United States Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
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þ
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QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
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For the Quarter Ended September 30, 2010
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o
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TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
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Commission File No. 0-12185
NGAS Resources, Inc.
(Exact name of registrant as specified in its charter)
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Province of British Columbia
(State or other jurisdiction of incorporation)
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Not Applicable
(I.R.S. Employer Identification No.)
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120 Prosperous Place, Suite 201
Lexington, Kentucky
(Address of principal executive offices)
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40509-1844
(Zip Code)
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(859) 263-3948
Registrants telephone number, including area code:
Indicate by check mark if the registrant (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months and (2) has been subject to those filing
requirements for the past 90 days. Yes
þ
No
o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate website, if any, every interactive data file required to be submitted and posted pursuant
to Rule 405 of Regulation S-T during the preceding 12 months (or for any shorter period required).
Yes
o
No
þ
Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Exchange
Act).
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Large accelerated filer
o
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Accelerated filer
þ
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Non-accelerated filer
o
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Smaller Reporting Company
o
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(Do not check if a smaller reporting company)
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Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2).
Yes
o
No
þ
As of November 3, 2010, there were 46,416,385 shares of the registrants common stock outstanding.
NGAS Resources, Inc.
120 Prosperous Place, Suite 201
Lexington, Kentucky 40509
Form 10-Q September 30, 2010
Table of Contents
Additional Information
We file annual, quarterly and other reports and information with the Securities Exchange
Commission. Promptly after their filing, we provide access to these reports without charge on our
website at www.ngas.com. Our principal and administrative offices are located in Lexington,
Kentucky. Our common stock is traded on the Nasdaq Global Select Market under the symbol
NGAS
.
Unless otherwise indicated, references in this report to the
Company
or to
we
,
our
or
us
include
NGAS Resources, Inc., our direct and indirect wholly owned subsidiaries and our interests in
sponsored drilling partnerships. As used in this report,
NGL
means natural gas liquids,
Dth
means decatherm,
Mcf
means thousand cubic feet,
Mcfe
means thousand cubic feet
of natural gas equivalents,
Mmcf
means million cubic feet,
Mmcf/d
means million cubic feet per day,
Bcf
means billion cubic feet and
EUR
means estimated ultimately recoverable volumes of natural gas
or oil.
NGAS Resources, Inc.
CONSOLIDATED BALANCE SHEETS
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September 30,
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December 31,
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2010
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2009
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(Unaudited)
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ASSETS
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Current assets:
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Cash
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$
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5,105,017
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$
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4,332,650
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Accounts receivable
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5,535,965
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7,277,311
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Note receivable
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6,632,906
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6,247,880
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Prepaid expenses and other current assets
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697,614
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633,884
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Loans to related parties
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75,141
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75,679
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Total current assets
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18,046,643
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18,567,404
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Bonds and deposits
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258,945
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258,695
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Note receivable
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1,742,524
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6,766,451
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Oil and gas properties
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175,109,611
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182,189,679
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Property and equipment
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9,590,271
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5,113,093
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Loans to related parties
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171,429
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171,429
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Deferred financing costs
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837,908
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1,235,705
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Goodwill
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313,177
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313,177
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Total assets
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$
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206,070,508
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$
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214,615,633
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LIABILITIES
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Current liabilities:
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Accounts payable
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$
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3,016,509
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$
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5,587,290
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Accrued liabilities
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892,858
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938,829
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Long-term debt, current portion
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49,892,193
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32,534,084
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Fair value of derivative financial instruments
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52,306
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111
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Customer drilling deposits
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2,511,856
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5,581,877
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Total current liabilities
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56,365,722
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44,642,191
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Deferred compensation
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1,112,198
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651,287
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Deferred income taxes
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10,289,262
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12,559,549
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Long-term debt
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15,256,975
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40,949,836
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Fair value of derivative financial instruments
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146,668
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Other long-term liabilities
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4,292,132
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3,962,254
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Total liabilities
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87,462,957
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102,765,117
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SHAREHOLDERS EQUITY
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Capital stock
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Authorized
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5,000,000 Preferred shares
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100,000,000 Common shares
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Issued
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42,530,766 Common shares (2009 30,484,361)
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132,034,607
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117,142,639
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21,100 Common shares held in treasury, at cost
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(23,630
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)
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(23,630
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)
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Paid-in capital options and warrants
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4,735,629
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4,467,246
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To be issued
:
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9,185 Common shares
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45,925
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45,925
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136,792,531
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121,632,180
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Deficit
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(18,184,980
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)
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(9,781,664
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)
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Total shareholders equity
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118,607,551
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111,850,516
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Total liabilities and shareholders equity
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$
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206,070,508
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$
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214,615,633
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See accompanying notes.
1
NGAS Resources, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
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Three Months Ended
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Nine Months Ended
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September 30,
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September 30,
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2010
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2009
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2010
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2009
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REVENUE
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Contract drilling
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$
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4,555,485
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$
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3,831,250
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$
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15,667,095
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$
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16,328,000
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Oil and gas production
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5,616,269
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6,239,324
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17,644,686
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20,198,187
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Gas transmission, compression
and processing
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784,750
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1,123,921
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2,835,327
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6,528,132
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Total revenue
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10,956,504
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11,194,495
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36,147,108
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43,054,319
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DIRECT EXPENSES
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Contract drilling
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3,196,824
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2,913,418
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11,574,230
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12,328,110
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Oil and gas production
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3,988,755
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2,658,985
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11,007,455
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7,598,044
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Gas transmission, compression
and processing
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91,902
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960,879
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512,452
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2,955,204
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Total direct expenses
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7,277,481
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6,533,282
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23,094,137
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22,881,358
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OTHER EXPENSES (INCOME)
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Selling, general and administrative
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2,479,006
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2,601,514
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7,811,382
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8,404,519
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Options, warrants and deferred compensation
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226,066
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285,309
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729,295
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1,022,774
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Depreciation, depletion and amortization
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|
3,388,841
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3,304,139
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|
9,906,178
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10,610,630
|
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Interest expense
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|
1,603,067
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|
|
2,196,091
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5,073,965
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|
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6,892,550
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Interest income
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|
(191,430
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)
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|
(52,698
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)
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(667,686
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)
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|
(67,708
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)
|
Loss (gain) on sale of assets
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|
209,206
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(3,356,177
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)
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218,709
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(3,369,082
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)
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Fair value loss (gain) on
derivative financial instruments
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|
(359,398
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)
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|
|
4,847
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337,195
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(4,477
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)
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Refinancing costs
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|
625,344
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Other, net
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(91,228
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)
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|
292,073
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(307,808
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)
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|
600,896
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Total other expenses
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|
|
7,264,130
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5,275,098
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23,726,574
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|
24,090,102
|
|
|
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LOSS BEFORE INCOME TAXES
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(3,585,107
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)
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(613,885
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)
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(10,673,603
|
)
|
|
|
(3,917,141
|
)
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INCOME TAX EXPENSE (BENEFIT)
|
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|
(1,075,874
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)
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|
|
508,116
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|
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|
(2,270,287
|
)
|
|
|
571,357
|
|
|
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NET LOSS
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|
$
|
(2,509,233
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)
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|
$
|
(1,122,001
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)
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|
$
|
(8,403,316
|
)
|
|
$
|
(4,488,498
|
)
|
|
|
|
|
|
|
|
|
|
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|
|
|
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|
|
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NET LOSS PER SHARE
|
|
|
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|
|
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|
|
|
|
|
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|
Basic
|
|
$
|
(0.06
|
)
|
|
$
|
(0.04
|
)
|
|
$
|
(0.23
|
)
|
|
$
|
(0.16
|
)
|
|
|
|
|
|
|
|
|
|
|
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|
Diluted
|
|
$
|
(0.06
|
)
|
|
$
|
(0.04
|
)
|
|
$
|
(0.23
|
)
|
|
$
|
(0.16
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SHARES OUTSTANDING
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
41,044,918
|
|
|
|
28,873,105
|
|
|
|
36,709,848
|
|
|
|
27,508,925
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
41,044,918
|
|
|
|
28,873,105
|
|
|
|
36,709,848
|
|
|
|
27,508,925
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
2
NGAS Resources, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(2,509,233
|
)
|
|
$
|
(1,122,001
|
)
|
|
$
|
(8,403,316
|
)
|
|
$
|
(4,488,498
|
)
|
Adjustments to reconcile net loss to net cash
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incentive bonus paid in common shares
|
|
|
80,002
|
|
|
|
68,001
|
|
|
|
80,002
|
|
|
|
426,251
|
|
Options, warrants and deferred compensation
|
|
|
226,066
|
|
|
|
285,309
|
|
|
|
729,295
|
|
|
|
1,022,774
|
|
Depreciation, depletion and amortization
|
|
|
3,388,841
|
|
|
|
3,304,139
|
|
|
|
9,906,178
|
|
|
|
10,610,630
|
|
Loss (gain) on sale of assets
|
|
|
209,206
|
|
|
|
(3,356,177
|
)
|
|
|
218,709
|
|
|
|
(3,369,082
|
)
|
Fair value loss (gain) loss on
derivative financial instruments
|
|
|
(359,398
|
)
|
|
|
4,847
|
|
|
|
337,195
|
|
|
|
(4,477
|
)
|
Accretion of debt discount
|
|
|
640,674
|
|
|
|
1,004,682
|
|
|
|
2,093,135
|
|
|
|
2,869,276
|
|
Deferred income taxes (benefit)
|
|
|
(1,075,874
|
)
|
|
|
508,116
|
|
|
|
(2,270,287
|
)
|
|
|
571,357
|
|
Changes in assets and liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
37,767
|
|
|
|
311,360
|
|
|
|
1,741,346
|
|
|
|
5,077,373
|
|
Prepaid expenses and other current assets
|
|
|
(269,700
|
)
|
|
|
(353,376
|
)
|
|
|
(63,730
|
)
|
|
|
(328,971
|
)
|
Accounts payable
|
|
|
(868,681
|
)
|
|
|
(144,533
|
)
|
|
|
(2,570,781
|
)
|
|
|
(7,269,488
|
)
|
Accrued liabilities
|
|
|
(68,916
|
)
|
|
|
(46,040
|
)
|
|
|
(45,971
|
)
|
|
|
(56,024
|
)
|
Deferred compensation
|
|
|
|
|
|
|
(2,094,700
|
)
|
|
|
|
|
|
|
(2,209,700
|
)
|
Customers drilling deposits
|
|
|
279,941
|
|
|
|
1,923,271
|
|
|
|
(3,070,021
|
)
|
|
|
358,716
|
|
Other long-term liabilities
|
|
|
99,025
|
|
|
|
155,091
|
|
|
|
329,878
|
|
|
|
477,917
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in)
operating activities
|
|
|
(190,280
|
)
|
|
|
444,989
|
|
|
|
(988,368
|
)
|
|
|
3,688,054
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from sale of assets
|
|
|
1,646,534
|
|
|
|
35,857,613
|
|
|
|
5,444,311
|
|
|
|
35,911,646
|
|
Purchase of property and equipment
|
|
|
(64,413
|
)
|
|
|
(195,261
|
)
|
|
|
(5,922,029
|
)
|
|
|
(2,683,061
|
)
|
Change in bonds and deposits
|
|
|
(250
|
)
|
|
|
5,000
|
|
|
|
(250
|
)
|
|
|
15,203
|
|
Change in oil and gas properties, net
|
|
|
(703,023
|
)
|
|
|
(3,841,799
|
)
|
|
|
(1,840,808
|
)
|
|
|
(7,918,894
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in)
investing activities
|
|
|
878,848
|
|
|
|
31,825,553
|
|
|
|
(2,318,776
|
)
|
|
|
25,324,894
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Decrease in loans to related parties
|
|
|
|
|
|
|
890
|
|
|
|
538
|
|
|
|
3,164
|
|
Proceeds from issuance of common shares
|
|
|
|
|
|
|
6,089,476
|
|
|
|
4,701,968
|
|
|
|
6,089,476
|
|
Payments of deferred financing costs
|
|
|
(2,499
|
)
|
|
|
(10,882
|
)
|
|
|
(166,773
|
)
|
|
|
(383,442
|
)
|
Proceeds from issuance of long-term debt
|
|
|
|
|
|
|
|
|
|
|
4,480,000
|
|
|
|
|
|
Payments of long-term debt
|
|
|
(65,494
|
)
|
|
|
(45,021,578
|
)
|
|
|
(4,936,222
|
)
|
|
|
(34,733,578
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in)
financing activities
|
|
|
(67,993
|
)
|
|
|
(38,942,094
|
)
|
|
|
4,079,511
|
|
|
|
(29,024,380
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in cash
|
|
|
620,575
|
|
|
|
(6,671,552
|
)
|
|
|
772,367
|
|
|
|
(11,432
|
)
|
Cash, beginning of period
|
|
|
4,484,442
|
|
|
|
7,642,019
|
|
|
|
4,332,650
|
|
|
|
981,899
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash, end of period
|
|
$
|
5,105,017
|
|
|
$
|
970,467
|
|
|
$
|
5,105,017
|
|
|
$
|
970,467
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL DISCLOSURE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
997,811
|
|
|
$
|
1,204,354
|
|
|
$
|
2,608,802
|
|
|
$
|
4,026,548
|
|
Income taxes paid
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
3
NGAS Resources, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1
Summary of Significant Accounting Policies
General.
