SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549




FORM
10-K




[x]
      Annual Report Pursuant to Section 13 or 15
(d)


of
      the Securities Exchange Act of 1934For
      the fiscal year ended December 31, 2007


[  ]
      Transition Report Pursuant to Section 13 of 15(d) of
  the


Securities
      Exchange Act of 1934For
      the transition period from _______ to _______Commission
      File Number:  1-31398







NATURAL GAS SERVICES GROUP,
INC.


(Exact
Name of Registrant as Specified in its Charter)





Colorado
            
            75-2811855(State
      or Other Jurisdiction of Incorporation or Organization)
            
            (I.R.S.  Employer
      Identification No.)2911
      South County Road 1260 Midland, Texas
            
            79706(Address
      of Principal Executive Offices)
            
            (Zip
      Code)Registrant’s
      Telephone Number, Including Area Code:
            
            (432)
      563-3974Securities
      Registered Pursuant to Section 12(b) of the Act:Title
      of Each Class
            
            Name
      of Each Exchange on Which RegisteredCommon
      Stock, $.01 par value
            
            American
      Stock Exchange


Securities
Registered Pursuant to Section 12(g) of the Act:  None.





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


Yes o                  No
þ





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.


Yes o                  No
þ





Indicate
by check mark whether the registrant:  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.


Yes þ                 No
o





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.[   ]





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.  See definition of
“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act.  (Check one):


Large
Accelerated Filer     ̈                                                                Accelerated
Filer  þ                                                      Non-Accelerated
Filer   ̈





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes o                  No
þ





The
aggregate market value of voting and non-voting common equity held by
non-affiliates of the Registrant as of March 5, 2008 was approximately
$250,171,836, based on the closing price of the common stock on the same
date.





At March
5, 2008, there were 12,085,000 shares of common stock outstanding.





Documents
Incorporated by Reference


Portions
of the definitive proxy statement for the registrant’s 2008 Annual Meeting of
Stockholders, to be filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934, are incorporated by reference into Part III of this
report.





FORM
      10-KNATURAL
      GAS SERVICES GROUP, INC.TABLE
      OF CONTENTSItem No.
            PagePART
      IItem
      1.
            Business
            1Item
      1A.
            Risk
      Factors
            8Item
      1B.
            Unresolved
      Staff Comments
            14Item
      2.
            Properties
            14Item
      3.
            Legal
      Proceedings
            15Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            15PART
      IIItem
      5.
            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            16Item
      6.
            Selected
      Financial Data
            18Item
      7.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            20Item
      7A.
            Quantitative
      and Qualitative Disclosures About Market Risk
            30Item
      8.
            Financial
      Statements and Supplementary Data
            30Item
      9.
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
            31Item
      9A.
            Controls
      and Procedures
            31Item
      9B.
            Other
      Information
            33PART
      IIIItem
      10.
            Directors,
      Executive Officers and Corporate Governance
            33Item
      11.
            Executive
      Compensation
            37Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            37Item
      13.
            Certain
      Relationships, Related Transactions, and Director
    Independence
            38Item
      14.
            Principal
      Accountant Fees and Services
            40PART
      IVItem
      15.
            Exhibits
      and Financial Statement Schedules
            E-1





SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS




This
Annual Report on Form 10-K contains certain forward-looking statements, within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
information pertaining to us, our industry and the oil and natural gas industry
that is based on the beliefs of our management, as well as assumptions made by
and information currently available to our management.  All
statements, other than statements of historical facts contained in this Annual
Report on Form 10-K, including statements regarding our future financial
position, growth strategy, budgets, projected costs, plans and objectives of
management for future operations, are forward-looking statements.  We
use the words “may,” “will,” “expect,” “anticipate,” “estimate,” “believe,”
“continue,” “intend,” “plan,” “budget” and other similar words to identify
forward-looking statements.  You should read statements that contain
these words carefully and should not place undue reliance on these statements
because they discuss future expectations, contain projections of results of
operations or of our financial condition and/or state other “forward-looking”
information.  We do not undertake any obligation to update or revise
publicly any forward-looking statements.  Although we believe our
expectations reflected in these forward-looking statements are based on
reasonable assumptions, no assurance can be given that these expectations or
assumptions will prove to have been correct.  Important factors that
could cause actual results to differ materially from the expectations reflected
in the forward-looking statements include, but are not limited to, the following
factors and the other factors described in this Annual Report on Form 10-K under
the caption “Risk Factors”:




·
            conditions
      in the oil and natural gas industry, including the demand for natural gas
      and fluctuations in the prices of oil and natural
  gas;




·
            competition
      among the various providers of compression services and
      products;




·
            changes
      in safety, health and environmental
regulations;




·
            changes
      in economic or political conditions in the markets in which we
      operate;




·
            failure
      of our customers to continue to rent equipment after expiration of the
      primary rental term;




·
            the
      inherent risks associated with our operations, such as equipment defects,
      malfunctions and natural disasters;




·
            our
      inability to comply with covenants in our debt agreements and the
      decreased financial flexibility associated with our substantial
      debt;




·
            future
      capital requirements and availability of
  financing;




·
            fabrication
      and manufacturing costs;




·
            general
      economic conditions;




·
            events
      similar to September 11, 2001; and




·
            fluctuations
      in interest rates.




