,717 1,166,004
------------ ------------
Total operating expenses 4,017,570 2,884,238
------------ ------------
INCOME FROM OPERATIONS 2,675,356 1,840,772
OTHER INCOME (EXPENSE):
Interest expense (667,122) (975,719)
Equity in earnings of joint venture -- 485,109
Other income (expense) (4,302) 19,386
------------ ------------
Total other income (expense) (671,424) (471,224)
------------ ------------
INCOME BEFORE PROVISION FOR INCOME TAXES 2,003,932 1,369,548
PROVISION FOR INCOME TAXES:
Current 25,000 25,900
Deferred 671,799 557,563
------------ ------------
Total income tax expense 696,799 583,463
------------ ------------
NET INCOME 1,307,133 786,085
PREFERRED DIVIDENDS 120,941 106,624
------------ ------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 1,186,192 $ 679,461
============ ============
NET INCOME PER COMMON SHARE:
Basic $ 0.24 $ 0.19
============ ============
Diluted $ 0.23 $ 0.16
============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic 4,946,922 3,649,413
Diluted 5,252,531 4,305,053
See accompanying notes to these consolidated financial statements.
F-3
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002
PREFERRED STOCK COMMON STOCK
------------------------------ ------------------------------
SHARES AMOUNT SHARES AMOUNT
------------- ------------- ------------- -------------
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, January 1, 2003 381,654 3,817 4,857,632 48,576
Exercise of common stock options and
warrants -- -- 135,549 1,355
Conversion of preferred stock to common
stock (38,000) (380) 38,000 380
Dividends on preferred stock -- -- -- --
Net income -- -- -- --
------------- ------------- ------------- -------------
BALANCES, December 31, 2003 343,654 $ 3,437 5,031,181 $ 50,311
============= ============= ============= =============
ADDITIONAL TOTAL
PAID-IN RETAINED STOCKHOLDERS'
CAPITAL EARNINGS EQUITY
------------- ------------- -------------
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, January 1, 2003 10,968,733 1,979,847 13,000,973
Exercise of common stock options and
warrants 236,642 -- 237,997
Conversion of preferred stock to common
stock -- -- --
Dividends on preferred stock -- (120,941) (120,941)
Net income -- 1,307,133 1,307,133
------------- ------------- -------------
BALANCES, December 31, 2003 $ 11,205,375 $ 3,166,039 $ 14,425,162
============= ============= =============
See accompanying notes to these consolidated financial statements.
F-4
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2003 2002
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,307,133 $ 786,085
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,725,717 1,166,004
Deferred taxes 671,799 557,563
Amortization of debt issuance costs 64,956 70,369
Gain on disposal of assets 18,615 (15,066)
Warrants issued for debt guarantee -- 42,025
Equity in earnings of joint venture -- (485,109)
Changes in current assets:
Trade and other receivables (391,498) 276,588
Inventory (1,078,445) 139,614
Prepaid expenses and other 66,272 (11,888)
Changes in current liabilities:
Accounts payable and accrued liabilities 542,790 (348,549)
Deferred income 173,678 134,187
Other changes (76,597) (105,870)
-------------- --------------
Net cash provided by operating activities 3,024,420 2,205,953
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (7,881,720) (4,414,952)
Proceeds from sale of property and equipment 119,500 40,000
Distribution from equity method investment 107,774 405,466
Decrease in lease receivable 210,512 84,908
-------------- --------------
Net cash used in investing activities (7,443,934) (3,884,578)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from lines of credit 300,000 --
Proceeds from long-term debt 3,478,568 1,956,893
Repayments of long-term debt (2,013,546) (4,463,612)
Dividends on preferred stock (120,941) (106,624)
Proceeds from sale of stock and exercise of stock options and
warrants
237,997 6,529,170
Net proceeds from preferred stock sales -- 12,767
Purchase of warrants from underwriter -- (43,000)
-------------- --------------
Net cash provided by financing activities 1,882,078 3,885,594
NET CHANGE IN CASH (2,537,436) 2,206,969
CASH, beginning of year 2,713,638 506,669
-------------- --------------
CASH, end of year $ 176,202 $ 2,713,638
============== ==============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 667,122 $ 975,719
============== ==============
Income taxes paid $ 35,292 $ 4,110
============== ==============
See accompanying notes to these consolidated financial statements.