The accompanying consolidated financial statements of NGAS Resources, Inc. (
NGAS
)
have been prepared in accordance with accounting principles generally accepted in the United States
of America (
GAAP
). Our accounting policies are described in Note 1 to the consolidated financial
statements in our annual report on Form 10-K for the year ended December 31, 2009 (
annual report
).
Our accounting policies and their method of application in the accompanying financial statements
are consistent with those described in the annual report.
Basis of Consolidation.
The consolidated financial statements include the accounts of our
direct and indirect wholly owned subsidiaries, NGAS Production Co. (
NGAS Production
), Sentra
Corporation (
Sentra
) and NGAS Securities, Inc. (
NGAS Securities
). NGAS Production (formerly named
Daugherty Petroleum, Inc.) conducts all our oil and gas drilling, production and gas gathering
operations. Sentra owns and operates natural gas distribution facilities for two communities in
Kentucky, and NGAS Securities provides marketing support services for private placement financings.
The consolidated financial statements also reflect our interests in investment partnerships
sponsored by NGAS Production to participate in many of our drilling initiatives. NGAS Production
maintains a combined interest as both general partner and an investor in those partnerships ranging
from 12.5% to 75%, with additional reversionary interests after certain distribution thresholds are
reached. We account for those interests using the proportionate consolidation method, with all
material inter-company accounts and transactions eliminated on consolidation. References to
we
,
our
or
us
include NGAS, NGAS Production, its subsidiaries and interests in managed drilling
partnerships.
Estimates.
The preparation of financial statements in conformity with GAAP requires us to
make estimates and assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities as of the date of the financial statements, as well
as the reported amounts of revenues and expenses. The most significant estimates pertain to proved
oil and gas reserves and related cash flows used in impairment tests of goodwill and other
long-lived assets and estimates of future development, production and abandonment costs. The
evaluations required for these estimates involve various uncertainties, and actual results could
differ from the estimates.
Convertible Note Restructuring.
In January 2010, we exchanged $37 million principal amount of
our 6% convertible notes due December 15, 2010 (
2005 notes
) for $28.7 million in new amortizing
convertible notes due May 1, 2012 (
2010 notes
), together with a combination of cash, common shares
and warrants. See Note 7 Deferred Financing Costs, Note 10 Long-Term Debt and Note 11
Capital Stock.
Subsequent Events.
Except as described in Note 16, there were no events or transactions
requiring recognition or disclosure as subsequent events in the accompanying consolidated financial
statements or notes.
Comprehensive Income and Loss.
The accompanying consolidated financial statements do not
include statements of comprehensive income since we had no items of comprehensive income or loss
for the reported periods.
Note 2 Recently Adopted Accounting Standards
Except as described in Note 2 to the consolidated financial statements in the annual report,
there have been no recent accounting pronouncements that could have a significant impact or
potential impact on our financial position, results of operations, cash flows or financial
statement disclosures.
Note 3
Oil and Gas Properties
The following table presents the capitalized costs and accumulated depreciation, depletion and
amortization (
DD&A
) for our oil and gas properties, gathering facilities and well equipment as of
September 30, 2010 and December 31, 2009.
4
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2010
|
|
|
2009
|
|
Proved oil and gas properties
|
|
$
|
203,725,293
|
|
|
$
|
203,670,153
|
|
Unproved oil and gas properties
|
|
|
6,140,187
|
|
|
|
5,441,933
|
|
Gathering facilities and well equipment
|
|
|
16,154,695
|
|
|
|
15,411,788
|
|
|
|
|
|
|
|
|
|
|
|
226,020,175
|
|
|
|
224,523,874
|
|
Accumulated DD&A
|
|
|
(50,910,564
|
)
|
|
|
(42,334,195
|
)
|
|
|
|
|
|
|
|
Net oil and gas properties and equipment
|
|
$
|
175,109,611
|
|
|
$
|
182,189,679
|
|
|
|
|
|
|
|
|
Note 4 Other Property and Equipment
The following table presents the capitalized costs and accumulated depreciation for our other
property and equipment as of September 30, 2010 and December 31, 2009. Capitalized costs for
building and improvements at September 30, 2010 reflect our purchase of the building in Lexington,
Kentucky that houses our principal and administrative offices for $5.6 million in February 2010.
The building had been acquired for approximately the same amount during 2006 by a company formed
for that purpose by our executive officers and a key employee. See Note 13 Related Party
Transactions. We obtained financing for part of the purchase price on the terms described in Note
10 Long-Term Debt.
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2010
|
|
|
2009
|
|
Land
|
|
$
|
12,908
|
|
|
$
|
12,908
|
|
Building and improvements
|
|
|
5,664,265
|
|
|
|
64,265
|
|
Machinery and equipment
|
|
|
5,414,634
|
|
|
|
5,866,853
|
|
Office furniture and fixtures
|
|
|
175,862
|
|
|
|
175,862
|
|
Computer and office equipment
|
|
|
717,130
|
|
|
|
688,261
|
|
Vehicles
|
|
|
1,735,852
|
|
|
|
1,810,064
|
|
|
|
|
|
|
|
|
|
|
|
13,720,651
|
|
|
|
8,618,213
|
|
Accumulated depreciation
|
|
|
(4,130,380
|
)
|
|
|
(3,505,120
|
)
|
|
|
|
|
|
|
|
Net other property and equipment
|
|
$
|
9,590,271
|
|
|
$
|
5,113,093
|
|
|
|
|
|
|
|
|
Note 5 Note Receivable
During the third quarter of 2009, we sold 485 miles of our Appalachian gas gathering
facilities (
Appalachian Gathering System
) to Seminole Energy Services, LLC and its subsidiary
(
Seminole Energy
) for $50 million, of which $14.5 million is payable in monthly installments
through December 2011 under a promissory note issued to NGAS Production. The note bears interest
at the rate of 8% per annum and is secured by a second mortgage on Seminole Energys interest in
the Appalachian Gathering System. We assigned the note as part of the collateral package under our
revolving credit facility and agreed to apply note payments to debt reduction under the facility.
See Note 10 Long-Term Debt.
Note 6 Loans to Related Parties
We extended loans to several of our officers prior to 2003 and to one of our shareholders in
2004. The shareholder loan bears interest at 5% per annum and had an outstanding balance of
$75,141 at September 30, 2010 and $75,679 at December 31, 2009. The loan is collateralized by the
shareholders interests in our drilling partnerships and is repayable from partnership
distributions. The loans receivable from officers totaled $171,429 at September 30, 2010 and
December 31, 2009. These loans are non-interest bearing and unsecured.
Note 7 Deferred Financing Costs
Other than refinancing costs recognized for our convertible note restructuring, the financing
costs for our convertible debt and secured credit facility are initially capitalized and amortized
at rates based on the terms of the underlying debt instruments. See Note 10 Long-Term Debt.
Upon any conversion of our outstanding 2010 notes or payment of amortization installments on the
notes in shares of our common stock, the principal amount converted or repaid will be added to
equity, net of a proportionate amount of the original financing costs. Unamortized deferred
financing costs for our convertible debt and credit facility aggregated $837,908 at September 30,
2010 and $1,235,705 at December 31, 2009, net of accumulated amortization.
5
Note 8 Goodwill
We recorded goodwill of $1,789,564 in our 1993 acquisition of NGAS Production and amortized
the goodwill on a straight-line, ten-year basis until 2002, when we adopted authoritative guidance
for evaluating goodwill annually and whenever potential impairment exists under a fair value
approach at the reporting unit level. With no impairment under our initial and subsequent
analyses, unamortized goodwill has remained at $313,177.
Note 9 Customer Drilling Deposits
Prepayments under drilling contracts with sponsored partnerships are recorded as customer
drilling deposits upon receipt. Contract drilling revenues are recognized on the completed
contract method as wells are drilled, rather than when funds are received. Customer drilling
deposits of $2,511,856 at September 30, 2010 and $5,581,877 at December 31, 2009 represent
unapplied prepayments for wells that were not completed as of the balance sheet dates.
Note 10 Long-Term Debt
Convertible Notes.