We
believe that it is important to communicate our expectations of future
performance to our investors.  However, events may occur in the future
that we are unable to accurately predict or that we are unable to
control.  When considering our forward-looking statements, you should
keep in mind the risk factors and other cautionary statements in this Annual
Report on Form 10-K.










PART
I





ITEM
1.                      BUSINESS





Unless
the context otherwise requires, references in this Annual Report on Form 10-K to
“Natural Gas Services Group,” “we,” “us,” “our” or “ours” refer to Natural Gas
Services Group, Inc.  Certain specialized terms used in describing our
natural gas compressor business are defined in "Glossary of Industry Terms" on
page 7.





The
Company





We are a
leading provider of small to medium horsepower compression equipment to the
natural gas industry.  We focus primarily on the non-conventional
natural gas production business in the United States (such as coalbed methane,
gas shales and tight gas), which, according to data from the Energy Information
Administration, is the single largest and fastest growing segment of U.S. gas
production.  We manufacture, fabricate and rent natural gas
compressors that enhance the production of natural gas wells and provide
maintenance services for those compressors.  In addition, we sell
custom fabricated natural gas compressors to meet customer specifications
dictated by well pressures, production characteristics and particular
applications.  We also manufacture and sell flare systems for oil and
gas plant and production facilities.





The vast
majority of our rental operations are in non-conventional natural gas regions,
which typically have lower initial reservoir pressures and faster well decline
rates.  These areas usually require compression to be installed sooner
and with greater frequency.





Historically,
the majority of our revenue has been derived from our compressor rental
business.  In January 2005, we acquired Screw Compression Systems,
Inc., or “SCS,” which predominantly focused on the custom fabrication sales
business.  By acquiring SCS, we increased our fabrication capacity by
over 91 thousand square feet.  We are using this capacity to expand
our rental fleet while continuing SCS’ core business of custom
fabrication.  On June 30, 2007, we merged SCS into Natural Gas
Services Group, Inc.





Natural gas compressors are used in a
number of applications for the production and enhancement of gas wells and in
gas transportation lines and processing plants.  Compression equipment
is often required to boost a well’s production to economically viable levels and
enable gas to continue to flow in the pipeline to its destination.





We
increased our revenue to $72.5 million in 2007 from $10.3 million in 2002, the
year we completed our initial public offering.  During the same
period, income from operations increased to $18.6 million from $1.8
million.  Our compressor rental fleet has grown from 302 compressors
at the end of 2002 to 1,353 compressors at December 31, 2007.





Net
income for the year ended December 31, 2007 increased 61.8% to $12.3 million
($1.01 per diluted share), as compared to $7.6 million ($.66 per diluted share)
for the year ended December 31, 2006.





At
December 31, 2007, current assets were $55.2 million, which included $245
thousand of cash and $18.7 million in short-term investments.  Current
liabilities were $16.6 million, and long-term debt, net of current portion, was
$9.6 million.  Our stockholders' equity as of December 31, 2007 was
$114.4 million.





We were
incorporated in Colorado on December 17, 1998 and initially operated through
wholly or partly owned subsidiaries, all of which have either been merged into
us or dissolved.





We
maintain our principal offices at 2911 South County Road 1260, Midland, Texas
79706 and our telephone number is (432) 563-3974.  Our website is
located at http://www.ngsgi.com.  The
information on or that can be accessed through our website is not part of this
Annual Report on Form 10-K.





Industry
Trends





Natural
gas prices historically have been volatile, and this volatility is expected to
continue.  Uncertainty continues to exist as to the direction of
future United States and worldwide natural gas and crude oil price
trends.  In our opinion, overall natural gas production in the United
States is declining. We believe that natural gas is a more environmentally
friendly source of energy which  is likely to result in increases
in demand.  Being primarily a provider of services and equipment to
natural gas producers, we are more significantly impacted by changes in natural
gas prices than by changes in crude oil and condensate prices.  Longer
term natural gas prices will be determined by the supply and demand for natural
gas as well as the prices of competing fuels, such as oil and coal.





We
believe part of the growth of the rental compression capacity in the U.S. market
has been driven by the trend toward outsourcing by energy producers and
processors.  Renting does not require the purchaser to make large
capital expenditures for new equipment or to obtain financing through a lending
institution.  This allows the customer’s capital to be used for
additional exploration and production of natural gas and oil.