F-5
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
Organization and Principles of Consolidation
--------------------------------------------
Natural Gas Services Group, Inc. (the "Company" or "NGSG") (a Colorado
corporation) was formed on December 18, 1998 for the purposes of combining
the operations of certain manufacturing, service and leasing entities.
As of December 31, 2003, NGSG conducted its operations through the
following wholly-owned subsidiaries:
o 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.
o 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.
o Great Lakes Compression, Inc., ("GLC") (a Colorado corporation) was
formed in March 2001 and acquired the assets and certain operations of
a business that fabricates, leases, and services natural gas
compressors to producers of oil and natural gas, primarily in
Michigan.
Effective January 1, 2004, RGS, GLC and NGE were merged into NGSG.
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.
Accounts Receivable
-------------------
The Company's trade receivables consist of customer obligations for the
sale of compressors and flare systems due under normal trade terms and
operating leases for the use of the Company's compressors. The receivables
are not collateralized except as provided for under lease agreements.
However, the Company requires deposits of as much as 50% for large custom
contracts. The Company extends credit based on management's assessment of
the customer's financial condition, receivable aging, customer disputes and
general business and economic conditions. Management believes the allowance
for doubtful accounts for trade receivables of $5,000 at December 31, 2003
is adequate.
F-6
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Inventory
---------
Inventory is valued at the lower of cost or market. The cost of inventories
in 2003 was determined by the weighted average method and previously by the
first-in, first-out method. The effect of changing the inventory method in
2003 was not material. At December 31, 2003, inventory consisted of the
following:
Raw materials $1,969,930
Work in process 584,309
----------
$2,554,239
==========
Property and Equipment
----------------------
Property and equipment are recorded at cost less accumulated depreciation
and amortization. Depreciation and amortization are computed using the
straight-line method over the estimated useful lives of the assets, which
range from five to thirty years.
Gains and losses resulting from sales and dispositions of property and
equipment are included in current operations. Maintenance and repairs are
charged to operations as incurred.
Patents
-------
The Company has patents for a flare tip ignition device and flare tip
burner pilot. The costs of the patents are being amortized on a
straight-line basis over nine years, the remaining life of the patents when
acquired. Amortization expense for patents of $27,484 was recognized for
each of the years ended December 31, 2003 and 2002. Amortization expense
for each of the next four years is expected to be $27,484 per year.
Goodwill
--------
Goodwill represents the cost in excess of fair value of the identifiable
net assets acquired in two acquisitions. Goodwill was being amortized on a
straight-line basis over 20 years, but the Company ceased amortization of
goodwill effective January 1, 2002 in accordance with Statement of
Financial Accounting Standards ("FAS") No. 142.
FAS 142 requires that goodwill be tested for impairment at least annually.
The Company completed its most recent test for goodwill impairment as of
June 30, 2003, at which time no impairment was indicated.
Long-Lived Assets
-----------------
The Company's policy is to periodically review the net realizable value of
its long-lived assets, other than goodwill, through an assessment of the
estimated future cash flows related to such assets. In the event that
assets are found to be carried at amounts in excess of estimated
undiscounted future cash flows, then the assets will be adjusted for
impairment to a level commensurate with a discounted cash flow analysis of
the underlying assets. Based upon its most recent analysis, the Company
believes no impairment of long-lived assets exists at December 31, 2003.
Advertising Costs
-----------------
Advertising costs are expensed as incurred. Total advertising expense was
$46,337 in 2003 and $49,720 in 2002.
F-7
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Instruments
---------------------
Management believes that generally the fair value of the Company's notes
payable at December 31, 2003 approximate their carrying values due to the
short-term nature of the instruments or the use of prevailing market
interest rates.