On January 12, 2010, we exchanged the entire $37 million outstanding
principal amount of our 2005 notes for $28.7 million in new amortizing convertible notes due May 1,
2012, together with a combination of common stock, warrants and cash payments of approximately $2.7
million. The 2010 notes bear interest at 6% per annum, payable quarterly in cash, and are
convertible at $2.18 per common share, subject to certain volume limitations and adjustments for
certain corporate events. We are required to make equal monthly principal amortization payments on
the 2010 notes during the last 24 months of their term. Subject to certain conditions and true-up
adjustments, we may elect to pay all or part of any principal installment in our common shares,
valued at the lesser of $2.18 per share or 95% of the 10-day volume-weighted average price (
VWAP
)
of the common stock prior to the installment date. We elected to pay the initial amortization
installments in common shares. See Note 11 Capital Stock and Note 16 Subsequent Events. As
of September 30, 2010, we had $23.9 million principal amount of 2010 notes outstanding.
Because the net present value of the cash flows from the 2010 notes did not change
significantly from the 2005 notes, we accounted for the exchange transaction as a debt modification
under FASB Accounting Standards Codification Topic (
ASC
) 470,
Debt
, which requires that any value
exchanged be deferred. In addition, deferred financing costs previously recorded for the 2005
notes continue to be amortized over the life of the 2010 notes, with debt issuance costs expensed
as incurred. See Note 7 Deferred Financing Costs. As a result, we recognized refinancing costs
of $625,344 during the first nine months of 2010. During that period, we also recognized non-cash
interest expenses of $2,093,136, representing accretion of the debt discount on the 2010 notes
under the effective interest method, as well as a fair value loss on derivative financial
instruments of $337,195 under the mark-to-market provisions of ASC 815,
Derivatives and Hedging
,
reflecting changes in fair values of the embedded conversion features of the convertible debt and
the warrants issued in the exchange transaction.
Credit Facility.
We have a revolving credit facility maintained by NGAS Production under a
credit agreement with KeyBank National Association, as administrative agent and primary lender.
The facility provides for revolving term loans in an aggregate amount up $125 million, subject to
borrowing base thresholds determined semi-annually by the lenders. Interest is payable at
fluctuating rates ranging from the agents prime rate to 2.25% above that rate, and amounted to
5.5% at September 30, 2010. The facility is guaranteed by NGAS and is secured by liens on our oil
and gas properties. The facility has a scheduled maturity in September 2011, resulting in the
classification of our revolving debt as a current liability at September 30, 2010.
We have outstanding borrowings of $37 million under the credit facility, with a borrowing base
of $37 million as of September 30, 2010. This reflects an amendment to
the credit agreement that permitted us to complete the exchange transaction for our convertible
debt in January 2010, subject to monthly reductions of $1 million to the borrowing base through
June 2010. The amendment also restricts upstream dividends from NGAS Production for any principal
amortization payments on the 2010 notes that would cause outstanding borrowings under the facility
to exceed 80% of the prevailing borrowing base. We are in compliance with our financial and other covenants under the credit
facility, subject to receiving a waiver or forbearance from the lenders with respect to our noncompliance with the leverage
ratio under our credit agreement as of September 30, 2010. See Note 16 Subsequent Events.
Building Loan.
In February 2010, NGAS Production financed 80% of the purchase price for the
office building that houses our administrative offices in Lexington, Kentucky with a $4.48 million
loan from Traditional Bank, Inc. See Note 13 Related Party Transactions. The loan bears
variable interest at 1.625% above the WSJ money rate index and is repayable in monthly installments
of $29,420 through February 2015, with the balance of approximately $3.75 million due at maturity.
Obligations under the loan are secured by a mortgage on the property and are guaranteed by NGAS.
The loan had an outstanding balance of $4,400,502 at September 30, 2010.
6
Installment Loan.
In June 2009, NGAS Production obtained a $2.3 million loan from Central
Bank & Trust Co. to finance its commitment under an airplane purchase contract entered in 2005.
The loan bears interest at 5.875% per annum and is repayable in monthly installments of $16,428
over a three-year term, with the balance due at maturity. During the second quarter of 2010, we
sold a 25% interest in the airplane for $700,000 and applied $575,000 of the proceeds as a partial
prepayment. The loan is secured by our remaining 75% interest in the airplane and had an
outstanding balance of $1,626,559 at September 30, 2010.
Acquisition Debt.
We issued a promissory note for $854,818 in 1986 to finance our acquisition
of mineral claims in Alaska. The note is repayable at the rate of $2,000 per month, without
interest, and had an outstanding balance of $252,818 at September 30, 2010.
Total Long-Term Debt and Maturities.
The following tables summarize our total long-term debt
at September 30, 2010 and December 31, 2009 and the principal payments due each year through 2015
and thereafter.
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
Principal Amount Outstanding
|
|
2010
|
|
|
2009
|
|
Total long-term debt (including current portion)
|
|
$
|
65,149,168
|
|
|
$
|
73,483,920
|
|
Less current portion
|
|
|
49,892,193
|
|
|
|
32,534,084
|
(1)
|
|
|
|
|
|
|
|
Total long-term debt
|
|
$
|
15,256,975
|
|
|
$
|
40,949,836
|
|
|
|
|
|
|
|
|
Debt Maturities
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remainder of 2010
|
|
$
|
3,092,879
|
|
|
|
|
|
2011
|
|
|
50,252,615
|
|
|
|
|
|
2012
|
|
|
7,533,024
|
|
|
|
|
|
2013
|
|
|
182,029
|
|
|
|
|
|
2014
|
|
|
189,907
|
|
|
|
|
|
2015 and thereafter
|
|
|
3,898,714
|
|
|
|
|
|
|
|
|
(1)
|
|
Excludes allocations of $2,047,378 for the unaccreted debt discount on the 2010 notes at
September 30, 2010 and $4,555,513 for the unaccreted debt discount on the 2005 notes at
December 31, 2009.
|
Note 11 Capital Stock
Preferred Shares.
We have 5,000,000 authorized shares of preferred stock, none of which were
outstanding at September 30, 2010 or December 31, 2009.
Common Shares.
The following table reflects transactions involving our common stock during
the reported periods. These include common shares and warrants issued in our convertible note
exchange during the first quarter of 2010 and in underwritten offerings during the third quarter of
2009 and the second quarter of 2010. We also issued common shares each month, beginning on June 1,
2010, in payment of the monthly amortization installments on the 2010 notes. See Note 10
Long-Term Debt. Under the true-up provisions of the 2010 notes, if the 20-day VWAP of our stock
following an installment payment in common shares differs from the share value applied to that
payment, any shortfall is settled in additional common shares, and any surplus is applied to reduce
the next amortization installment. The table reflects these monthly share issuances and related
true-up adjustments through the end of September 2010. See Note 16 Subsequent Events.
|
|
|
|
|
|
|
|
|
Common Shares Issued
|
|
Shares
|
|
|
Amount
|
|
Balance, December 31, 2008
|
|
|
26,543,646
|
|
|
$
|
110,626,912
|
|
Issued in underwritten offering
|
|
|
3,480,000
|
|
|
|
6,089,476
|
|
Issued as stock awards under incentive plan
|
|
|
460,715
|
|
|
|
426,251
|
|
|
|
|
|
|
|
|
Balance, December 31, 2009
|
|
|
30,484,361
|
|
|
|
117,142,639
|
|
Issued in convertible note restructuring
|
|
|
3,037,151
|
|
|
|
5,188,333
|
|
Issued in underwritten offering
|
|
|
3,960,000
|
|
|
|
4,701,968
|
|
Issued in payment of amortization installments under 2010 notes
|
|
|
4,973,062
|
|
|
|
4,921,665
|
|
Issued as stock awards under incentive plan
|
|
|
76,192
|
|
|
|
80,002
|
|
|
|
|
|
|
|
|
Balance, September 30, 2010
|
|
|
42,530,766
|
|
|
$
|
132,034,607
|
|
|
|
|
|
|
|
|
7
|
|
|
|
|
|
|
|
|
Paid In Capital Options and Warrants
|
|
|
|
|
|
Amount
|
|
Balance, December 31, 2008
|
|
|
|
|
|
$
|
3,774,600
|
|
Recognized
|
|
|
|
|
|
|
692,646
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2009
|
|
|
|
|
|
|
4,467,246
|
|
Recognized
|
|
|
|
|
|
|
268,383
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2010
|
|
|
|
|
|
$
|
4,735,629
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Shares to be Issued
|
|
Shares
|
|
|
Amount
|
|
Balance, September 30, 2010 and December 31, 2009
|
|
|
9,185
|
|
|
$
|
45,925
|
|
|
|
|
|
|
|
|
Stock Options and Awards.
We maintain equity incentive plans adopted in 2001 and 2003 for the
benefit of our directors, officers, employees and certain consultants. The 2001 plan provides for
the grant of options to purchase up to 3 million common shares, and the 2003 plan reserves 4
million common shares for stock awards and grants of stock options. Awards may be subject to
restrictions or vesting requirements, and option grants must be at prevailing market prices. Stock
awards were made under the 2003 plan for a total of 460,715 shares during 2009 and 76,192 shares
during the first nine months of 2010. Transactions in stock options during those periods are shown
in the following table.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
Stock Options
|
|
Issued
|
|
|
Exercisable
|
|
|
Exercise Price
|
|
Balance, December 31, 2008
|
|
|
4,613,668
|
|
|
|
1,413,668
|
|
|
$
|
3.95
|
|
Vested
|
|
|
|
|
|
|
1,225,000
|
|
|
|
4.69
|
|
Expired
|
|
|
(740,000
|
)
|
|
|
(740,000
|
)
|
|
|
4.06
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2009
|
|
|
3,873,668
|
|
|
|
1,898,668
|
|
|
|
3.92
|
|
Vested
|
|
|
|
|
|
|
317,500
|
|
|
|
6.53
|
|
Expired
|
|
|
(1,553,668
|
)
|
|
|
(1,553,668
|
)
|
|
|
5.37
|
|
Forfeited
|
|
|
(75,000
|
)
|
|
|
(27,500
|
)
|
|
|
3.71
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2010
|
|
|
2,245,000
|
|
|
|
635,000
|
|
|
$
|
2.93
|
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2010, the exercise prices of options outstanding under our equity plans
ranged from $1.51 to $7.64 per share, with a weighted average remaining contractual life of 3.75
years. The following table provides additional information on the terms of stock options
outstanding at September 30, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
|
Options Exercisable
|
|
|
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
|
Weighted
|
|
Exercise
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
Price
|
|
|
|
|
|
Remaining
|
|
|
Exercise
|
|
|
|
|
|
|
Exercise
|
|
or Range
|
|
Number
|
|
|
Life (years)
|
|
|
Price
|
|
|
Number
|
|
|
Price
|
|
$1.51
|
|
|
1,610,000
|
|
|
|
4.61
|
|
|
$
|
1.51
|
|
|
|
|
|
|
$
|
|
|
6.51 7.64
|
|
|
635,000
|
|
|
|
1.57
|
|
|
|
6.53
|
|
|
|
635,000
|
|
|
|
6.53
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,245,000
|
|
|
|
|
|
|
|
|
|
|
|
635,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We use the Black-Scholes pricing model to determine the fair value of each stock option at the
grant date, and we recognize the compensation cost ratably over the vesting period. For the
periods presented in the accompanying consolidated financial statements, the fair value estimates
for option grants assumes a risk free interest rate ranging from 0.03% to 6%, no dividend yield, a
theoretical volatility ranging from 0.30 to 0.85 and an expected life ranging from six months to
six years based on the vesting provisions of the options. This resulted in non-cash charges for
options and warrants of $692,646 in 2009 and $268,383 in the first nine months of 2010.