1





We
believe that there will continue to be a growing demand for natural
gas.  We expect demand for our products and services to continue to
rise as a result of:





·
            the
      increasing demand for and limited supply of energy, both domestically and
      abroad;





·
            continued
      non-conventional gas exploration and
production;





·
            environmental
      considerations which provide strong incentives to use natural gas in place
      of other carbon fuels;





·
            the
      cost savings of using natural gas rather than electricity for heat
      generation;





·
            implementation
      of international environmental and conservation
  laws;





·
            the
      aging of producing natural gas reserves worldwide;
  and





·
            the
      extensive supply of undeveloped natural gas
  reserves.





Our
Operating Units





The Company identifies its segments
based upon major revenue sources as Gas Compressor Rental, Engineered Equipment
Sales, Service and Maintenance and Corporate.  Please refer to
Footnote 12 on page F-18 of the Notes to Consolidated Financial
Statements.





Gas Compressor
Rental.Our rental business is primarily focused on
non-conventional gas production.  We provide rental of small to medium
horsepower compression equipment to customers under contracts typically having
minimum initial terms of six to 24 months.  Historically, in our
experience, most customers retain the equipment beyond the expiration of the
initial term.  By outsourcing their compression needs, we believe our
customers are able to increase their revenues by producing a higher volume of
natural gas due to greater equipment run-time.  Outsourcing also
allows our customers to reduce their compressor downtime, operating and
maintenance costs and capital investments and more efficiently meet their
changing compression needs.  As of December 31, 2007, the utilization
rate of our rental fleet was 88.2%.  In 2008, we intend to increase
the number of units in our rental fleet by approximately 300 to 350 additional
units.





The size,
type and geographic diversity of our rental fleet enables us to provide our
customers with a range of compression units that can serve a wide variety of
applications, and to select the correct equipment for the job, rather than the
customer trying to fit the job to its own equipment.  We base our gas
compressor rental rates on several factors, including the cost and size of the
equipment, the type and complexity of service desired by the customer, the
length of contract and the inclusion of any other services desired, such as
rental, installation, transportation and daily operation.





As of
December 31, 2007, we had 1,353 natural gas compressors in our rental fleet
totaling approximately 160,733 horsepower, as compared to 1,111 natural gas
compressors totaling approximately 129,158 horsepower at December 31,
2006.  As of December 31, 2007, we had 1,194 natural gas compressors
totaling approximately 140,853 horsepower rented to 94 third parties, compared
to 974 natural gas compressors totaling approximately 112,718 horsepower rented
to 84 third parties at December 31, 2006.


2




Engineered
Equipment Sales.





·
            Compressor
      fabrication.Fabrication involves the assembly of
      compressor components manufactured by us or other third parties into
      compressor units that are ready for rental or sale.  In addition
      to fabricating compressors for our rental fleet, we engineer and fabricate
      natural gas compressors for sale to customers to meet their specifications
      based on well pressure, production characteristics and the particular
      applications for which compression is
sought.





·
            Compressor
      manufacturing.We design and manufacture our own
      proprietary line of reciprocating compressor frames, cylinders and parts
      known as our “CiP”, or Cylinder-in-Plane, product line.  We use
      the finished components to fabricate compressor units for our rental fleet
      or for sale to third parties.  We also sell finished components
      to other fabricators.





·
            Flare
      fabrication.We design, fabricate, sell, install and
      service flare stacks and related ignition and control devices for the
      onshore and offshore incineration of gas compounds such as hydrogen
      sulfide, carbon dioxide, natural gas and liquefied petroleum
      gases.  Applications for this equipment are often
      environmentally and regulatory driven, and we believe we are a leading
      supplier to this market.





·
            Parts sales
      and compressor rebuilds.To provide customer support for
      our compressor and flare sales businesses, we stock varying levels of
      replacement parts at our Midland, Texas facility and at field service
      locations.  We also provide an exchange and rebuild program for
      screw compressors and maintain an inventory of new and used compressors to
      facilitate this part of our
business.





Service and
Maintenance.We service and maintain compressors owned by our
customers on an “as needed” basis.  Natural gas compressors require
routine maintenance and periodic refurbishing to prolong their useful
life.  Routine maintenance includes physical and visual inspections
and other parametric checks that indicate a change in the condition of the
compressors.  We perform wear-particle analysis on all packages and
perform overhauls on a condition-based interval or a time-based
schedule.  Based on our past experience, these maintenance procedures
maximize component life and unit availability and minimize
downtime.





Business
Strategy





Our
intentions to grow our revenue and profitability is based on the following
business strategies:





·
            Expand
      rental fleet.Using our additional fabrication capacity,
      we intend to increase our market share by expanding our rental fleet by
      approximately 300 to 350 additional units by the end of
      2008.  We believe our growth will continue to be primarily
      driven through our placement of small to medium horsepower wellhead
      natural gas compressors for non-conventional natural gas production, which
      is the single largest and fastest growing segment of U.S. gas production
      according to data from the Energy Information
      Administration.  As of December 31, 2007, we had 1,194 natural
      gas compressors rented to third
parties.