Revenue Recognition
-------------------
Revenue from the sales of custom and fabricated compressors, and flare
systems is recognized upon shipment of the equipment to customers. Exchange
and rebuilt compressor revenue is recognized when both the replacement
compressor has been delivered and the rebuild assessment has been
completed. Revenue from compressor service, and retrofitting services is
recognized upon providing services to the customer. Maintenance agreement
revenue is recognized as services are rendered. Rental and lease revenue is
recognized over the terms of the respective lease agreements based upon the
classification of the lease. Deferred income represents payments received
before a product is shipped.
Per Share Data
--------------
Basic earnings per common share is computed using the weighted average
number of common shares outstanding during the period. Diluted earnings per
common share is computed using the weighted average number of common and
common stock equivalent shares outstanding during the period. Common stock
equivalent shares are excluded from the computation if their effect is
antidilutive. In 2003 and 2002, antidilutive shares related to common stock
options and warrants and convertible preferred stock totaled 2,156,154 and
2,181,654, respectively.
The following table sets forth the computation of basic and diluted
earnings per share:
YEAR ENDED DECEMBER 31,
-----------------------
2003 2002
---------- ----------
Numerator:
Net income $1,307,133 $ 786,085
Less preferred dividends 120,941 106,624
---------- ----------
Net income available to common stockholders 1,186,192 679,461
========== ==========
Denominator for basic net income per share:
Weighted average common shares outstanding 4,946,922 3,649,413
Denominator for diluted net income per share:
Weighted average common shares outstanding 4,946,922 3,649,413
Dilutive effect of stock options and warrants 305,609 655,640
---------- ----------
Diluted weighted average shares 5,252,531 4,305,053
========== = =========
Net income per share:
Basic $ 0.24 $ 0.19
Diluted $ 0.23 $ 0.16
F-8
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock-Based Compensation
------------------------
The Company accounts for stock-based awards to employees using the
intrinsic value method described in Accounting Principles Board Opinion
(APB) No. 25, Accounting for Stock Issued to Employees, and its related
interpretations. Accordingly, no compensation expense has been recognized
in the accompanying consolidated financial statements for stock-based
awards to employees or directors when the exercise price of the award is
equal to or greater than the quoted market price of the stock on the date
of the grant.
FAS No. 123, Accounting for Stock-Based Compensation, 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 the use of option pricing models, which were
developed for use in estimating the fair value of traded options, which
have no vesting restrictions and are fully transferable. These models also
require subjective assumptions, including future stock price volatility and
expected time to exercise, which greatly affect the calculated values. The
Company's fair value calculations for awards from stock option plans in
2003 and 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 44% in 2003 and 50% in 2002; risk
free interest rate 4.0% in 2003 and 5.2% in 2002 and no dividends during
the expected term as the Company does not have a history of paying cash
dividends.
If the computed fair values of the stock-based awards had been amortized to
expense over the vesting period of the awards, net income and net income
per share, basic and diluted, would have been as follows:
YEARS ENDED DECEMBER 31,
--------------------------
2003 2002
----------- -----------
Net income, as reported $ 1,307,133 $ 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 (64,000) (39,000)
----------- -----------
Net income, pro forma $ 1,243,448 $ 747,085
----------- -----------
F-9
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Net income per share:
Basic, as reported $ 0.24 $ 0.19
=========== ===========
Basic, pro forma $ 0.23 $ 0.18
=========== ===========
Diluted, as reported $ 0.23 $ 0.16
=========== ===========
Diluted, pro forma $ 0.21 $ 0.15
=========== ===========
Weighted average fair value of options granted during the
year $ 3.35 $ 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 leases are classified
as operating leases. See Note 4.
Income Taxes
------------
The Company files a consolidated tax return with its subsidiaries. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to temporary differences between the financial statement
carrying amounts of assets and liabilities and their respective tax bases,
and operating losses and tax credit 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 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 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. Two transition methods are permitted for
adoption of the fair value 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). 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.
In June 2003, the FASB approved SFAS 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity. SFAS 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity.
