================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB (X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003 OR ( ) 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. (Exact name of small business issuer as specified in its charter) Colorado 75-2811855 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2911 SCR 1260 Midland, Texas 79706 (Address of principal executive offices) (915) 563-3974 (Issuer's Telephone number) N/A ---------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Check whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes No --- ---- APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date. Outstanding at Class June 30, 2003 -------------------------- -------------------------- Common Stock, $.001 par value 4,881,632 -------------------------- Transitional Small Business Disclosure Format (Check one): Yes No X --- --- NATURAL GAS SERVICES GROUP, INC. Commission File Number: 1-31398 Quarter Ended June 30, 2003 FORM 10-QSB Part I - FINANCIAL INFORMATION Item 1. Financial Statements............................................Page 1 Unaudited Consolidated Balance Sheet.....................................Page 1 Unaudited Consolidated Income Statements.................................Page 2 Unaudited Consolidated Statements of Cash Flows..........................Page 3 Notes to Unaudited Consolidated Financial Statements.....................Page 4 Item 2. Management's Discussion and Analysis or Plan of Operation.......Page 7 Item 3. Controls and Procedures.........................................Page 12 Part II - OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds.......................Page 13 Item 4. Submission of Matters to a Vote of Security Holders.............Page 14 Item 6. Exhibits and Reports on Form 8-K................................Page 15 Signatures...............................................................Page 16 Natural Gas Services Group, Inc. Consolidated Balance Sheet (unaudited) June 30, 2003 ASSETS Current Assets: Cash and cash equivalents $ 976,004 Accounts receivable - trade 1,482,762 Inventory 2,292,196 Prepaid expenses 81,156 ----------- Total current assets 4,832,118 Lease equipment, net 16,709,633 Other property, plant and equipment, net 2,616,661 Goodwill, net 2,589,655 Patents, net 127,684 Other assets 114,605 ----------- Total assets $26,990,356 =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Current portion of long term debt and capital lease $ 2,278,951 Accounts payable and accrued liabilities 973,025 Unearned Income 588,007 ----------- Total current liabilities 3,839,983 Long term debt and capital lease, less current portion 6,708,947 Subordinated notes, net 1,376,865 Deferred income tax payable 1,492,573 ----------- Total liabilities 13,418,368 SHAREHOLDERS' EQUITY Preferred stock 3,577 Common stock 49,816 Paid in capital 11,167,733 Retained earnings 2,350,862 ----------- Total shareholders' equity 13,571,988 ----------- Total liabilities and shareholders' equity $26,990,356 =========== The accompanying notes are an integral part of the consolidated balance sheet. 1 Natural Gas Services Group, Inc. Consolidated Income Statements (unaudited) Three months ended June 30 Six months ended June 30 -------------------------- -------------------------- 2003 2002 2003 2002 ----------- ----------- ----------- ----------- Revenue: Sales $ 939,838 $ 962,252 $ 1,505,110 $ 2,311,269 Service and maintenance 516,573 410,158 893,883 752,020 Leasing income 1,764,404 1,056,750 3,165,567 2,056,267 ----------- ----------- ----------- ----------- 3,220,815 2,429,160 5,564,560 5,119,556 Cost of revenue: Cost of sales 713,624 472,567 1,146,797 1,561,452 Cost of service and maintenance 335,928 348,634 671,229 658,049 Cost of leasing 406,867 303,764 767,784 586,299 ----------- ----------- ----------- ----------- 1,456,419 1,124,965 2,585,810 2,805,800 ----------- ----------- ----------- ----------- Gross Margin 1,764,396 1,304,195 2,978,750 2,313,756 Operating Cost: Selling expense 185,604 119,003 324,551 243,670 General and administrative expense 410,838 326,946 791,004 600,487 Amortization and depreciation 417,589 283,196 779,555 537,600 ----------- ----------- ----------- ----------- 1,014,031 729,145 1,895,110 1,381,757 ----------- ----------- ----------- ----------- Operating income 750,365 575,050 1,083,640 931,999 Interest expense (175,706) (265,480) (329,789) (522,840) Equity in earnings of joint venture -- 124,151 -- 207,603 Other income (21,760) 212 787 1,910 ----------- ----------- ----------- ----------- Income before income taxes 552,899 433,933 754,638 618,672 Income tax expense 237,747 191,000 321,603 279,563 ----------- ----------- ----------- ----------- Net income 315,152 242,933 433,035 339,109 Preferred dividends 31,010 31,430 62,020 75,614 ----------- ----------- ----------- ----------- Net income available to common shareholders $ 284,142 $ 211,503 $ 371,015 $ 263,495 =========== =========== =========== =========== Earnings per share: Basic $ 0.06 $ 0.06 $ 0.08 $ 0.08 Diluted $ 0.06 $ 0.05 $ 0.07 $ 0.06 Weighted average shares: Basic 4,875,324 3,357,632 4,866,527 3,357,632 Diluted 5,024,774 4,193,490 5,116,332 4,163,710 The accompanying notes are an integral part of the consolidated income statements. 