·
            Operational
      expansion.With the planned increase in our rental
      fleet, we will continue to expand our operations in existing areas, as
      well as pursue focused expansion into new geographic
    regions.





·
            Expand CiP
      (Cylinder-in-Plane) product line.The CiP, or
      Cylinder-in-Plane, is our proprietary reciprocating compressor product
      line.  This product line has allowed us to expand our compressor
      rentals and sales into higher pressure gas gathering and transmission
      lines.  We intend to establish new distributorship relationships
      and after-market sales and services
networks.





·
            Selectively
      pursue acquisitons.We will continue to evaluate
      potential acquisitions that would provide us with access to new markets or
      enhance our current market
position.


3




Competitive
Strengths





We
believe our competitive strengths include:





·
            Superior
      customer service.Our emphasis on the small to medium
      horsepower markets has enabled us to effectively meet the evolving needs
      of our customers.  We believe these markets have been
      under-serviced by our larger competitors which, coupled with our
      personalized services and in-depth knowledge of our customers’ operating
      needs and growth plans, have allowed us to enhance our relationships with
      existing customers as well as attract new customers.  The size,
      type and geographic diversity of our rental fleet enables us to provide
      customers with a range of compression units that can serve a wide variety
      of applications.  We are able to select the correct equipment
      for the job, rather than the customer trying to fit its application to our
      equipment.





·
            Diversified
      product line.Our compressors are available as high and
      low pressure rotary screw and reciprocating packages.  They are
      designed to meet a number of applications, including wellhead production,
      natural gas gathering, natural gas transmission, vapor recovery and gas
      and plunger lift.  In addition, our compressors can be built to
      handle a variety of gas mixtures, including air, nitrogen, carbon dioxide,
      hydrogen sulfide and hydrocarbon gases.  A diversified product
      line helps us compete by being able to satisfy widely varying pressure,
      volume and production conditions that customers
  encounter.





·
            Purpose
      built rental compressors.Our rental compressor packages
      have been designed and built to address the primary requirements of our
      customers in the producing regions in which we operate.  Our
      units are compact in design and are easy, quick and inexpensive to move,
      install and start-up.  Our control systems are technically
      advanced and allow the operator to start and stop our units remotely
      and/or in accordance with well conditions.  We believe our
      rental fleet is also one of the newest with an average age of less than
      four years old.





·
            Experienced
      management team.On average, our executive and operating
      management team has over 20 years of oilfield services industry
      experience.  We believe our management team has successfully
      demonstrated its ability to grow our business both organically and through
      selective acquisitions.





·
            Broad
      geographic presence.We presently provide our products
      and services to a customer base of oil and natural gas exploration and
      production companies operating in New Mexico, Texas, Michigan, Colorado,
      Wyoming, Utah, Oklahoma, Pennsylvania, West Virginia and
      Kansas.  Our footprint allows us to service many of the natural
      gas producing regions in the United States.  We believe that
      operating in diverse geographic regions allows us better utilization of
      our compressors, minimal incremental expenses, operating synergies,
      volume-based purchasing, leveraged inventories and cross-trained
      personnel.





·
            Long-standing
      customer relationships.We have developed long-standing
      relationships providing compression equipment to many major and
      independent oil and natural gas companies.  Our customers
      generally continue to rent our compressors after the expiration of the
      initial terms of our rental agreements, which we believe reflects their
      satisfaction with the reliability and performance of our services and
      products.


Major
Customers





Sales to
XTO Energy, Inc. in the year ended December 31, 2005 amounted to 36% of
consolidated revenue.  Sales to XTO Energy, Inc. and Energen Resources
Corporation  in the year ended December 31, 2006 amounted to 39% and
12% of consolidated revenue, respectively.  Sales to XTO Energy, Inc.
and Devon Energy, Inc. in the year ended December 31, 2007 amounted to 40% and
12% of consolidated revenue, respectively.  No other single customer
accounted for more than 10% of our revenues in 2005, 2006 or
2007.  XTO Energy, Inc. amounted to 54% and 64% of our accounts
receivable as of December 31, 2006 and 2007, respectively.  No other
customer amounted to more than 10% of our consolidated accounts receivable as of
December 31, 2006 and 2007.  The loss of any one or more of the above
customers could have a material adverse effect on our business, consolidated
financial condition, results of operations and cash flows, depending upon the
demand for our compressors at the time of such loss and our ability to attract
new customers.





Sales
and Marketing





Our sales
force pursues the rental and sales market for compressors and flare equipment
and other services in their respective territories.  Additionally, our
personnel coordinate with each other to develop relationships with customers who
operate in multiple regions.  Our sales and marketing strategy is
focused on communication with current customers and potential customers through
frequent direct contact, technical assistance, print literature, direct mail and
referrals.  Our sales and marketing personnel coordinate with our
operations personnel in order to promptly respond to and address customer
needs.  Our overall sales and marketing efforts concentrate on
demonstrating our commitment to enhancing the customer’s cash flow through
enhanced product design, fabrication, manufacturing, installation, customer
service and support.