Common Stock Purchase Warrants.
As part of separate underwritten offerings in August 2009 and
May 2010, we issued warrants to purchase up to 1,740,000 common shares through February 13, 2014 at
$2.35 per share, subject to adjustment for certain dilutive issuances, and warrants to purchase up
to 1,584,000 common shares through November 17, 2014 at $1.61 per share, subject to adjustment for
certain corporate events. In addition, as part of the consideration in our convertible note
exchange, we issued warrants to purchase up to 1,285,038 common shares through January 12, 2015 at
$2.37 per share, subject to adjustment for certain corporate events.
8
Note 12 Loss Per Share
The following table shows the computation of basic and diluted loss per share (
EPS
) for the
reporting periods in accordance with ASC 260,
Earnings per Share
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss as reported for basic EPS
|
|
$
|
(2,509,233
|
)
|
|
$
|
(1,122,001
|
)
|
|
$
|
(8,403,316
|
)
|
|
$
|
(4,488,498
|
)
|
Adjustments to loss for diluted EPS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss for diluted EPS
|
|
$
|
(2,509,233
|
)
|
|
$
|
(1,122,001
|
)
|
|
$
|
(8,403,316
|
)
|
|
$
|
(4,488,498
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares for basic
and diluted EPS
|
|
|
41,044,918
|
|
|
|
28,873,105
|
|
|
|
36,709,848
|
|
|
|
27,508,925
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted EPS
|
|
$
|
(0.06
|
)
|
|
$
|
(0.04
|
)
|
|
$
|
(0.23
|
)
|
|
$
|
(0.16
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Note 13 Related Party Transactions
The building in Lexington, Kentucky that houses our principal and administrative offices was
acquired during 2006 by a company formed for that purpose by our executive officers and a key
employee. We occupy 13,852 square feet under lease renewals entered in November 2007 for a
five-year term at monthly rents initially totaling $20,398, subject to annual escalations on the
same terms as our prior lease. In February 2010, NGAS Production purchased the building for $5.6
million, of which $4.48 million was funded from proceeds of a five-year installment loan secured by
a mortgage on the property. Note 10 Long-Term Debt. The terms of the transaction were
negotiated on our behalf by one of our independent directors appointed for that purpose by our
board. The negotiations were conducted at arms length with the management company for the
building, and our purchase price was approximately the same as the sale price for the building in
2006. The fairness of the consideration was supported by an independent appraisal based on recent
sales of comparable office buildings in our locale.
Note 14 Segment Information
We have a single reportable operating segment for our oil and gas business based on the
integrated way we are organized by management in making operating decisions and assessing
performance. Although our financial reporting reflects our separate revenue streams from drilling,
production and gas gathering activities, along with the direct expenses for each component, we do
not consider the components as discreet operating segments under ASC 280, S
egment Reporting.
Note 15 Commitments
Operating Lease Obligations.
We incurred operating lease expenses totaling $2,670,002 in 2009
and $1,872,074 in the first nine months of 2010. As of September 30, 2010, we had future
obligations under operating leases as follows:
|
|
|
|
|
Future Lease Obligations
|
|
|
|
|
Remainder of 2010
|
|
$
|
579,862
|
|
2011
|
|
|
1,853,837
|
|
2012
|
|
|
616,087
|
|
2013
|
|
|
77,495
|
|
2014 and thereafter
|
|
|
31,959
|
|
|
|
|
|
Total
|
|
$
|
3,159,240
|
|
|
|
|
|
Gas Gathering and Sales Commitments.
We have various long-term commitments under gas
gathering and sales agreements entered with Seminole Energy in connection with our sale of the
Appalachian Gathering System during the third quarter of 2009. See Note 5 Note Receivable.
These include monthly gathering fees of $862,750, with annual escalations at the rate of 1.5%,
operating fees of $182,612 per month, plus $0.20 per Mcf of purchased gas, and capital fees in
amounts intended to yield a 20% internal rate of return for all capital expenditures on the system
by Seminole Energy. These agreements have an initial term of fifteen years with extension rights.
9
Note 16 Subsequent Events
Convertible Note Amortization
. On October 1 and November 1, 2010, we paid monthly
amortization installments on the 2010 notes in common shares. See Note 10 Long-Term Debt.
Based on the pricing and true-up provisions of the 2010 notes, we issued a total of 1,628,385
shares for the October installment and 2,257,235 shares for the November installment. These
issuances increased our total common stock outstanding to 46,416,385 shares as of the date of this
report. See Note 11 Capital Stock.
Credit Facility Noncompliance.
In November 2010, we entered into negotiations with the
lenders under our credit facility for a waiver or forbearance with respect to our noncompliance
with the leverage ratio under our credit agreement as of September 30, 2010. The covenant limits
our consolidated funded indebtedness (excluding the 2010 notes) at the end of the quarter to not
more than 4.75 times our consolidated earnings for the trailing twelve-month period before cash
interest expense, income tax expense and DD&A, to the extent deducted in determining our
consolidated net income or loss for that period. If we are unable to obtain a waiver of the
covenant default, we will be required to restructure or seek to replace our credit facility.
10
NGAS Resources, Inc.
Item 2.
Managements Discussion and Analysis of Financial Condition and Results
of Operations
General
We are an independent exploration and production company focused on unconventional natural gas
plays in the eastern United States, principally in the southern Appalachian Basin. For over 25
years, we have specialized in generating our own geological prospects in this region, where we have
established expertise and recognition. We also operate the gas gathering facilities for our core
properties, providing deliverability directly from the wellhead to the interstate pipeline network
serving major east coast natural gas markets. During the last three years, we have successfully
transitioned to horizontal drilling throughout our Appalachian acreage and expanded our operations
to the Illinois Basin. We believe our extensive operating experience, coupled with our
relationships with partners, suppliers and mineral interest owners, gives us competitive advantages
in developing these resources to deliver volumetric growth.
Capital Structure
Since mid-2009, we completed several deleveraging initiatives. During the third quarter last year, we substantially reduced our credit facility debt
with proceeds from the sale of 485 miles of our Appalachian gas gathering facilities (
Appalachian
Gathering System
) for $35.5 million, plus a promissory note for $14.5 million, payable in monthly
installments with 8% interest through December 2011. We further reduced our credit facility debt
by $8.8 million with proceeds from equity offerings in August 2009 and May 2010. In addition,
during the first quarter of 2010, we exchanged $37 million of 6% convertible notes due December
2010 for $28.7 million in new amortizing convertible notes due May 1, 2012 (
2010 notes
), together
with a combination of cash, common shares and warrants. See Liquidity and Capital Resources.
Business Strategy
Our oil and gas properties span over 360,000 gross acres, concentrated in the southern
Appalachian Basin, where we added 60,000 acres last year near our Leatherwood and Amvest fields.
Over 76% of our operated properties in this region and in the Illinois Basin are undeveloped. Our
strategy for efficient development of these resources has been transformed by advances in
air-driven horizontal drilling and staged completion technology optimized for our operating areas.
We began this transition early in 2008 and had a total of 56 horizontals on line by the end of
September 2010. With an extensive inventory of horizontal locations for ongoing development, we
are positioned to achieve sustainable growth under a low-cost structure with several key
components.
|
|
|
Organic Growth with Reduced Capital Spending
. We have addressed the
challenging conditions in our industry by funding our capital budget from cash flow and
opening up our core properties to joint development with industry partners and
sponsored drilling partnerships. Our 2009 drilling partnership raised over $19 million
for participation in 22 horizontal wells. We have a 20% interest in that program,
increasing to 35% after payout. This enabled us to meet our near-term drilling
commitments and objectives with a reduced budget of $12 million in 2009. We have
retained this structure for participation by our current drilling partnership in up to
57 horizontal wells on our core Appalachian properties through the first quarter of
2011, while continuing to maintain our capital expenditures in line with our operating
cash flows.
|
|
|
|
Horizontal Drilling Advances
. Horizontal drilling has enhanced the value
proposition of our properties by substantially increasing recovery volumes and rates at
dramatically lower finding costs. The ability to drill extended lateral legs also
allows us to develop areas that would otherwise be inaccessible due to challenging
terrain or coal mining activities. Most of our horizontals traverse one or more
sections of the Devonian shale formation, which blankets our Appalachian properties at
an average depth of 4,500 feet, or the New Albany shale in the Illinois Basin at depths
from 2,600 to 2,800 feet. By extending the laterals and increasing the number of
completion stages, we continue to improve the performance of our horizontal shale
wells. We have also drilled our first two horizontals through the Weir sandstone
formation in the Roaring Fork field. Although the wells are at the beginning stages of
production, we are very encouraged by initial results We have over 70,000 undeveloped
acres that are prospective for this play and plan to drill additional Weir horizontals
at an accelerated pace, with a view to shifting more of our production to crude oil.
|
11
|
|
|
Infrastructure Position
. We operate the Appalachian Gathering System and
have firm capacity rights for 30 Mmcf/d of controlled gas through the system, which
interconnects to Spectra Energy Partners East Tennessee Interstate pipeline network.
This ensures long-term deliverability from our connected fields, representing over 90%
of our Appalachian production. Our operating and capacity rights also preserve our
competitive advantages in assembling additional undeveloped acreage around our core
properties in the region as coal mining operations wind down. The sale of the
Appalachian Gathering System did not include our 50% interest in a processing plant for
extracting natural gas liquids (
NGL
) from system throughput at its delivery point in
Rogersville, Tennessee. This is within 5.5 miles of an 880-megawatt gas-fired power
plant under construction by the Tennessee Valley Authority, which will substantially
increase regional demand when completed next year.
|
Drilling Operations
Geographic Focus
. As of September 30, 2010, we had interests in approximately 1,400
wells, concentrated on our Appalachian properties, which span over 315,000 acres. We believe our
long and successful operating history has positioned us as a leading producer in this region.
Although mineral development in Appalachia has historically been dominated by coal mining
interests, it is also one of the oldest and most prolific natural gas producing areas in the United
States. The primary payzone throughout our Appalachian acreage is the Devonian shale formation,
also referred to as the Huron shale. This is considered an unconventional target due to its low
permeability, requiring effective treatment to enhance gas flows. Estimated ultimately recoverable
volumes (
EUR
s) of natural gas for our vertical Devonian shale wells reflect modest initial volumes
offset by low annual decline rates. Our New Albany shale play in the Illinois Basin has similar
geological, production and reserve characteristics.