2 Natural Gas Services Group, Inc. Consolidated Statements of Cash Flows (unaudited) Six Months Six Months Ended Ended June 30, 2003 June 30, 2002 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 433,035 $ 339,109 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 779,555 537,600 Deferred taxes 321,573 279,563 Amortization of debt issuance costs 32,478 32,477 Warrants Issued for debt guarantee -- 42,025 Equity in earnings of joint venture -- (207,603) Gain on disposal of assets 10,547 -- Changes in operating assets and liabilities: Trade and other receivables (836,812) (174,984) Inventory and work in progress (746,248) (247,991) Prepaid expenses and other 92,146 (23,513) Accounts payable and accrued liabilities 270,867 276,419 Unearned income 270,446 449,065 Other (91,341) (23,760) ------------- ------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 536,246 1,278,407 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (4,465,223) (2,296,033) Acquisition of remaining interest in joint venture, net of cash acquired 242,753 -- Proceeds from sale of property and equipment 112,500 -- Decrease in lease receivable 210,512 40,954 Distribution from equity method investee 49,090 123,353 ------------- ------------- NET CASH USED IN INVESTING ACTIVITIES (3,850,368) (2,131,726) CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from bank loans and line of credit 2,438,997 1,353,386 Repayments of long term debt (1,000,489) (449,123) Deferred offering costs -- (152,326) Proceeds from stock offering, net of offering cost -- 12,724 Dividends paid on preferred stock (62,020) (75,614) Proceeds from exercise of warrants 200,000 -- ------------- ------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 1,576,488 689,047 ------------- ------------- NET CHANGE IN CASH AND CASH EQUVALENTS (1,737,634) (164,272) CASH AT BEGINNING OF PERIOD 2,713,638 506,669 ------------- ------------- CASH AT END OF PERIOD $ 976,004 $ 342,397 ============= ============= SUPPLEMENTAL DICLOSURE OF CASH FLOW INFORMATION: Interest paid $ 329,789 $ 470,697 Income taxes paid $ -- $ -- The accompanying notes are an integral part of the consolidated statements of cash flows. 3 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) Basis of Presentation The accompanying unaudited financial statements present the consolidated results of our company and its wholly-owned subsidiaries taken from our books and records. In our opinion, such information includes all adjustments, consisting of only normal recurring adjustments, which are necessary to make our financial position at June 30, 2003 and the results of our operations for the six months periods ended June 30, 2003 and 2002 not misleading. As permitted by the rules and regulations of the Securities and Exchange Commission (SEC) the accompanying financial statements do not include all disclosures normally required by accounting principles generally accepted in the United States of America. These financial statements should be read in conjunction with the financial statements included in our Annual Report on Form 10-KSB on file with the SEC. Investments in joint ventures in which our company does not have majority voting control are accounted for by the equity method. All intercompany balances and transactions have been eliminated in consolidation. In our opinion , the consolidated financial statements are a fair presentation of the financial position, results of operations and cash flows for the periods presented. The results of operations for the six months ended June 30, 2003 are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2003 (2) Stock-based Compensation Statement of Financial Accounting Standards No. 123, ("SFAS 123") "Accounting for Stock-Based Compensation," encourages, but does not require, the adoption of a fair value-based method of accounting for employee stock-based compensation transactions. We have elected to apply the provisions of Accounting Principles Board Opinion No. 25 ("Opinion 25"), "Accounting for Stock Issued to Employees," and related interpretations, in accounting for our employee stock-based compensation plans. Under Opinion 25, compensation cost is measured as the excess, if any, of the quoted market price of our stock at the date of the grant above the amount an employee must pay to acquire the stock. Had compensation costs for options granted to our employees been determined based on the fair value at the grant dates consistent with the method prescribed by SFAS No. 123, our pro forma net income and earnings per share