4




Competition





We have a
number of competitors in the natural gas compression segment, some of which have
greater financial resources.  We believe that we compete effectively
on the basis of price, customer service, including the ability to place
personnel in remote locations, flexibility in meeting customer needs, and
quality and reliability of our compressors and related services.





Compressor
industry participants can achieve significant advantages through increased size
and geographic breadth.  As the number of rental compressors in our
rental fleet increases, the number of sales, support, and maintenance personnel
required and the minimum level of inventory does not increase
commensurately.





Backlog





As of
December 31, 2007, we had a sales backlog of approximately $23.3
million.  We expect to fulfill substantially all of the backlog in
2008.  Sales backlog consists of firm customer orders for which a
purchase or work order has been received, satisfactory credit or a financing
arrangement exists, and delivery is scheduled.  There can be no
assurance, however, that the orders representing such backlog will not be
cancelled.





Employees




As of
December 31, 2007, we had 270 total employees.  No employees are
represented by a labor union and we believe we have good relations with our
employees.




Liability
and Other Insurance Coverage




Our
equipment and services are provided to customers who are subject to hazards
inherent in the oil and gas industry, such as blowouts, explosions, craterings,
fires, and oil spills.  We maintain liability insurance that we
believe is customary in the industry.  We also maintain insurance with
respect to our facilities.  Based on our historical experience, we
believe that our insurance coverage is adequate.  However, there is a
risk that our insurance may not be sufficient to cover any particular loss or
that insurance may not cover all losses.  In addition, insurance rates
have in the past been subject to wide fluctuation, and changes in coverage could
result in less coverage, increases in cost or higher deductibles and
retentions.




Government
Regulation




All of
our operations and facilities are subject to numerous federal, state, foreign
and local laws, rules and regulations related to various aspects of our
business, including containment and disposal of hazardous materials, oilfield
waste, other waste materials and acids.




To date,
we have not been required to expend significant resources in order to satisfy
applicable environmental laws and regulations.  We do not anticipate
any material capital expenditures for environmental control facilities or
extraordinary expenditures to comply with environmental rules and regulations in
the foreseeable future.  However, compliance costs under existing laws
or under any new requirements could become material and we could incur
liabilities for noncompliance.




Our
business is generally affected by political developments and by federal, state,
foreign and local laws and regulations, which relate to the oil and natural gas
industry.  The adoption of laws and regulations affecting the oil and
natural gas industry for economic, environmental and other policy reasons could
increase our costs and could have an adverse effect on our
operations.  The state and federal environmental laws and regulations
that currently apply to our operations could become more stringent in the
future.




We have
utilized operating and disposal practices that were or are currently standard in
the industry.  However, materials such as solvents, thinner, waste
paint, waste oil, washdown waters and sandblast material may have been disposed
of or released in or under properties currently or formerly owned or operated by
us or our predecessors.  In addition, some of these properties have
been operated by third parties over whom we have no control either as to such
entities' treatment of materials or the manner in which such materials may have
been disposed of or released.




The
federal Comprehensive Environmental Response Compensation and Liability Act of
1980, commonly known as CERCLA, and comparable state statutes impose strict
liability on:




·
            owners
      and operators of sites,




·
            persons
      who disposed of or arranged for the disposal of "hazardous substances"
      found at sites.




5




The
federal Resource Conservation and Recovery Act and comparable state statutes
govern the disposal of "hazardous wastes." Although CERCLA currently excludes
certain materials from the definition of "hazardous substances," and the
Resource Conservation and Recovery Act also excludes certain materials from
regulation, such exemptions by Congress under both CERCLA and the Resource
Conservation and Recovery Act may be deleted, limited or modified in the
future.  We could become subject to requirements to remove and
remediate previously disposed of materials (including materials disposed of or
released by prior owners or operators) from properties.




The
federal Water Pollution Control Act and the Oil Pollution Act of 1990 and
implementing regulations govern:




·
            the
      prevention of discharges, including oil and produced water spills,
      and




·
            liability
      for drainage into waters.




Our
operations are also subject to federal, state, and local regulations for the
control of air emissions.  The federal Clean Air Act and various state
and local laws impose on us certain air quality
requirements.  Amendments to the Clean Air Act revised the definition
of "major source" such that emissions from both wellhead and associated
equipment involved in oil and natural gas production may be added to determine
if a source is a "major source." As a consequence, more facilities may become
major sources and thus may require us to make increased compliance
expenditures.