This statement is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise was effective at the beginning
of the Company's third quarter of fiscal 2003. Implementation of SFAS 150
did not affect the Company's financial position.
F-10
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. PROPERTY AND EQUIPMENT
----------------------
Property and equipment consists of the following at December 31, 2003:
Land and building $ 1,345,740
Leasehold improvements 150,268
Office equipment and furniture 152,729
Software 125,905
Machinery and equipment 424,080
Vehicles 1,526,452
Less accumulated depreciation (906,736)
-----------
$ 2,818,438
===========
Depreciation expense for property and equipment and the leased compressors
described in Note 4 was $1,681,232 and $1,137,520 for the years ended
December 31, 2003 and 2002, respectively.
3. ACQUISITION
-----------
On March 31, 2003, the Company acquired 28 gas compressor packages from
Hy-Bon Engineering Company, Inc. ("Hy-Bon"). The adjusted purchase price
amounted to approximately $2,150,000. As part of the purchase and sale
agreement, Hy-Bon withdrew as a member of Hy-Bon Rotary Compression, L.L.C.
("Joint Venture") effective as of January 1, 2003. The Company, as the
other member, retained all assets of the Joint Venture, which had an
unaudited aggregate value of $346,511 as of December 31, 2002. The Company
dissolved the Joint Venture and agreed not to operate under the name
Hy-Bon. The Company consolidated the operations of the Joint Venture
beginning January 1, 2003 and began recording its share of the profit of
the acquired interest beginning April 1, 2003. Prior to the acquisition,
the Company had owned a non-controlling 50% interest in the Joint Venture
and accounted for it on the equity method.
4. LEASING ACTIVITY
----------------
The Company leases natural gas compressor packages to entities in the
petroleum industry. The Company's cost and accumulated depreciation for the
leased compressors as of December 31, 2003 was $21,965,038 and $2,978,848,
respectively. 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, 2003 are as follows:
Year Ended December 31,
-----------------------
2004 $ 3,548,618
2005 1,935,272
2006 234,959
2007 85,423
-------------
Total $ 5,804,272
=============
F-11
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. LINE OF CREDIT
--------------
The Company has a line of credit with a financial institution that allows
for borrowings up to $750,000, bears interest at the prime rate plus 1%
(5.00% at December 31, 2003) and requires monthly interest payments with
principal due at maturity on March 26, 2004. The line of credit is
collateralized by substantially all of the assets of the Company. At
December 31, 2003, there was $300,000 outstanding balance on this line of
credit.
The line of credit and first three notes listed in Note 6 below are with
the same bank and include certain covenants, the most restrictive of which
require the Company to maintain certain working capital, debt to equity and
cash flow ratios and certain minimum net worth. The Company was in
compliance with all covenants at December 31, 2003.
6. LONG-TERM DEBT
--------------
Long-term debt at December 31, 2003 consisted of the following:
Note payable to a bank, interest at bank's prime rate plus
1.0% but not less than 5.25% (5.25% at December 31, 2003),
monthly payments of principal of $170,801 plus interest
until maturity on September 15, 2007. The note is
collateralized by substantially all of the assets $ 7,350,308
Note payable to a bank, interest at bank's prime rate plus 1%
but not less than 5.25% (5.25% at December 31, 2003). This is
an advance line credit note for $10,000,000. Interest is
payable monthly. Principal is due in 60 consecutive payments
beginning December 15, 2004 until November 15, 2009. The note
is collateralized by substantially all of the assets of the
Company. See Note 5 regarding loan covenants 750,000
Note payable to a bank, interest at 7%, monthly payments of
principal and interest totaling $2,614 until maturity in
September 2010, collateralized by a building 199,778
Note payable to an individual, interest at 7%, monthly payments
of principal and interest totaling $1,255 until maturity
in October 2009. This note is collateralized by a building 71,584
Various notes payable to a bank, interest rates ranging from prime
plus 1% (5.00% at December 31, 2003) to 7.50% 311,402
Capital lease 29,135
Other notes payable for vehicles, various terms 302,206
-----------
Total 9,014,413
-----------
Less current portion (2,363,927)
-----------
$ 6,650,486
===========
F-12
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Maturities of long-term debt based on contractual requirements for the
years ending December 31 are as follows:
2004 $ 2,363,927
2005 2,450,855
2006 2,337,091
2007 1,376,970
2008 173,652
Thereafter 311,918
------------
$ 9,014,413
============
7. SUBORDINATED NOTES
------------------
In 2001, the Company completed an offering of units consisting of
subordinated debt and warrants. The balance of the subordinated debt, net
of unamortized discount of $129,918, is $1,409,343 at December 31, 2003.