would have been reduced to the pro forma amounts listed below: Three Months Ended Six Months Ended June 30 June 30 2003 2002 2003 2002 ----------- ----------- ----------- ----------- Pro forma impact of fair value method Income applicable to common shares, as reported $ 284,142 $ 211,503 $ 371,015 $ 263,495 Pro-forma stock-based compensation costs under the fair value method, net of related tax (7,683) (14,010) (15,365) (14,010) ----------- ----------- ----------- ----------- Pro-forma income applicable to common shares $ 276,459 $ 197,493 $ 355,650 $ 249,485 under the fair-value method Earnings per common share Basic earnings per share reported $ 0.06 $ 0.06 $ 0.08 $ 0.08 Diluted earnings per share reported $ 0.06 $ 0.05 $ 0.07 $ 0.06 Pro-forma basic earnings per share under the fair value method $ 0.06 $ 0.06 $ 0.07 $ 0.07 Pro-forma diluted earnings per share under the fair value method $ 0.05 $ 0.05 $ 0.07 $ 0.06 Weighted average Black-Scholes fair value assumptions: Risk free rate 4.0% - 5.2% Expected life 5-10 yrs Expected volatility 50.0% Expected dividend yield 0.0% 4 (3) Acquisitions On March 31, 2003 we acquired 28 gas compressor packages from Hy-Bon Engineering Company, Inc. ("Hy-Bon"). The adjusted purchase price amounted to approximately $2,140,000. As part of the purchase and sale agreement, Hy-Bon withdrew as a member of Hy-Bon Rotary Compression, L.L.C. ("Joint Venture") effective as of January 1, 2003. We, as the other member of Hy-Bon Rotary Compression, L.L.C., retained all assets of Hy-Bon Rotary Compression, L.L.C. that as of December 31, 2002 had an unaudited aggregate value of $346,511. We plan to dissolve Hy-Bon Rotary Compression, L.L.C. and have agreed not to operate under the name Hy-Bon. We have consolidated the operations of the Joint Venture beginning January 1, 2003 and then began recording our share of the profit of the acquired interest beginning April 1, 2003. (4) Long Term Debt We entered into a new loan agreement with our bank, as of March 26, 2003 that included new borrowing of $2,150,000 in the form of a term loan with monthly principal payments of $35,833 with interest at 1% over prime but not less than 5.25% for 60 months. The proceeds from this new borrowing were used to purchase the 28 gas compressors from Hy-Bon Engineering Company, Inc. The new loan agreement also included the renewal of our line of credit for $750,000 with interest at 1% over prime but not less than 5.25% for one year. (5) Segment Information FAS No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes standards for public companies relating to the reporting of information about their operating segments in financial statements. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by chief operating decision-makers in deciding how to allocate resources and in assessing performance. Our segment information is set forth in the following table: Natural Gas (in thousands) Rotary NGE Great Lakes Services Gas Leasing Compression Group Total Six Months Ended ----------- ----------- ----------- ----------- ----------- June 30, 2003 Revenue $ 1,200 $ 2,070 $ 2,295 $ -- $ 5,565 Inter-segment revenue 2,744 35 8 -- 2,787 Net Income (loss) (54) 874 394 (781) 433 Segment Assets 4,323 12,986 9,195 486 26,990 Natural Gas (in thousands) Rotary NGE Great Lakes Services Gas Leasing Compression Group Total Six Months Ended ----------- ----------- ----------- ----------- ----------- June 30, 2002 Revenue $ 1,571 $ 1,059 $ 2,490 $ -- $ 5,120 Inter-segment revenue 3,046 -- -- -- 3,046 Net Income (loss) 196 515 188 (560) 339 Segment Assets 4,504 6,711 9,160 695 21,070 5 Natural Gas (in thousands) Rotary NGE Great Lakes Services Gas Leasing Compression Group Total Three Months Ended ----------- ----------- ----------- ----------- ----------- June 30, 2003 Revenue $ 756 $ 1,211 $ 1,254 $ -- $ 3,221 Inter-segment revenue 1,337 18 3 -- 1,358 Net Income (loss) (11) 541 265 (480) 315 Natural Gas (in thousands) Rotary NGE Great Lakes Services Gas Leasing Compression Group Total Three Months Ended ----------- ----------- ----------- ----------- ----------- June 30, 2002 Revenue $ 704 $ 560 $ 1,166 $ -- $ 2,430 Inter-segment revenue 1,629 -- -- -- 1,629 Net Income (loss) 179 282 134 (352) 243 (6) Earnings per common share The following table reconciles the numerators and denominators of the basic and diluted earnings per share computation. Three Months Ended Six Months Ended June 30, June 30, 2003 2002 2003 2002 -------------- ----------- -------------------------- Basic earnings per share Numerator: Net income $ 315,152 $ 242,933 $ 433,035 $ 339,109 Less: dividends on preferred shares (31,010) (31,430) (62,020) (75,614) ----------- ----------- ----------- ----------- Net income available to common shareholders $ 284,142 $ 211,503 $ 371,015 $ 263,495 =========== =========== =========== =========== Denominator - Weighted average common shares outstanding 4,875,324 