Horizontal Air Drilling
. Air-driven horizontal drilling and staged completion
technology has dramatically improved the economics of our shale plays in the Appalachian and
Illinois Basins. Our laterals are drilled to traverse the targeted section of the payzone, guided
by real-time data on the drill bit location. This allows the well bore to stay in contact with the
reservoir longer and to intersect more fractures in the formation. We perform a staged treatment
process on our horizontal shale wells to enhance natural fracturing with large volumes of nitrogen,
generally one-million standard cubic feet for each of eight or more stages. While approximately
three times more expensive than our vertical shale wells, horizontal drilling has substantially
increased our recovery volumes and rates at lower overall finding costs. Extending the lateral
legs out to 4,800 feet and adding more completion stages has further improved our performance this
year, with anticipated EURs exceeding 1.0 Bcfe. In addition, by stacking multiple horizontals on a
single drill site, we continue to drive down our finding and development costs.
Drilling Results
. The following table shows our gross and net development and
exploratory wells drilled during 2009 and the first nine months of 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Development Wells
|
|
|
Exploratory Wells
|
|
|
|
Productive
|
|
|
Dry
|
|
|
Productive
|
|
|
Dry
|
|
|
|
Gross
|
|
|
Net
|
|
|
Gross
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vertical
|
|
|
10
|
|
|
|
1.6972
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Horizontal
|
|
|
24
|
|
|
|
5.0588
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
(1)
|
|
|
34
|
|
|
|
6.7560
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended September 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vertical
|
|
|
1
|
|
|
|
1.0000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Horizontal
|
|
|
22
|
|
|
|
3.5000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
23
|
|
|
|
4.5000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
57
|
|
|
|
11.2650
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Includes 9 gross (1.9560 net) non-operated wells.
|
Participation Rights
. The interests in some of our operated properties in the
Appalachian Basin, primarily our Leatherwood field, are subject to participation rights retained by
the mineral interest owners, generally up to 50% of the working interest in wells drilled on the
covered acreage. We had third-party participation for working interests in our horizontal
Leatherwood wells averaging 35% in 2009 and 33% in the first nine months of 2010.
12
Drilling Partnerships
Benefits
. Since 1996, we have sponsored 38 drilling partnerships for accredited
investors to participate in many of our drilling initiatives. In addition to addressing the high
capital requirements of our business, this structure enables us to diversify our well inventory,
satisfy our drilling commitments and reduce our finding costs by leveraging our buying power for
drilling services and materials. It also allows us to capture higher and more stable sales prices
by expanding the production capacity we can provide to gas purchasers. We focus on low risk,
repeatable locations for our drilling partnerships, generally near existing production on large
tracts with excellent geology that is well suited for horizontal drilling. This years drilling
partnership has held initial closings of its private placement for approximately $16 million
through the date of this report and will participate with us in up to 57 horizontal wells planned
through the first quarter of 2011.
Structure
. Our drilling partnerships are structured to share development costs and
returns with private investors and optimize their tax advantages through functional allocations of
intangible drilling costs. Under this structure, proceeds from the private placement of interests
in each investment partnership, together with our 1% capital contribution, are pooled in a separate
joint venture or program that we form to conduct operations. We contribute capital to each joint
venture program in proportion to our initial interest, established at 20% in recent programs.
After program payout, we earn an additional reversionary interests in program wells, generally
amounting to 15% of the total program interests. We conduct drilling operations for managed
programs on a cost-plus basis, with our share of drilling contract profit eliminated on
consolidation in our financial statements.
Producing Activities
Regional Advantages
. Our proved reserves are concentrated in the southern Appalachian
Basin. In addition to the regions established geology for predictable, long-lived natural gas
reserves, its proximity to major east coast gas markets generates realization premiums above Henry
Hub spot prices. Our Appalachian natural gas production also has a high energy content, providing
energy related premiums over normal pipeline quality gas.
Liquids Extraction
. In response to a FERC tariff limiting the upward range of
throughput into the East Tennessee Interstate pipeline to 1.1 Dth per Mcf, we constructed a
processing plant in Rogersville, Tennessee with a joint venture partner during 2007 to extract NGL
from production serviced by the Appalachian Gathering System prior to delivery into the pipeline.
The plant was brought on line in January 2008, ensuring our compliance with the FERC tariff. Sales
of extracted NGL and our share of processing fees for third-party gas have more than offset the
reduction in energy-related yields from our Appalachian gas sales.
Production Profile, Volumes and Prices
. Our Appalachian wells produce high quality
natural gas at low pressures with little or no water production. As of December 31, 2009, the
reserve life index of our estimated proved reserves, representing the ratio of reserves to annual
production, was 19.7 years overall and approximately 13.5 years for our proved developed producing
reserves, based on annualized fourth quarter production. The following table shows our production
volumes of natural gas, crude oil and NGL during the three months and nine months ended September
30, 2010 and 2009 and the year ended December 31, 2009, along with our average sales prices in each
of the reported periods.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
Year Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
2009
|
|
Production volumes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Natural gas (Mcf)
|
|
|
652,780
|
|
|
|
816,393
|
|
|
|
2,028,711
|
|
|
|
2,521,223
|
|
|
|
3,321,146
|
|
Oil (Bbl)
|
|
|
12,769
|
|
|
|
11,887
|
|
|
|
36,886
|
|
|
|
37,313
|
|
|
|
48,737
|
|
Natural gas liquids (gallons)
|
|
|
1,540,637
|
|
|
|
1,458,541
|
|
|
|
3,489,610
|
|
|
|
3,895,199
|
|
|
|
4,858,044
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equivalents (Mcfe)
|
|
|
844,944
|
|
|
|
997,103
|
|
|
|
2,511,748
|
|
|
|
3,037,238
|
|
|
|
3,977,920
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average sales prices:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Natural gas (per Mcf)
|
|
$
|
5.74
|
|
|
$
|
5.67
|
|
|
$
|
5.98
|
|
|
$
|
6.31
|
|
|
$
|
6.17
|
|
Oil (per Bbl)
|
|
|
69.12
|
|
|
|
60.76
|
|
|
|
70.52
|
|
|
|
48.03
|
|
|
|
52.63
|
|
Natural gas liquids (per gallon)
|
|
|
0.64
|
|
|
|
0.61
|
|
|
|
0.83
|
|
|
|
0.64
|
|
|
|
0.73
|
|
13
Future Gas Sales Contracts
. We use fixed-price, fixed-volume physical delivery
contracts that cover portions of our natural gas production at specified prices during varying
periods of time to address commodity price volatility. Our physical delivery contracts are not
treated as financial hedges and are not subject to mark-to-market accounting. The financial impact
of these contracts is included in our oil and gas revenues at the time of settlement. As of
September 30, 2010, we have contracts in place for approximately 46% of our gas production from
operated Appalachian properties at a weighted average sales price of $6.61 per Mcf during the
remainder of the year and for approximately 33% of that production at a weighted average sales
price of $6.66 per Mcf during the first six months of 2011.
Results of Operations Three Months Ended September 30, 2010 and 2009
Revenues
. The following table shows the components of our revenues for the three
months ended September 30, 2010 and 2009, together with their percentage of total revenues in the
current period and percentage change on a period-over-period basis.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
|
% of
|
|
|
|
|
|
|
%
|
|
Revenue:
|
|
2010
|
|
|
Revenue
|
|
|
2009
|
|
|
Change
|
|
Contract drilling
|
|
$
|
4,555,485
|
|
|
|
42
|
%
|
|
$
|
3,831,250
|
|
|
|
19
|
%
|
Oil and gas production
|
|
|
5,616,269
|
|
|
|
51
|
|
|
|
6,239,324
|
|
|
|
(10
|
)
|
Gas transmission, compression and processing
|
|
|
784,750
|
|
|
|
7
|
|
|
|
1,123,921
|
|
|
|
(30
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
10,956,504
|
|
|
|
100
|
%
|
|
$
|
11,194,495
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues for the three months ended September 30, 2010 reflect the impact of reduced
drilling activity in prior periods, low natural gas prices and third-party ownership of the
Appalachian Gathering System, which eliminated both our revenues and cost savings from these
facilities following their sale during the third quarter last year. Although our revenues
benefitted from a ramp up in contract drilling for our 2010 partnership during the third quarter,
in view of our current business model for maintaining our capital budget in line with operating
cash flows, we do not expect this overall trend to reverse without significant improvement in
commodity prices.
Contract drilling revenues are driven by the size and timing of our drilling partnership
initiatives. We generally receive the proceeds from private placements by sponsored partnerships
as prepayments under our drilling contracts and recognize contract drilling revenues as the wells
are drilled. Prior to the third quarter of 2010, however, we drilled several horizontal wells with
planned participation by this years partnership in advance of funding from its private placement,
which was launched in April 2010. Contract drilling revenues for the current quarter reflect
reimbursements for the partnerships share of drilling costs for those wells, together with funding
for the partnerships participation in additional horizontals drilled during the quarter.
Production revenues for the third quarter of 2010 reflect reduced drilling activity in prior
periods, higher transportation costs and continued weakness in natural gas prices. Our production
output of 845 Mmcfe in the current quarter was 15% below our near-record production of 997 Mmcfe in
the third quarter of 2009, which benefitted from higher working interests in wells drilled during
the prior year on operated properties. Weighted average prices for our natural gas sales were
$6.08 per Mcf for Appalachian production and $5.74 per Mcf overall during the current quarter,
compared to $6.53 and $5.67 per Mcf, respectively, in the third quarter of 2009. Approximately 50%
of our natural gas production in the current quarter was sold under fixed-price physical delivery
contracts, and the balance primarily at prices determined monthly under formulas based on
prevailing market indices.
The contraction of gas transmission, compression and processing revenues was driven by our
sale of the Appalachian Gathering System in the third quarter of 2009. Following the sale, this
revenue base has been limited primarily to gas utility sales, monthly operating fees from managed
partnerships, third-party fees from our interest in the Rogersville processing plant, which we
continue to co-own with Seminole Energy, and fees for operating the Appalachian Gathering System.