We
believe that our existing environmental control procedures are adequate and that
we are in substantial compliance with environmental laws and regulations, and
the phasing in of emission controls and other known regulatory requirements
should not have a material adverse affect on our financial condition or
operational results.  However, it is possible that future
developments, such as new or increasingly strict requirements and environmental
laws and enforcement policies thereunder, could lead to material costs of
environmental compliance by us.  While we may be able to pass on the
additional cost of complying with such laws to our customers, there can be no
assurance that attempts to do so will be successful.  Some risk of
environmental liability and other costs are inherent in the nature of our
business, however, and there can be no assurance that environmental costs will
not rise.




Patents,
Trademarks and Other Intellectual Property




We
believe that the success of our business depends more on the technical
competence, creativity and marketing abilities of our employees than on any
individual patent, trademark, or copyright.  Nevertheless, as part of
our ongoing research, development and manufacturing activities, we may seek
patents when appropriate on inventions concerning new products and product
improvements.  We currently own one United States patent covering
certain flare system technologies, which will expire in January
2010.  We do not own any foreign patents.  Although we
continue to use the patented technology and consider it useful in certain
applications, we do not consider this patent to be material to our business as a
whole.




Suppliers
and Raw Materials




Fabrication
of our rental compressors involves the purchase by us of engines, compressors,
coolers and other components, and the assembly of these components on skids for
delivery to customer locations.  These major components of our
compressors are acquired through periodic purchase orders placed with
third-party suppliers on an "as needed" basis, which typically requires a three
to four month lead time with delivery dates scheduled to coincide with our
estimated production schedules.  Although we do not have formal
continuing supply contracts with any major supplier, we believe we have adequate
alternative sources available.  In the past, we have not experienced
any sudden and dramatic increases in the prices of the major components for our
compressors.  However, the occurrence of such an event could have a
material adverse effect on the results of our operations and financial
condition, particularly if we were unable to increase our rental rates and sale
prices proportionate to any such component price increases.




6




Glossary
of Industry Terms




"coalbed
methane" – A natural gas generated during coal formation and provided from coal
seams or adjacent sandstones.




"gas
shales" – Fine grained rocks where the predominant gas storage mechanism is
sorption and gas is stored in volumes that are potentially
economic.




"reciprocating
compressors" – A reciprocating compressor is a type of compressor which
compresses vapor by using a piston in a cylinder and a back-and-forth
motion.




"screw
compressors" – A type of compressor used in vapor compression where two
intermesh rotors create pockets of continuously decreasing volume, in which the
vapor is compressed and its pressure is increased.




"tight
gas" – A gas bearing sandstone or carbonate matrix (which may or may not contain
natural fractures) which exhibits a low-permeability (tight)
reservoir.




7


ITEM
1A.                      RISK
FACTORS




You
should carefully consider the following risks before you decide to buy our
common stock.  If any of the following risks actually occur, our
business, financial condition or results of operations would likely
suffer.  If this occurs, the trading price of our common stock could
decline, and you could lose all or part of the money you paid to buy our common
stock.  Although the risks described below are the risks that we
believe are material, they are not the only risks relating to our industry, our
business and our common stock.  Additional risks and uncertainties,
including those that are not yet identified or that we currently believe are
immaterial, may also adversely affect our business, financial condition or
results of operations.





Risks
Associated With Our Industry





Decreased
oil and natural gas prices and oil and gas industry expenditure levels would
adversely affect our revenue.





Our
revenue is derived from expenditures in the oil and natural gas industry, which,
in turn, are based on budgets to explore for, develop and produce oil and
natural gas.  If these expenditures decline, our revenue will
suffer.  The industry’s willingness to explore for, develop and
produce oil and natural gas depends largely upon the prevailing view of future
oil and natural gas prices.  Prices for oil and gas historically have
been, and are likely to continue to be, highly volatile.  Many factors
affect the supply and demand for oil and natural gas and, therefore, influence
oil and natural gas prices, including:





·
            the
      level of oil and natural gas
production;





·
            the
      level of oil and natural gas
inventories;





·
            domestic
      and worldwide demand for oil and natural
gas;





·
            the
      expected cost of developing new
reserves;





·
            the
      cost of producing oil and natural
gas;





·
            the
      level of drilling and producing
activity;





·
            inclement
      weather;





·
            domestic
      and worldwide economic activity;





·
            regulatory
      and other federal and state requirements in the United
    States;





·
            the
      ability of the Organization of Petroleum Exporting Countries to set and
      maintain production levels and prices for
oil;





·
            political
      conditions in or affecting oil and natural gas producing
      countries;





·
            terrorist
      activities in the United States and
elsewhere;





·
            the
      cost of developing alternate energy
sources;





·
            environmental
      regulation; and





·
            tax
      policies.





If the
demand for oil and natural gas decreases, then demand for our compressors likely
will decrease.