3,357,632 4,866,527 3,357,632 =========== =========== =========== =========== Basic earnings per share $ 0.06 $ 0.06 $ 0.08 $ 0.08 =========== =========== =========== =========== Diluted earnings per share Numerator: Net income $ 315,152 $ 242,933 $ 433,035 $ 339,109 Less: dividends on preferred shares (1) (31,010) (31,430) (62,020) (75,614) ----------- ----------- ----------- ----------- Net income available to common shareholders $ 284,142 $ 211,503 $ 371,015 $ 263,495 =========== =========== =========== =========== Denominator : Weighted average common shares outstanding 4,875,324 3,357,632 4,866,527 3,357,632 Common stock options and warrants 149,450 835,858 249,805 806,078 Conversion of preferred shares (1) -- -- -- -- ----------- ----------- ----------- ----------- 5,024,774 4,193,490 5,116,332 4,163,710 =========== =========== =========== =========== Diluted earnings per share $ 0.06 $ 0.05 $ 0.07 $ 0.06 =========== =========== =========== =========== (1) Preferred shares were anti-dilutive for the six and three months ended June 30, 2003 and 2002. 6 Item 2. Management's Discussion and Analysis or Plan of Operation Overview We include the operations of Rotary Gas Systems, NGE Leasing and Great Lakes Compression, which are wholly owned subsidiaries. These entities provide products and services to the oil and gas industry and are engaged in (1) the manufacture, service, sale, and rental of natural gas compressors to enhance the productivity of oil and gas wells, and (2) the manufacture, sale and rental of flares and flare ignition systems for plant and production facilities. We are the parent company and provide administrative and management support and therefore, have expenses associated with that activity. Liquidity and Capital Resources We have funded our operations through public and private offerings of our common and preferred stock, subordinated debt and bank debt. Proceeds were primarily used to pay debt and to fund the manufacture and fabrication of additional units for our rental fleet of gas compressors. At June 30, 2003, we had cash and cash equivalents of $976,004, working capital of $992,135 and non-subordinated debt of $8,987,898, of which $2,278,951 was classified as current. We had net cash flow from operating activities of $536,246 during the first six months of 2003. This was primarily from net income of $433,035 plus depreciation and amortization of $779,555, an increase in accounts payable and accrued liabilities of $270,867, an increase in deferred taxes of $321,573 and an increase in deferred income of $270,446, offset by an increase in inventory of $746,248 and accounts receivable of $836,812. On October 24, 2002, we paid off the note of $6,952,464 payable to Dominion Michigan, used for the acquisition of the compression related assets of Great Lakes Compression. $3,452,464 of the funds to pay the note came from the proceeds of our initial public offering, and $3,500,000 came from additional bank financing to be amortized over 60 months at prime plus 1%. We entered into a new loan agreement with our bank, dated as of March 26, 2003. This included new borrowing of $2,150,000 in the form of a term loan with monthly principal payments of $35,833 with interest at 1% over prime but not less than 5.25% for 60 months. The proceeds from this new borrowing were used to purchase the 28 gas compressors from Hy-Bon. The new loan agreement also included the renewal of our line of credit for $750,000 with interest at 1% over prime for one year. We have not drawn from the line of credit as of June 30, 2003. Funds from the initial public offering, which closed on October 24, 2002, will permit us to actively pursue adding gas compressors to our rental fleet. We expect to fund additional rental units through the use of the offering proceeds, additional bank debt and cash flow from operations. A summary of the use of proceeds from our initial public offering as of June 30, 2003 is as follows: o $3,458,464 to reduce indebtedness; o $2,577,870 for the manufacture of gas compressors placed in our rental fleet and o $492,836 in temporary investments - Bank Money Market Account. 7 Results of Operations Six Months Ended June 30, 2003. Compared to the Six Months Ended June 30, 2002. Natural Gas (in thousands) Rotary NGE Great Lakes Services Gas Leasing Compression Group Total ----------- ----------- ----------- ----------- ----------- Six Months Ended June 30, 2003 Revenue $ 1,200 $ 2,070 $ 2,295 $ -- $ 5,565 Inter-segment revenue 2,744 35 8 -- 2,787 Gross margin 479 1,554 946 -- 2,979 Selling, general and administrative expense 460 86 135 434 1,115 Depreciation and amortization expense 70 379 319 12 780 Operating income (loss) (51) 1,089 492 (446) 1,084 Interest expense 3 224 89 13 329 Other income or (expense) -- 9 (9) -- -- Provision for income tax -- -- -- 322 322 ----------- ----------- ----------- ----------- ----------- Net