14
Expenses
. The following table shows the components of our direct and other expenses
for the three months ended September 30, 2010 and 2009. Percentages listed in the table reflect
margins for each component of direct expenses and percentages of total revenue for each component
of other expenses.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Direct Expenses:
|
|
2010
|
|
|
Margin
|
|
|
2009
|
|
|
Margin
|
|
Contract drilling
|
|
$
|
3,196,824
|
|
|
|
30
|
%
|
|
$
|
2,913,418
|
|
|
|
24
|
%
|
Oil and gas production
|
|
|
3,988,755
|
|
|
|
29
|
|
|
|
2,658,985
|
|
|
|
57
|
|
Gas transmission, compression and processing
|
|
|
91,902
|
|
|
|
88
|
|
|
|
960,879
|
|
|
|
15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total direct expenses
|
|
$
|
7,277,481
|
|
|
|
34
|
|
|
$
|
6,533,282
|
|
|
|
42
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Expenses (Income):
|
|
|
|
|
|
% Revenue
|
|
|
|
|
|
|
% Revenue
|
|
Selling, general and administrative
|
|
$
|
2,479,006
|
|
|
|
23
|
%
|
|
$
|
2,601,514
|
|
|
|
23
|
%
|
Options, warrants and deferred compensation
|
|
|
226,066
|
|
|
|
2
|
|
|
|
285,309
|
|
|
|
3
|
|
Depreciation, depletion and amortization
|
|
|
3,388,841
|
|
|
|
31
|
|
|
|
3,304,139
|
|
|
|
30
|
|
Interest expense, net of interest income
|
|
|
1,411,637
|
|
|
|
13
|
|
|
|
2,143,393
|
|
|
|
19
|
|
Loss (gain) on sale of assets
|
|
|
209,206
|
|
|
|
2
|
|
|
|
(3,356,177
|
)
|
|
|
N/A
|
|
Fair value loss (gain) on derivative financial instruments
|
|
|
(359,398
|
)
|
|
|
N/A
|
|
|
|
4,847
|
|
|
|
|
|
Other, net
|
|
|
(91,228
|
)
|
|
|
N/A
|
|
|
|
292,073
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other expenses
|
|
$
|
7,264,130
|
|
|
|
|
|
|
$
|
5,275,098
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract drilling expenses reflect the level and timing of drilling initiatives conducted with
participation by our sponsored partnerships. These expenses represented 70% of contract drilling
revenues in the current quarter, compared to 76% in the year-earlier period. Margins for contract
drilling operations reflect our cost-plus pricing model, which we adopted in 2006 to address price
volatility for drilling services, equipment and steel casing requirements, as well as improved
efficiencies from ongoing refinements in our horizontal drilling and completion techniques.
Production expenses represent lifting costs, field operating and maintenance expenses, related
overhead, severance and other production taxes, third-party transportation fees and processing
costs. The increase in production expenses on a period-over-period basis primarily reflects higher
transportation costs following our sale of the Appalachian Gathering System during the third
quarter last year. Our ownership of the facilities in prior periods eliminated all transportation
costs for our share of Leatherwood, Straight Creek, Fonde and Stone Mountain production delivered
through the system.
Our gas transmission and compression expenses, as well as capitalized costs for this part of
our business, have been substantially reduced from our sale of the Appalachian Gathering System.
Our remaining infrastructure position consists of 100% interests in the gas gathering facilities
for our Haleys Mill and Kay Jay fields, 50% interests in our Haleys Mill and Rogersville
processing plants and a 25% interest in the gathering system for our non-operated Arkoma
properties. Our gas transmission, compression and processing expenses will continue to reflect
this reduction in our infrastructure asset base.
Selling, general and administrative (
SG&A
) expenses are comprised primarily of selling and
promotional costs for our sponsored drilling partnerships and general overhead costs. Our SG&A
expenses in the current quarter decreased by 5% from the same period last year, primarily due to
the timing of marketing activities for sponsored drilling partnerships and the level of partnership
sales. As a percentage of revenues, SG&A was flat on a year-over-year basis.
Non-cash charges for options, warrants and deferred compensation reflect the fair value method
of accounting for employee stock options. Employee stock options are valued under this method at
the grant date using the Black-Scholes model, and the compensation cost is recognized ratably over
the vesting period. We also recognized an accrual of $153,637 for deferred compensation cost in
the current quarter.
Depreciation, depletion and amortization (
DD&A
) is recognized under the units-of-production
method, based on the estimated proved developed reserves of the underlying oil and gas properties,
and on a straight-line basis over the useful life of other property and equipment. The decrease in
DD&A charges reflects a reduction in historical depletion costs for the Appalachian Gathering
System following its sale, partially offset by additions to our oil and gas properties.
15
Cash interest expense for the current quarter was $962,393, representing a 19% decrease from
the third quarter of 2009. This resulted primarily from lower convertible debt levels following
our note restructuring in January 2010 and a reduction of $48.8 million in credit facility debt
from our monetization of the Appalachian Gathering System and equity raises during the third
quarter of 2009 and the second quarter of 2010. See Liquidity and Capital Resources. We
recognized non-cash interest expense of $640,674 in the current quarter for accretion of the debt
discount on the 2010 notes under the effective interest method.
We recorded a fair value gain of $359,398 on derivative financial instruments during the
current quarter under mark-to-market accounting for the embedded conversion features of the
2010 notes and related warrants. The accounting treatment of the convertible debt restructuring is
discussed in Note 10 to the consolidated financial statements included in this report.
Net Loss and EPS
. We recognized net losses of $2,509,233 in the third quarter of 2010
and $1,122,001 in the same period last year, reflecting the foregoing factors. Basic and diluted
loss per share (
EPS
) was $(0.06) on 41,044,918 weighted average common shares outstanding in the
current quarter, compared to $(0.04) on 28,873,105 weighted average shares in the third quarter of
2009.
Results of Operations Nine Months Ended September 30, 2010 and 2009
Revenues
. The following table shows the components of our revenues for the nine
months ended September 30, 2010 and 2009, together with their percentages of total revenue in the
current period and percentage change on a period-over-period basis.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
% of
|
|
|
|
|
|
|
%
|
|
Revenue:
|
|
2010
|
|
|
Revenue
|
|
|
2009
|
|
|
Change
|
|
Contract drilling
|
|
$
|
15,667,095
|
|
|
|
43
|
%
|
|
$
|
16,328,000
|
|
|
|
(4
|
)%
|
Oil and gas production
|
|
|
17,644,686
|
|
|
|
49
|
|
|
|
20,198,187
|
|
|
|
(13
|
)
|
Gas transmission, compression and processing
|
|
|
2,835,327
|
|
|
|
8
|
|
|
|
6,528,132
|
|
|
|
(57
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
36,147,108
|
|
|
|
100
|
%
|
|
$
|
43,054,319
|
|
|
|
(16
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract drilling revenues for the first nine months of 2010 reflect the 80% share of outside
investors in the last four wells drilled with our 2009 partnership and the initial 19 wells with
participation by this years drilling partnership, which was launched in April 2010. Our 2010
drilling partnership has raised approximately $16 million through the date of this report.
Production revenues for the first nine months of 2010 reflect lower natural gas prices as well
as reduced drilling activity during prior periods, which contributed to a 17% decrease in
production output to 2,512 Mmcfe, compared to record production of 3,037 Mmcfe in the first nine
months of 2009. During the current period, weighted average prices for our natural gas sales were
$6.44 per Mcf for our Appalachian production and $5.98 per Mcf overall, compared to $7.44 and
$6.31 per Mcf, respectively, in first nine months of 2009. Approximately 50% of our natural gas
production in the current period was sold under fixed-price physical delivery contracts, and the
balance primarily at prices determined monthly under formulas based on prevailing market indices.
The contraction of gas transmission, compression and processing revenues was driven by our
sale of the Appalachian Gathering System in the third quarter of 2009. Following the sale, this
revenue base has been limited primarily to gas utility sales, monthly operating fees from managed
partnerships, third-party fees from our interest in the Rogersville processing plant, which we
continue to co-own with Seminole Energy, and fees for operating the Appalachian Gathering System.
Expenses
. The following table shows the components of our direct and other expenses
for the nine months ended September 30, 2010 and 2009. Percentages listed in the table reflect
margins for each component of direct expenses and percentages of total revenue for each component
of other expenses.
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
Direct Expenses:
|
|
2010
|
|
|
Margin
|
|
|
2009
|
|
|
Margin
|
|
Contract drilling
|
|
$
|
11,574,230
|
|
|
|
26
|
%
|
|
$
|
12,328,110
|
|
|
|
24
|
%
|
Oil and gas production
|
|
|
11,007,455
|
|
|
|
38
|
|
|
|
7,598,044
|
|
|
|
62
|
|
Gas transmission, compression and processing
|
|
|
512,452
|
|
|
|
82
|
|
|
|
2,955,204
|
|
|
|
55
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total direct expenses
|
|
$
|
23,094,137
|
|
|
|
36
|
|
|
$
|
22,881,358
|
|
|
|
47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Expenses (Income):
|
|
|
|
|
|
% Revenue
|
|
|
|
|
|
|
% Revenue
|
|
Selling, general and administrative
|
|
$
|
7,811,382
|
|
|
|
22
|
%
|
|
$
|
8,404,519
|
|
|
|
20
|
%
|
Options, warrants and deferred compensation
|
|
|
729,295
|
|
|
|
2
|
|
|
|
1,022,774
|
|
|
|
2
|
|
Depreciation, depletion and amortization
|
|
|
9,906,178
|
|
|
|
27
|
|
|
|
10,610,630
|
|
|
|
25
|
|
Interest expense, net of interest income
|
|
|
4,406,279
|
|
|
|
12
|
|
|
|
6,824,842
|
|
|
|
16
|
|
Loss (gain) on sale of assets
|
|
|
218,709
|
|
|
|
1
|
|
|
|
(3,369,082
|
)
|
|
|
N/A
|
|
Fair value loss (gain) on derivative financial instruments
|
|
|
337,195
|
|
|
|
1
|
|
|
|
(4,477
|
)
|
|
|
|
|
Refinancing costs
|
|
|
625,344
|
|
|
|
2
|
|
|
|
|
|
|
|
N/A
|
|
Other, net
|
|
|
(307,808
|
)
|
|
|
N/A
|
|
|
|
600,896
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other expenses
|
|
$
|
23,726,574
|
|
|
|
|
|
|
$
|
24,090,102
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract drilling expenses reflect the level and timing of drilling initiatives conducted with
participation by our sponsored drilling partnerships. These expenses represented 74% of contract
drilling revenues in the current quarter, compared to 76% in the year-earlier period, reflecting
our cost-plus pricing model adopted in 2006 to address price volatility for drilling services and
materials, coupled with improved horizontal drilling efficiencies.
The increase in production expenses on a period-over-period basis primarily reflects higher
transportation costs following our sale of the Appalachian Gathering System during the third
quarter last year. Our ownership of the facilities in prior periods eliminated all transportation
costs for our share of Leatherwood, Straight Creek, Fonde and Stone Mountain production delivered
through the system.
Our gas transmission and compression expenses, as well as capitalized costs for this part of
our business, have been substantially reduced from our sale of the Appalachian Gathering System.
Our gas transmission, compression and processing expenses will continue to reflect this reduction
in our infrastructure asset base.
SG&A expenses in the first nine months of 2010 decreased by 7% from the same period last year,
primarily due to various cost cutting measures as well as the timing of marketing activities for
sponsored drilling partnerships and the level of partnership sales. As a percentage of revenues,
SG&A increased to 22% in the current period from 20% in the first nine months of 2009.
Non-cash charges for options, warrants and deferred compensation primarily reflect amounts
recognized for employee stock options granted in prior periods. Employee stock options are valued
under the fair value method of accounting at the grant date using the Black-Scholes model, and the
compensation cost is recognized ratably over the vesting period. We also recognized an accrual of
$460,911 for deferred compensation cost in the current period.