Depending
on the market prices of oil and natural gas, companies exploring for oil and
natural gas may cancel or curtail their drilling programs, thereby reducing
demand for our equipment and services.  Our rental contracts are
generally short-term, and oil and natural gas companies tend to respond quickly
to upward or downward changes in prices.  Any reduction in drilling
and production activities may materially erode both pricing and utilization
rates for our equipment and services and adversely affects our financial
results.  As a result, we may suffer losses, be unable to make
necessary capital expenditures and be unable to meet our financial
obligations.


8




The
intense competition in our industry could result in reduced profitability and
loss of market share for us.





In our
business segments, we compete with the oil and natural gas industry’s largest
equipment and service providers who have greater name recognition than we
do.  These companies also have substantially greater financial
resources, larger operations and greater budgets for marketing, research and
development than we do.  They may be better able to compete because of
their broader geographic dispersion, the greater number of compressors in their
fleet or their product and service diversity.  As a result, we could
lose customers and market share to those competitors.  These companies
may also be better positioned than us to successfully endure downturns in the
oil and natural gas industry.





Our
operations may be adversely affected if our current competitors or new market
entrants introduce new products or services with better prices, features,
performance or other competitive characteristics than our products and
services.  Competitive pressures or other factors also may result in
significant price competition that could harm our revenue and our
business.  Additionally, we may face competition in our efforts to
acquire other businesses.





Our
industry is highly cyclical, and our results of operations may be
volatile.





Our
industry is highly cyclical, with periods of high demand and high pricing
followed by periods of low demand and low pricing.  Periods of low
demand intensify the competition in the industry and often result in rental
equipment being idle for long periods of time.  We may be required to
enter into lower rate rental contracts in response to market conditions in the
future, and our sales may decrease as a result of such conditions.





Due to
the short-term nature of most of our rental contracts, changes in market
conditions can quickly affect our business.  As a result of the
cyclicality of our industry, our results of operations may be volatile in the
future.





We
are subject to extensive environmental laws and regulations that could require
us to take costly compliance actions that could harm our financial
condition.





Our
fabrication and maintenance operations are significantly affected by stringent
and complex federal, state and local laws and regulations governing the
discharge of substances into the environment or otherwise relating to
environmental protection.  In these operations, we generate and manage
hazardous wastes such as solvents, thinner, waste paint, waste oil, washdown
wastes, and sandblast material.  We attempt to use generally accepted
operating and disposal practices and, with respect to acquisitions, will attempt
to identify and assess whether there is any environmental risk before completing
an acquisition.  Based on the nature of the industry, however,
hydrocarbons or other wastes may have been disposed of or released on or under
properties owned or leased by us or on or under other locations where such
wastes have been taken for disposal.  The waste on these properties
may be subject to federal or state environmental laws that could require us to
remove the wastes or remediate sites where they have been
released.  We could be exposed to liability for cleanup costs, natural
resource and other damages as a result of our conduct or the conduct of, or
conditions caused by, prior owners, lessees or other third
parties.  Environmental laws and regulations have changed in the past,
and they are likely to change in the future.  If existing regulatory
requirements or enforcement policies change, we may be required to make
significant unanticipated capital and operating expenditures.




Any
failure by us to comply with applicable environmental laws and regulations may
result in governmental authorities taking actions against our business that
could harm our operations and financial condition, including the:
 
 ·
              issuance
      of administrative, civil and criminal
penalties;
 
 ·
              denial
      or revocation of permits or other
  authorizations;
 
 ·
              reduction
      or cessation in operations; and
 
 ·
              performance
      of site investigatory, remedial or other corrective
    actions.
 
 Risks
Associated With Our Company
 
 We
might be unable to employ qualified technical personnel, which could hamper our
plans for expansion or increase our costs.
 
 Many of
the compressors that we sell or rent are mechanically complex and often must
perform in harsh conditions.  We believe that our success depends upon
our ability to employ and retain a sufficient number of technical personnel who
have the ability to design, utilize, enhance and maintain these
compressors.  Our ability to expand our operations depends in part on
our ability to increase our skilled labor force.  The demand for
skilled workers is high and supply is limited.  A significant increase
in the wages paid by competing employers could result in a reduction of our
skilled labor force or cause an increase in the wage rates that we must pay or
both.  If either of these events were to occur, our cost structure
could increase and our operations and growth potential could be
impaired.


9





We
could be subject to substantial liability claims that could harm our financial
condition.





Our
products are used in hazardous drilling and production applications where an
accident or a failure of a product can cause personal injury, loss of life,
damage to property, equipment or the environment, or suspension of
operations.





While we
maintain insurance coverage, we face the following risks under our insurance
coverage:





·
            we
      may not be able to continue to obtain insurance on commercially reasonable
      terms;





·
            we
      may be faced with types of liabilities that will not be covered by our
      insurance, such as damages from significant product liabilities and from
      environmental contamination;





·
            the
      dollar amount of any liabilities may exceed our policy limits;
      and





·
            we
      do not maintain coverage against the risk of interruption of our
      business.