Income (loss) $ (54) $ 874 $ 394 $ (781) $ 433 =========== =========== =========== =========== =========== Six Months Ended June 30, 2002 Revenue $ 1,571 $ 1,059 $ 2,490 $ -- $ 5,120 Inter-segment revenue 3,046 -- -- -- 3,046 Gross margin 656 761 897 -- 2,314 Selling, general and administrative expense 398 80 126 240 844 Depreciation and amortization expense 59 189 270 20 538 Operating income (loss) 199 492 501 (260) 932 Interest expense 4 186 313 20 523 Equity in earnings from joint venture -- 208 -- -- 208 Other income or (expense) 1 1 -- -- 2 Provision for income tax -- -- -- 280 280 ----------- ----------- ----------- ----------- ----------- Net income (loss) $ 196 $ 515 $ 188 $ (560) $ 339 =========== =========== =========== =========== =========== -------------------------------------------------------------------------------- Rotary Gas Systems Operations Revenue from outside sources decreased 24% or $371,000 for the six months ended June 30, 2003, as compared to the same period ended June 30, 2002. Because our products are custom-built, fluctuations in revenue from outside sources are expected. This decrease was mainly the result of a reduction in the sale of flare units to third parties. The gross margin percentage decreased from 42% for the six months ended June 30, 2002, to 40% for the same period ended June 30, 2003. The cost of revenue is comprised of expenses associated with service, parts and manufacturing expenses. This decrease resulted mainly from a change in the product mix. Selling, general and administrative expense increased $62,000 or 16% for the six months ended June 30, 2003, as compared to the same period ended June 30, 2002. This was mainly the result of the addition of new salesmen in the Farmington, New Mexico and West Texas areas. Depreciation expense increased 19% or $11,000 for the six months ended June 30, 2003, as compared to the same period ended June 30, 2002. This increase was mainly due to the purchase of additional sales vehicles, shop and office equipment. 8 There was a decrease of $1,000 in interest expense for the six months ended June 30, 2003, as compared to the same period ended June 30, 2002, mainly due to the reduction in loan balances on vehicles. NGE Leasing Operations Revenue from our rental of natural gas compressors increased 95% for the six months ended June 30, 2003, as compared to the same period in 2002. This increase is the result of units added to our rental fleet. From June 30, 2002, to June 30, 2003, we added 137 gas compressor units to our rental fleet, which included the 28 units we purchased from Hy-Bon Engineering Company, Inc. on March 31, 2003. The revenue from the Joint Venture, which was previously using the equity method, has been consolidated beginning January 1, 2003. The revenue from the units purchased from Hy-Bon Engineering Company, Inc. is included in our consolidated revenue beginning April 1, 2003. The gross margin percentage increased from 72% for the six months ended June 30, 2002 to 75% for the same period ending 2003. This increase mainly resulted from a slight reduction in the maintenance expenses associated with the compressor units and also additional revenue recognized from the sale of our irrigation pump engines. Selling, general and administrative expense increased $6,000 or 8% for the six months ended June 30, 2003, as compared to the same period in 2002. This was mainly the result of an increase in sales commissions from increased rental revenue. Depreciation expense increased 101% or $190,000 for the six months ended June 30, 2003, as compared to the same period ended June 30, 2002. This increase was the result of new gas compressor rental units being added to the rental fleet during the period. There was an increase in interest expense of 20% from $186,000 for the six months ended June 30, 2002, to $224,000 for the same period ended June 30, 2003. This is mainly as a result of an increase in bank debt used to purchase equipment for the rental fleet. Great Lakes Compression Revenue decreased 8% for the six months ended June 30, 2003, compared to the same period in 2002. This decrease resulted from a decrease in the sales of compressor units to third parties. In the period ended June 30, 2002 we had unit sales of approximately $501,000 to third parties while in the same period 2003 we had no unit sales to third parties. At the same time our rental revenue increased 5% and our parts sales increased 2%. Because our compressor units are custom-built, fluctuations in revenue from outside sources are expected. The gross margin percentage increased from 36% for the six months ended June 30, 2002 to 41% for the same period in 2003. The cost of revenue is comprised of expenses associated with the maintenance of the gas compressor rental activity, service, parts and manufacturing expenses. This increase resulted mainly from a change in the sales product mix. Selling, general and administrative expense increased by 7% or $9,000 for the six months ended June 30, 2003, as compared to the same period in 2002. This is mainly the result of an increase in selling expense. Depreciation expense increased from $270,000 for the six months ended June 30, 2002, to $319,000 for the same period ended June 30, 2003. The increase is the result of equipment that was added to the rental fleet and the replacement of several service vehicles. 