The decrease in DD&A charges reflects a reduction in historical depletion costs for the
Appalachian Gathering System following its sale, partially offset by additions to our oil and gas
properties. DD&A is recognized under the units-of-production method for oil and gas properties and
on a straight-line basis over the useful life of other property and equipment.
Cash interest expense for the current period was of 2,980,830, representing a 26% decrease
from the first nine months of 2009. This resulted primarily from lower convertible debt levels
following our note restructuring in January 2010 and a reduction of $48.8 million in credit
facility debt from our monetization of the Appalachian Gathering System and equity raises during
the third quarter of 2009 and the second quarter of 2010. See Liquidity and Capital Resources.
We recognized non-cash interest expense of $2,093,135 in the current period for accretion of the
debt discount on the 2010 notes under the effective interest method.
We recognized a fair value loss of $337,195 on derivative financial instruments during the
current period under mark-to-market accounting for the embedded conversion features of the
2010 notes and related warrants. We also recognized refinancing costs of $625,344 during the
current period for the note restructuring.
17
Net Loss and EPS
. We recognized net losses of $8,403,316 in the first nine months of
2010 and $4,488,498 in the same period last year, reflecting the foregoing factors. Basic and
diluted EPS was $(0.23) on 36,709,848 weighted average common shares outstanding in the current
period, compared to $(0.16) on 27,508,925 weighted average shares in the first nine months of 2009.
The non-cash interest charges for accretion of the debt discount on our convertible debt and the
fair value loss on derivative financial instruments accounted for $2,430,330 or $(0.07) per share
of our reported net loss in the first nine months of 2010.
The results of operations for the three months and nine months ended September 30, 2010 are
not necessarily indicative of results to be expected for the full year.
Liquidity and Capital Resources
Liquidity
. We completed an underwritten offering of 3.96 million units at $1.31 per
unit in May 2010, with net proceeds of approximately $4.7 million. We applied $2.7 million of the
proceeds to debt reduction under our revolving credit facility and the balance to working capital.
Each unit consists of one share of our common stock and a warrant to buy 0.5 common share. The
warrants are exercisable through November 17, 2014 for up to 1,584,000 shares of our common stock
at $1.61 per share, subject to adjustment upon certain fundamental change transactions or any share
recapitalization.
Net cash of $988,368 was used in operating activities in the first nine months of 2010.
During the period, we used net cash of $2,318,776 in investing activities, of which approximately
$1.8 million represents capital expenditures for developing our oil and gas properties. Our net
cash of $4,079,511 from financing activities primarily reflects proceeds from our equity raise,
part of which was applied to debt reduction under our credit facility, and proceeds of an
installment loan, which was used to fund part of our office building acquisition. See Related
Party Transactions. As a result of these activities and related cash management, our net cash
increased from $4,332,650 at December 31, 2009 to $5,105,017 at September 30, 2010.
We had a working capital deficit of $38,319,079 at September 30, 2010. This reflects the current portion of the 2010 notes and the reclassification of our credit
facility debt as a current liability based on the scheduled maturity of the facility in September
2011. In addition, as of September 30, 2010, we were not in compliance with the leverage ratio
under our credit agreement. We have entered into negotiations with the lenders to restructure the
facility as a result of the covenant default, which could otherwise result in a cross-default under
our 2010 notes. See Risk Factors. We have engaged financial advisors to assist us pursue
strategic alternatives, which may include the sale of assets or other types of merger or
acquisition transactions intended to maximize shareholder value.
Capital Resources
. Our business involves significant capital requirements. The rate
of production from oil and gas properties declines as reserves are depleted. Without successful
development activities, our proved reserves would decline as oil and gas is produced from our
proved developed reserves. We also have substantial annual drilling commitments under various
leases and farmouts for our Appalachian properties, including an annual 25-well commitment for our
Leatherwood field. Our long-term performance and profitability is dependent not only on meeting
these commitments and recovering existing oil and gas reserves, but also on our ability to find or
acquire additional reserves and fund their development on terms that are economically and
operationally advantageous.
Historically, we have relied on a combination of cash flows from operations, bank borrowings
and private placements of our convertible notes and equity securities to fund our reserve and
infrastructure development and acquisition activities. We have also relied to varying degrees on
participation by outside investors in sponsored drilling partnerships. During 2008, we changed our
business model to accelerate organic growth by retaining all of our available working interest in
wells drilled on operated properties. While we remain committed to expanding our reserves and
production through the drill bit, we have addressed the challenging economic environment by
monetizing gas gathering assets, restructuring convertible debt, reducing capital expenditures and
returning to our successful partnership model for sharing development costs and returns on operated
properties.
We raised $19.25 million last year for our 2009 drilling partnership, which participated with
us in a portfolio of 22 horizontal wells on our operated properties. We have a 20% interest before
payout and a 35% interest after payout in our 2009 program. This structure and several joint
venture arrangements with industry partners enabled us to meet our annual drilling commitments with
$12 million of capital expenditures last year, reflecting a 75% reduction from our 2008 drilling
budget. We have retained this structure for our 2010 drilling partnership, which has raised
$16 million through the date of this report. With our critical infrastructure in place and our
partnership sales on track, we expect to meet our current drilling commitments and near-term
objectives for organic growth with a reduced drilling budget funded from operating cash flow.
18
In January 2010, we exchanged our outstanding 6% convertible notes due December 15, 2010 in
the aggregate principal amount of $37 million (
2005 notes
) for $28.7 million in new amortizing
convertible notes due May 1, 2012, together with common shares, warrants and cash payments of
approximately $2.7 million. The 2010 notes bear interest at 6% per annum, payable quarterly. They
are convertible at the option of the holders into our common stock at $2.18 per share, and the
warrants issued in the exchange are exercisable at $2.37 per share, subject in each case to certain
volume limitations and adjustments for certain fundamental change transactions or share
recapitalizations. We are required to make equal monthly principal amortization payments on the
2010 notes during the last 24 months of their term. Subject to certain volume limitations, true-up
adjustments and other conditions, we may elect to pay all or part of any principal installment in
common stock, valued at the lesser of $2.18 per share or 95% of the 10-day volume weighted-average
price of the stock prior to the installment date. We made the monthly amortization installments in
common shares, resulting in total issuances of 8,858,682 shares as of the date of this report, with
approximately $21.5 million in 2010 notes outstanding.
The 2010 notes are subject to customary non-financial covenants and remedies upon specified
events of default, including cross-default with our credit facility. Holders also have the right
to require us to redeem their notes in cash upon any event of default at 125% of their principal
amount or upon a change of control at 110% of their principal amount. Alternatively, holders may
convert their 2010 notes in connection with any change of control and receive either common shares
based on the price of our stock at that time or the consideration that would be received for the
underlying shares in the change of control transaction. Under certain conditions, we may call the
2010 notes for redemption to force their conversion. Any 2010 notes that are neither repaid,
redeemed nor converted will be repayable at maturity in cash plus accrued and unpaid interest.
We have a senior secured revolving credit facility maintained by our operating subsidiary,
NGAS Production Co., with KeyBank National Association, as agent and primary lender. The facility
provides for revolving term loans and letters of credit in an aggregate amount up to $125 million,
subject to borrowing base thresholds determined semi-annually by the lenders. The facility has a
scheduled maturity in September 2011, resulting in the classification of our revolving debt as a
current liability at September 30, 2010. Outstanding borrowings under the facility bear interest
at fluctuating rates ranging from the agents prime rate to 2.25% above that rate, depending on the
amount of borrowing base utilization. The facility is guaranteed by NGAS and is secured by liens
on our oil and gas properties.
In January 2010, we entered into an amendment to the credit agreement for the facility that
permitted us to complete our convertible note exchange, subject to certain non-financial covenants
and borrowing base modifications. These include restrictions on upstream dividends from NGAS
Production for any principal amortization payments on the 2010 notes that would cause outstanding
borrowings under the facility to exceed 80% of the prevailing borrowing base. The amendment also
provided for monthly borrowing base reductions of $1 million through June 30, 2010. At that time,
the borrowing base for the facility was redetermined at $37 million, reflecting the commodity price
environment and our reduced drilling activity. Outstanding borrowings under the credit facility
totaled $37 million on September 30, 2010 and the date of this report.
As of September 30, 2010, we had $37 million outstanding under the credit facility, with $35.8 million outstanding as of the date
of this report. As of September 30, 2010, we were not in compliance with the leverage ratio under our credit agreement. The covenant
limits our consolidated funded indebtedness (excluding the 2010 notes) at the end of the quarter to not more than 4.75 times our consolidated earnings
for the trailing twelve-month period before cash interest expense,
income tax expense and DD&A, to the extent deducted in determining
our consolidated net income or loss for that period. We have entered into negotiations with the lenders to restructure the facility
as a result of the covenant default, which could otherwise result in a cross-default under our 2010 notes. See Risk Factors.
Our ability to maintain covenant compliance for our credit facility and to service and repay
our revolving and convertible debt will be subject to our future performance and prospects as well
as market and general economic conditions. Our future revenues, profitability and rate of growth
will continue to be substantially dependent on the market price for natural gas. Future commodity
prices will also have a significant impact on our ability to maintain or increase our borrowing
capacity, obtain additional capital on acceptable terms and attract drilling partnership capital.
While we have been able to mitigate some of the steep decline in natural gas prices with
fixed-price, fixed-volume physical delivery contracts that cover portions of our natural gas
production, we are exposed to price volatility for future production not covered by these
arrangements. See Quantitative and Qualitative Disclosures
about Market Risk and Risk Factors.
We have addressed the economic downturn and challenging conditions in our industry by
monetizing most of our gas gathering infrastructure, deleveraging and modifying our business model
to reduce our reliance on the financial and capital markets. To realize our long-term goals for
growth in revenues and reserves, however, we will continue to be dependent on those sources of
capital or other financing alternatives. Any constriction in the capital markets or protracted
weakness in domestic energy markets could require us to sell additional assets or pursue other
financing or strategic arrangements to meet those objectives and to repay or refinance our
long-term debt at maturity.