Each unit consists of a $25,000 10% subordinated note due December 31, 2006
and a five-year warrant to purchase 10,000 shares of the Company's common
stock at $3.25 per share. Interest only is payable annually, with all
principal due at maturity. Warrants to purchase 61,570 shares were also
granted on the same terms to a placement agent in connection with the
offering. Certain stockholders, officers and directors purchased units in
the subordinated debt offering, (totaling $259,261 in notes and warrants
representing 103,704 shares) on the same terms and conditions as
non-affiliated purchasers in the offering. As of December 31, 2003,
warrants were outstanding from the offering for the purchase of a total of
626,175 shares.
8. INCOME TAXES
------------
The provision for income taxes consists of the following:
2003 2002
---------- ----------
Current provision:
Federal $ -- $ --
State 25,000 25,900
---------- ----------
25,000 25,900
Deferred provision:
Federal 592,799 491,363
State 79,000 66,200
---------- ----------
671,799 557,563
---------- ----------
$ 696,799 $ 583,463
========== ==========
The income tax effects of temporary differences that give rise to
significant portions of deferred income tax assets and (liabilities) are as
follows:
2003 2002
---------- ----------
Deferred income tax assets:
Net operating loss $ 727,000 $ 892,000
Other 5,000 48,000
---------- ----------
Total deferred income tax assets 732,000 940,000
---------- ----------
F-13
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred income tax liabilities:
Property and equipment (2,410,000) (1,962,000)
Goodwill and other intangible assets (154,000) (149,000)
Other (11,000) --
----------- -----------
Total deferred income tax liabilities (2,575,000) (2,111,000)
----------- -----------
Net deferred income tax liabilities $(1,843,000) $(1,171,000)
=========== ===========
The effective tax rate differs from the statutory rate as follows:
2003 2002
----------- -----------
Statutory rate 34% 34%
State and local taxes 5% 7%
Other (4)% 2%
----------- -----------
Effective rate 35% 43%
=========== ===========
At December 31, 2003, the Company had available federal net operating loss
("NOL") carryforwards of approximately $1,970,000, which may be used to
reduce future taxable income and expire in 2020 through 2023.
9. STOCKHOLDERS' EQUITY
--------------------
Initial Public Offering
-----------------------
In October, 2002, the Company closed an initial public offering in which it
sold 1,500,000 shares of common stock and warrants to purchase 1,500,000
shares of common stock for a total of $7,875,000. Costs and commissions
associated with the offering totaled $1,345,830. The warrants are
exercisable anytime through October 2006 at $6.25 per share. In connection
with this offering, the underwriter received options to purchase 150,000
shares of common stock at $6.25 per share and warrants at $0.3125 per
share. The warrants, if purchased by the underwriter, will contain an
exercise price of $7.81 per share. The underwriter's options expire in
October 2007 and include a cashless exercise provision utilizing the
Company's common stock.
Warrants
--------
In April 2002 and March 2001, five-year warrants to purchase 16,472 shares
of common stock at $3.25 per share and 68,524 shares at $2.50 per share,
respectively, were issued to certain board members and stockholders as
compensation for their debt guarantees. These warrants were immediately
exercisable and were recorded at their estimated fair values of $42,025 in
2002 and $23,137 in 2001. All of these warrants remained outstanding as of
December 31, 2003.