9 There was a decrease in interest expense of 72% from $313,000 for the six months ended June 30, 2002 to $89,000 for the six months ended June 30, 2003. This decrease resulted from a reduction of the debt owed to Dominion Michigan. Part of the proceeds from our initial public offering was used to reduce debt in the amount of $3,452,464 and our bank financed the remaining balance of $3,500,000 at a more favorable interest rate. Natural Gas Services Group Selling, general and administrative expense increased 81% from $240,000 for the six months ended June 30, 2002, as compared to $434,000 for the same period ended June 30, 2003. This was mainly the result of the added expense for being a publicly held company such as legal fees, auditor fees, underwriters and public relations fees. Amortization and depreciation expense decreased 40% from $20,000 for the six months ended June 30, 2002, to $12,000 for the same period ended June 30, 2003. This mainly resulted from vehicles that were moved to our subsidiary, Great Lakes Compression. Interest expense decreased 35% from $20,000 for the six months ended June 30, 2002, to $13,000 for the same period ended June 30, 2003. This decrease resulted from a reduction in the interest rate and from bank notes for vehicles moved to our subsidiary. Provision for income tax is accounted for on a consolidated basis. Therefore, the tax for all companies is included in the provision for income tax for Natural Gas Services Group Inc. Income tax expense increased $42,000 or 15%, which is consistent with and pursuant to changes in state and federal tax statutes and the increase in net taxable income. Three Months Ended June 30, 2003. Compared to the Three Months Ended June 30, 2003. (in thousands) Natural Gas Rotary NGE Great Lakes Services Gas Leasing Compression Group Total ----------- ----------- ----------- ----------- ----------- Three Months Ended June 30, 2003 Revenue $ 756 $ 1,211 $ 1,254 $ -- $ 3,221 Inter-segment revenue 1,337 18 3 -- 1,358 Gross margin 276 923 566 -- 1,765 Selling, general and administrative expense 250 45 70 230 595 Depreciation and amortization Expense 36 215 161 7 419 Operating income (loss) (10) 663 335 (237) 751 Interest expense 2 124 44 5 175 Other income or (expense) 1 2 (26) -- (23) Provision for income tax -- -- -- (238) 238 =========== =========== =========== =========== =========== Net Income (loss) $ (11) $ 541 $ 265 $ (480) $ 315 =========== =========== =========== =========== =========== Three Months Ended June 30, 2002 Revenue $ 704 $ 560 $ 1,166 $ -- $ 2,430 Inter-segment revenue 1,629 -- -- -- 1,629 Gross margin 410 399 495 -- 1,304 Selling, general and administrative expense 199 42 65 139 445 Depreciation and amortization Expense 30 103 140 11 284 Operating income (loss) 181 254 290 (150) 575 Interest expense 2 96 156 11 265 Equity in earnings from joint venture -- 124 -- -- 124 Provision for income tax -- -- -- 191 191 ----------- ----------- ----------- ----------- ----------- Net income (loss) $ 179 $ 282 $ 134 $ (352) $ 243 =========== =========== =========== =========== =========== 10 Rotary Gas Systems Operations Revenue from outside sources decreased $52,000 or 7% for the three months ended June 30, 2003, as compared to the same period ended June 30, 2002. Because our products are custom-built, fluctuations in revenue from outside sources are expected. This decrease was mainly the result of a reduction in the sale of flare units to third parties. The gross margin percentage decreased to 37% for the three months ended June 30, 2003, as compared to 58% for the same period ended June 30, 2002. The cost of revenue is comprised of expenses associated with service, parts and manufacturing expenses. This decrease resulted mainly from a change in the product-mix. Selling, general and administrative expense increased 26% or $51,000 for the three months ended June 30, 2003, as compared to the same period ended June 30, 2002. This was mainly the result of the addition of new salesmen in the Farmington, New Mexico and West Texas areas. Depreciation expense increased 20% from $30,000 for the three months ended June 30, 2002, to $36,000 for the same period ended June 30, 2003. This increase was mainly due to the purchase of additional service vehicles, shop and office equipment. There was a slight decrease in interest expense for the three months ended June 30, 2003, as compared to the same period ended