19
Forward Looking Statements
Some statements made by us in this report are prospective and constitute forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act and Section 27A of the
Securities Act of 1933. Other than statements of historical fact, all statements that address
future activities, outcomes and other matters we plan, expect, budget, intend or estimate, and
other similar expressions, are forward-looking statements. These forward-looking statements
involve known and unknown risks, uncertainties and other factors, many of which are beyond our
control. If the assumptions we use in making forward-looking statements prove incorrect or the
risks described in this report and incorporated by reference to our
2009 annual report on Form 10-K were to
occur, our actual results could differ materially from future results expressed or implied by the
forward-looking statements in this report. See Risk
Factors. Risks that could affect forward-looking statements
include the following:
|
|
|
uncertainty about future production levels, required
capital expenditures and credit agreement compliance;
|
|
|
|
commodity price volatility;
|
|
|
|
increases in the cost of developing and producing our reserves;
|
|
|
|
unavailability or increased costs of drilling rigs, services and materials;
|
|
|
|
drilling, operational and environmental risks;
|
|
|
|
regulatory changes and litigation risks; and
|
|
|
|
uncertainties in estimating oil and gas reserves and projecting future production
rates.
|
Contractual Obligations and Commercial Commitments
General
. Our contractual obligations include long-term debt, operating leases,
drilling commitments, transportation commitments, asset retirement obligations and leases for
various types of equipment. The following table summarizes our contractual financial obligations
at September 30, 2010 and their future maturities. The table does not include commitments under
our gas gathering and sales agreements described below.
|
|
|
|
|
|
|
|
|
|
|
Operating
|
|
|
Debt
|
|
Year
|
|
Leases
|
|
|
Maturities
(1)
|
|
Remainder of 2010
|
|
$
|
579,862
|
|
|
$
|
3,092,879
|
|
2011
|
|
|
1,853,837
|
|
|
|
50,252,615
|
|
2012
|
|
|
616,087
|
|
|
|
7,533,024
|
|
2013
|
|
|
77,495
|
|
|
|
182,029
|
|
2014
|
|
|
25,567
|
|
|
|
189,907
|
|
2015 and thereafter
|
|
|
6,392
|
|
|
|
3,898,714
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
3,159,240
|
|
|
$
|
65,149,168
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Excludes an allocation of $2,047,378 for the unaccreted debt discount on the 2010 notes.
|
Gas Gathering and Sales Commitments
. We have various commitments under our gas
gathering and sales agreements entered with Seminole and Seminole Energy in connection with our
sale of the Appalachian Gathering System in 2009. These agreements provide us with firm capacity
rights for 30 Mmcf/d of controlled gas and have an initial term of fifteen years with extension
rights. Our commitments under these agreements include:
|
|
|
Base monthly gathering fees of $862,750, with annual escalations at the rate of
1.5%;
|
|
|
|
Base monthly operating fees of $182,612, plus $0.20 per Mcf of purchased gas; and
|
|
|
|
Monthly capital fees in amounts intended to yield a 20% internal rate of return for
all capital expenditures on the Appalachian Gathering System by Seminole Energy.
|
Related Party Transactions
General
. Because we operate through subsidiaries and managed drilling partnerships,
various agreements and transactions in the normal course of business may be treated as related
party transactions. Our policy is to structure any transactions with related parties only on terms
that are no less favorable to the company than we could obtain on an arms length basis from
unrelated parties. Significant related party transactions are summarized below and in Notes 6 and
13 to the consolidated financial statements included in this report.
20
Purchase of Office Building
. The building in Lexington, Kentucky that houses our
principal and administrative offices was acquired during 2006 by a company formed for that purpose
by our executive officers and a key employee. We occupy 13,852 square feet under lease renewals
entered in November 2007 for a five-year term at monthly rents initially totaling $20,398, subject
to annual escalations on the same terms as our prior lease. In February 2010, NGAS Production
purchased the building for $5.6 million, of which $4.48 million was funded from proceeds of a
five-year installment loan secured by a mortgage on the property, as described in Note 10 to the
consolidated financial statements included in this report. The terms of the transaction were
negotiated on our behalf by one of our independent directors appointed for that purpose by our
board. The negotiations were conducted at arms length with the management company for the
building, and our purchase price was approximately the same as the sale price for the building in
2006. The fairness of the consideration was supported by an independent appraisal based on recent
sales of comparable office buildings in our locale.
Critical Accounting Policies and Estimates
General
. The preparation of financial statements requires management to utilize
estimates and make judgments that affect the reported amounts of assets, liabilities, revenues and
expenses and related disclosure of contingent assets and liabilities. These estimates are based on
historical experience and on various other assumptions that management believes to be reasonable
under the circumstances. The estimates are evaluated by management on an ongoing basis, and the
results of these evaluations form a basis for making decisions about the carrying value of assets
and liabilities that are not readily apparent from other sources. Although actual results may
differ from these estimates under different assumptions or conditions, management believes that the
estimates used in the preparation of our financial statements are reasonable. The critical
accounting policies affecting our financial reporting are summarized or incorporated in Note 1 to
the consolidated financial statements included in this report. Policies involving the most
significant judgments and estimates are summarized below.
Estimates of Proved Reserves and Future Net Cash Flows
. Estimates of our proved oil
and gas reserves and related future net cash flows are used in impairment tests of goodwill and
other long-lived assets. These estimates are prepared as of year-end by independent petroleum
engineers and are updated internally at mid-year. There are many uncertainties inherent in
estimating quantities of proved reserves and in projecting future rates of production and timing of
development expenditures. The accuracy of any reserve estimate is dependent on the quality of
available data and is subject to engineering and geological interpretation and judgment. Results
of our drilling, testing and production after the date of these estimates may require future
revisions, and actual results could differ materially from the estimates.
Impairment of Long-Lived Assets
.
Our long-lived assets include property, equipment
and goodwill. Long-lived assets with an indefinite life are reviewed at least annually for
impairment, and all long-lived assets are reviewed whenever events or changes in circumstances
indicate that their carrying values may not be recoverable.
Allowance for Doubtful Accounts
.
We maintain an allowance for doubtful accounts when
deemed appropriate to reflect losses that could result from failures by customers or other parties
to make payments on our trade receivables. The estimates of this allowance, when maintained, are
based on a number of factors, including historical experience, aging of the trade accounts
receivable, specific information obtained on the financial condition of customers and specific
agreements or negotiated settlements.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet debt or other unrecorded obligations with unconsolidated
entities to enhance our liquidity, provide capital resources or for any other purpose.
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Commodity Price Risk
Our major market risk exposure is the pricing of natural gas production, which has been highly
volatile and unpredictable during the last several years. While we do not use financial hedging
instruments to manage our exposure to these fluctuations or for speculative trading purposes, we do
use fixed-price, fixed-volume physical delivery contracts that cover portions of our natural gas
production at specified prices during varying periods of time up to two years from the contract
date. Because these physical delivery contracts qualify for the normal purchase and sale exception
from derivative accounting rules, they are not treated as financial hedging activities. The
financial impact of physical delivery contracts is included in our oil and gas revenues at the time
of settlement, which in turn affects our average realized natural gas prices.
21
Financial Market Risks
Interest Rate Risk
. Borrowings under our secured credit facility bear interest at
fluctuating market-based rates. Accordingly, our interest expense is sensitive to market changes,
which exposes us to interest rate risk on current and future borrowings under the facility.
Foreign Market Risk
. We sell our products and services exclusively in the United
States and receive payment solely in United States dollars. As a result, our financial results are
unlikely to be affected by factors such as changes in foreign currency exchange rates or weak
economic conditions in foreign markets, except to the extent they affect domestic natural gas
markets.
Item 4.
Controls and Procedures
Managements Responsibility for Financial Statements
Our management is responsible for the integrity and objectivity of all information presented
in this report. The consolidated financial statements included in this report have been prepared
in accordance with U.S. GAAP and reflect managements judgments and estimates on the effect of the
reported events and transactions.
Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial
officer, evaluated the effectiveness of our disclosure controls and procedures, as defined in
Rule 13a-15(e) under the Exchange Act, as of the end of the period covered by this report. Based
on managements evaluation as of September 30, 2010 in connection with the filing of this report,
our chief executive officer and chief financial officer have concluded that our disclosure controls
and procedures are effective to ensure that material information about our business and operations
is recorded, processed, summarized and publicly reported within the time periods required under the
Exchange Act, and that this information is accumulated and communicated to our management to allow
timely decisions about required disclosures.
Managements Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. Management assessed the
effectiveness of our internal control over financial reporting as of September 30, 2010 in
connection with the filing of this report, using the criteria established under
Internal Control
Integrated Framework
, issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on that assessment, management concluded that our internal control over
financial reporting was effective based on those criteria as of September 30, 2010.
Changes in Internal Control over Financial Reporting
We regularly review our system of internal control over financial reporting to ensure the
maintenance of an effective internal control environment. There were no changes in our internal
control over financial reporting during the period covered by this report that have materially
affected or are reasonably likely to materially affect our internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 1A
Risk Factors
In addition to the risks described elsewhere in this report and incorporated by reference to
our 2009 annual report on Form 10-K, we are subject to the following risks relating to our secured
credit facility, which could also impact our outstanding convertible debt.
Our cash flow is not sufficient to maintain compliance with the covenants of our existing credit
facility.
As of the date of this report, we have outstanding borrowings of $37 million under our credit
facility, with a borrowing base of $37 million, and $21.5 million principal amount of outstanding
2010 notes. Our credit facility requires that as of the end of each quarter our consolidated
funded indebtedness (excluding the 2010 notes) be not more than 4.75 times our consolidated
earnings for the trailing twelve-month period before cash interest expense, income tax expense,
depreciation and amortization, each as defined in our credit agreement. As of September 30, 2010, we were not in compliance with the leverage ratio covenant.
In
November 2010, we entered into negotiations with the lenders under our credit facility
for a waiver or forbearance with respect to our covenant default, which will require us to to
restructure our credit facility.
In the event we are unsuccessful in
negotiating a restructuring under our credit agreement, we could be required to repay the total
outstanding credit facility balance. In addition, our 2010 notes contain a cross default provision
that would entitle the holders to call their 2010 notes for redemption at a default rate equal to
125% of their principal amount if we were unable to reach agreement with our credit facility
lenders. We do not have sufficient cash to make these payments and can make no assurances that our
negotiations with our credit facility lenders for restructuring our obligations under the facility
will be successful. If we are unable to restructure these obligations or develop a plan acceptable
to our lenders for regaining compliance with the leverage covenant or for refinancing our credit
facility within a specified period, our creditors could force us into bankruptcy and liquidate our
assets to satisfy their debt.
Item 2
Unregistered Sales of Equity Securities and Use of Proceeds
During the third quarter of 2010, we issued a total of 3,857,357 shares of our common stock to
the holders of our 2010 notes in payment of the monthly amortization installments on the notes.
The shares were issued without registration under the Securities Act of 1933 based on their status
as exempt securities under Section 3(a)(9) of the Securities Act.
Item 6
Exhibits
See Index to Exhibits attached to this report and incorporated herein by reference.
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
|
|
|
|
NGAS Resources, Inc.
|
|
Date: November 9, 2010
|
By:
|
/s/
William S. Daugherty
|
|
|
|
William S. Daugherty
|
|
|
|
Chief Executive Officer
(Duly Authorized Officer)
(Principal Executive Officer)
|
|
23
Exhibit Index
|
|
|
Exhibit
|
|
|
Number
|
|
Description of Exhibit
|
31.1
|
|
Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a), as
adopted under Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
|
|
31.2
|
|
Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a), as
adopted under Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
|
|
32.1
|
|
Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(b), as
adopted under Section 906 of the Sarbanes-Oxley Act of 2002.
|
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