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, 381,654 shares are designated 10% Convertible Series A
Preferred Stock. (The number of Series A shares authorized was reduced from
1,177,000 to 381,654 in 2003.) 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
F-14
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. In connection with the
offering, the underwriter received warrants to purchase 38,165 shares of
common stock at $3.25 per share through December 1, 2006.
The Company had a private placement of its Series A shares in 2001 and
2002. In 2003, 38,000 Series A shares were converted to common stock. Total
Series A shares outstanding at December 31, 2003 were 343,654.
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.
10. STOCK-BASED COMPENSATION
------------------------
Stock Options
-------------
In December 1998, the Board of Directors adopted the 1998 Stock Option Plan
(the "Plan"). 150,000 shares of common stock have been reserved for
issuance under the Plan. All options granted under the Plan will expire ten
years after date of grant. The option price is to be determined by the
Board of Directors on date of grant. The Company has also issued options
that are not subject to the Plan.
In December 2003, the Company granted a total of 12,500 non-qualified stock
options to its outside directors to purchase the Company's common stock at
$5.55 per share any time through December 2013. Also, in December 2003,
options were granted to employees to purchase 15,000 shares of common stock
at $5.58 per share. The employee options vest over three years and expire
in December 2013.
In 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. At
December 31, 2003, 33,000 of these options were outstanding. In December
2002, the Company granted a total of 7,500 non-qualified stock options to
its outside directors to purchase the Company's common stock at $3.88 per
share any time through December 2012. All of these options were outstanding
at December 31, 2003.
The following is a summary of activity for the stock options outstanding
for the years ended December 31, 2003 and 2002:
F-15
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 DECEMBER 31, 2002
-------------------- -------------------
Weighted Weighted
Number Average Number Average
Of Exercise Of Exercise
Shares Price Shares Price
-------- -------- -------- --------
Outstanding, beginning of year 161,500 $ 2.41 112,000 $ 2.00
Canceled or expired (9,000) 3.25 -- --
Granted 27,500 5.57 49,500 3.35
Exercised (100,000) 2.00 -- --
-------- -------- -------- --------
Outstanding, end of year 80,000 $ 3.92 161,500 $ 2.41
======== ======== ======== ========
Exercisable, end of year 43,000 $ 3.68 128,800 $ 2.21
======== ======== ======== ========
11. COMMITMENT
----------
401(k) Plan
-----------
The Company offers a 401(k) Plan (the "401(k) Plan") to all employees that
have reached the age of eighteen and have completed six months of service.
The participants may contribute up to 15% of their salary. Employer
contributions are subject to Board discretion and are subject to a vesting
schedule of 20% each year after the first year and 100% after six years.
The Company contributed $60,735 and $50,233 to the 401(k) Plan in 2003 and
2002, respectively.
12. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK
Sales to two customers in the year ended December 31, 2003 and one customer
in the year ended December 31, 2002 amounted to a total of 38% and 30% of
consolidated revenue, respectively. No other single customer accounted for
more than 10% of the Company's sales in 2003 or 2002. At December 31, 2003,
no customer accounted for as much as 10% of the Company's trade accounts
receivable. The Company generally does not obtain collateral, but requires
deposits of as much as 50% on large custom contracts.
13. 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:
F-16
NATURAL GAS SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RGS NGE GLC NGSG Elim. Total
-------- -------- -------- -------- -------- --------
For the year ended December 31, 2003:
Revenue from external customers $ 2,884 $ 4,803 $ 5,062 $ -- $ -- $ 12,749
Inter-segment revenue 6,558 95 14 -- (6,667) --
Gross profit 1,255 3,418 2,020 -- -- 6,693
Depreciation and amortization 150 888 662 25 -- 1,725
Interest expense 7 475 162 23 -- 667
Other income (4) (11) 11 -- -- (4)
Income taxes -- -- -- 859 -- 859
Net income (loss) 170 1,870 890 (1,785) -- 1,145
As of December 31, 2003:
Segment assets 4,495 14,228 9,042 505 -- 28,270
Goodwill 1,873 -- 717 -- -- 2,590
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 (loss) 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