June 30, 2002, mainly due to the reduction in loan balances on vehicles. NGE Leasing Operations Revenue from our rental of natural gas compressors increased 116% for the three months ended June 30, 2003, as compared to the same period in 2002. This increase is the result of the revenue from units added to our rental fleet and also additional revenue recognized from the sale of our irrigation pump engines. The gross margin percentage increased from 71% for the three months ended June 30, 2002, to 76% the same period in 2003. This increase mainly resulted from the sale of the irrigation pump engines mentioned above and slight reduction in the maintenance expenses associated with the compressor units. Selling, general and administrative expense increased from $42,000 for the three months ended June 30, 2002, to $45,000 for the same period in 2003. This was mainly the result of an increase in sales commissions due to increased rental revenue. Depreciation expense increased 109% from $103,000, for the three months ended June 30, 2002 to $215,000 for the three months ended June 30, 2003. 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 from $96,000 for the three months ended June 30, 2002, to $124,000 for the same period ended June 30, 2003. This is mainly a result of an increase in bank debt used to purchase equipment for the rental fleet. Great Lakes Compression Revenue increased 8% for the three months ended June 30, 2003, as compared to the same period in 2002. This increase was the result of an increase in maintenance, labor and parts sales to third parties. 11 The gross margin percentage increased from 42% for the three months ended June 30, 2002, to 45% for the same period in 2003. The cost of revenue is comprised of expenses associated with the maintenance of the gas compressor rental activity, service, parts and manufacturing expenses. This increase resulted mainly from a change in the sales product mix. Selling, general and administrative expense increased from $65,000 for the three months ended June 30, 2002, to $70,000 for the same period in 2003. This is mainly the result of an increase in selling expense. Depreciation expense increased from $140,000 for the three months ended June 30, 2002, to $161,000 for the same period ended June 30, 2003. The increase is the result of equipment that was added to the rental fleet. There was a decrease in interest expense from $156,000 for the three months ended June 30, 2002, to $44,000 for the same period ended June 30, 2003. This decrease resulted from a reduction of the debt owed to Dominion Michigan. Part of the proceeds from our initial public offering was used to reduce debt in the amount of $3,452,464 and our bank financed the remaining balance of $3,500,000 at a more favorable interest rate. Natural Gas Services Group Selling, general and administrative expense increased 65% from $139,000 for the three months ended June 30, 2002, to $230,000 for the same period ended June 30, 2003. This was mainly the result of an added expense for being a publicly held company such as legal fees, auditor fees, underwriters and public relations fees. Amortization and depreciation expense decreased 36% from $11,000 for the three months ended June 30, 2002, to $7,000 for the same period ended June 30, 2003. This mainly resulted from vehicles that were moved to our subsidiary, Great Lakes Compression. Interest expense decreased 55% from $11,000 for the three months ended June 30, 2002, to $5,000 for the same period ended June 30, 2003. This decrease resulted from a reduction in the interest rate and for bank notes for vehicles moved to our 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 Natural Gas Services Group, Inc. Income tax expense increased $47,000 or 25%, which is consistent with and pursuant to changes in state and federal tax statutes. This increase is mainly due to an increase in income before taxes. Item 3. Controls and Procedures (a) Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934) as of a date (the "Evaluation Date") within 90 days prior to the filing date of this report. Based upon that evaluation, our chief executive officer and chief financial officer concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective in timely alerting them to the material information relating to us and our consolidated subsidiaries required to be included in our periodic filings with the SEC. 12 (b) Changes in internal controls. There were no significant changes made in our internal controls during the period covered by this report or, to our knowledge, in other factors that could significantly affect these controls subsequent to the date of their evaluation. PART II - OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds (c) 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 placed on the certificates unless the shares were sold pursuant to the provisions of Rule 144. (d) On October 21, 2002, our Registration Statement (File No. 333-88314) was declared effective. Since October 21, 2002, we have incurred an aggregate of approximately $1,345,830 of expenses in connection with the offering, including underwriting discounts ($708,750), expenses paid to or for the underwriter ($157,500), and other expenses of the offering ($479,680). Such amounts were not paid directly or indirectly to the directors, the officers or to persons owning 10% or more of any class of our equity securities or to our affiliates. Rather, such payments were to others. After deducting the total expenses, we received net offering proceeds of approximately $6,529,170. Through June 30, 2003, the net offering proceeds have been used for: o $3,458,464 to reduce indebtedness; o $2,577,870 for the manufacture of gas compressors placed in our rental fleet and o $492,836 in temporary investments - Bank Money Market Account. 13 Item 4. Submission of Matters to a Vote of Security Holders On June 18, 2003, we held our Annual Meeting of Shareholders. At the Annual Meeting of Shareholders, Richard L. Yadon was elected for a term expiring at the Annual Meeting of Shareholders to be held in 2004, Gene A. Strasheim was elected for a term expiring at the Annual Meeting of Shareholders to be held in 2005, and James T. Grigsby and Scott W. Sparkman were elected for terms expiring at the Annual Meeting of Shareholders to be held in 2006. The terms of Charles G. Curtis, Wallace O. Sellers and Wayne L. Vinson as directors continued after the Annual Meeting of Shareholders until the Annual Meetings of Shareholders held in 2005, 2005 and 2004, respectively. Voting for Richard L. Yadon For: 4,680,928 Withheld: 25 Abstentions: -0- ---- --------- ------------- Voting for Gene A. Strasheim For: 4,680,928 Withheld: 25 Abstentions: -0- ---- --------- ------------ Voting for James T. Grisgby For: 4,680,928 Withheld: 25 Abstentions: -0- ---- --------- ------------ Voting for Scott W. Sparkman For: 4,680,928 Withheld: 25 Abstentions: -0- ---- --------- ------------ Also, at the Annual Meeting of Shareholders held on June 18, 2003, the shareholders adopted an amendment to the Articles of Incorporation to reduce the number of designated shares of 10% Convertible Series A Preferred Stock. The votes were as follows: For: 3,431,554 Against: 25 Abstentions: 71,150 Broker Non-Votes: -0- ---- -------- ------------ ----------------- 14 NATURAL GAS SERVICES GROUP, INC. Commission File Number: 1-31398 Quarter Ended June 30, 2003 Form 10-QSB Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 2.1 Purchase and Sale Agreement by and between Hy-Bon Engineering Company, Inc. and NGE Leasing, Inc. (previously filed as Exhibit 2.1 to Natural Gas Services Group, Inc. Current Report on Form 8-K filed on March 6, 2003, File No. 1-31398, and incorporated herein by reference) 3.1 Articles of Amendment to the Articles of Incorporation filed on June 19, 2003 10.1 First Amended and Restated Loan Agreement between Natural Gas Services Group, Inc. and Western National Bank (previously filed as Exhibit 10.1 to Natural Gas Services Group, Inc. Current Report on Form 8-K filed on April 14, 2003, File No. 1-31398, and incorporated herein by reference) 31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) 31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 (b) Reports on Form 8-K On April 14, 2003, we filed a Current Report on Form 8-K dated March 27, 2003, reporting under Item 5 the closing of the agreement to acquire certain compressor packages from Hy-Bon Engineering Company, Inc., and filing the Purchase and Sale Agreement and the First Amended and Restated Loan Agreement as an Exhibits under Item 7. On May 8, 2003, we filed a Current Report on Form 8-K dated May 9, 2003, filing a news release as an Exhibit under Item 7. 15 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NATURAL GAS SERVICES GROUP, INC. By: /s/ Wayne L. Vinson ----------------------------- Wayne L. Vinson President and Chief Executive Officer By: /s/ Earl R. Wait ----------------------------- Earl R. Wait Chief Financial Officer And Treasurer August 7, 2003 EXHIBIT INDEX 2.1 Purchase and Sale Agreement by and between Hy-Bon Engineering Company, Inc. and NGE Leasing, Inc. (previously filed as Exhibit 2.1 to Natural Gas Services Group, Inc. Current Report on Form 8-K filed on March 6, 2003, File No. 1-31398, and incorporated herein by reference) 3.1 Articles of Amendment to the Articles of Incorporation filed on June 19, 2003 10.1 First Amended and Restated Loan Agreement between Natural Gas Services Group, Inc. and Western National Bank (previously filed as Exhibit 10.1 to Natural Gas Services Group, Inc. Current Report on Form 8-K filed on April 14, 2003, File No. 1-31398, and incorporated herein by reference) 31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) 31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 16