Any
claims made under our policies will likely cause our premiums to
increase.  Any future damages caused by our products or services that
are not covered by insurance, are in excess of policy limits or are subject to
substantial deductibles, would reduce our earnings and our cash available for
operations.





We
will require a substantial amount of capital to expand our compressor rental
fleet and grow our business.





During
2008, we plan to spend approximately $35.0 million in capital expenditures to
expand our rental fleet.  The amount and timing of these capital
expenditures may vary depending on a variety of factors, including the level of
activity in the oil and natural gas exploration and production industry and the
presence of alternative uses for our capital, including any acquisitions that we
may pursue.




Historically,
we have funded our capital expenditures through internally generated funds,
borrowings under bank credit facilities and the proceeds of equity
financings.  Although we believe that the proceeds from the public
offering we completed in March 2006, cash flows from our operations and
borrowings under our existing bank credit facility will provide us with
sufficient cash to fund our planned capital expenditures for 2008, we cannot
assure you that these sources will be sufficient.  We may require
additional capital to fund any unanticipated capital expenditures, including any
acquisitions, and to fund our growth beyond 2008, and necessary capital may not
be available to us when we need it or on acceptable terms.  Our
ability to raise additional capital will depend on the results of our operations
and the status of various capital and industry markets at the time we seek such
capital.  Failure to generate sufficient cash flow, together with the
absence of alternative sources of capital, could have a material adverse effect
on our business, consolidated financial condition, results of operations or cash
flows.





Our
current debt level may negatively impact our current and future financial
stability.





As of
December 31, 2007, we had an aggregate of approximately $14.6 million of
outstanding indebtedness, and accounts payable and accrued expenses of
approximately $8.1 million.  As a result of our significant
indebtedness, we might not have the ability to incur any substantial additional
indebtedness.  The level of our indebtedness could have several
important effects on our future operations, including:





·
            our
      ability to obtain additional financing for working capital, acquisitions,
      capital expenditures and other purposes may be
  limited;





·
            a
      significant portion of our cash flow from operations may be dedicated to
      the payment of principal and interest on our debt, thereby reducing funds
      available for other purposes; and





·
            our
      significant leverage could make us more vulnerable to economic
      downturns.





If
we are unable to service our debt, we will likely be forced to take remedial
steps that are contrary to our business plan.





As of
December 31, 2007, our principal payments for our debt service requirements were
approximately $282 thousand on a monthly basis; $845 thousand on a quarterly
basis; and $3.4 million on an annual basis.  It is possible that our
business will not generate sufficient cash flow from operations to meet our debt
service requirements and the payment of principal when due.  If this
were to occur, we may be forced to:





·
            sell
      assets at disadvantageous prices;





·
            obtain
      additional financing; or





·
            refinance
      all or a portion of our indebtedness on terms that may be less favorable
      to us.


10




Our
current bank loan agreement contains covenants that limit our operating and
financial flexibility and, if breached, could expose us to severe remedial
provisions.





Under the
terms of our loan agreement, we must:





·
            comply
      with a minimum current ratio;





·
            maintain
      minimum levels of tangible net
worth;





·
            not
      exceed specified levels of debt;





·
            comply
      with a debt service coverage ratio;
and





·
            comply
      with a debt to tangible net worth
ratio.





Our
ability to meet the financial ratios and tests under our bank loan agreement can
be affected by events beyond our control, and we may not be able to satisfy
those ratios and tests.  A breach of any one of these covenants could
permit the bank to accelerate the debt so that it is immediately due and
payable.  If a breach occurred, no further borrowings would be
available under our loan agreement.  If we were unable to repay the
debt, the bank could proceed against and foreclose on our assets, substantially
all of which have been pledged as collateral to secure payment of our
indebtedness.





If
we fail to acquire or successfully integrate additional businesses, our growth
may be limited and our results of operations may suffer.





As part
of our business strategy, we intend to evaluate potential acquisitions of other
businesses or assets.  However, there can be no assurance that we will
be successful in consummating any such acquisitions.  Successful
acquisition of businesses or assets will depend on various factors, including,
but not limited to, our ability to obtain financing and the competitive
environment for acquisitions.  In addition, we may not be able to
successfully integrate any businesses or assets that we acquire in the
future.  The integration of acquired businesses is likely to be
complex and time consuming and place a significant strain on management and may
disrupt our business.  We also may be adversely impacted by any
unknown liabilities of acquired businesses, including environmental
liabilities.  We may encounter substantial difficulties, costs and
delays involved in integrating common accounting, information and communication
systems, operating procedures, internal controls and human resources practices,
including incompatibility of business cultures and the loss of key employees and
customers.  These difficulties may reduce our ability to gain
customers or retain existing customers, and may increase operating expenses,
resulting in reduced revenues and income and a failure to realize the
anticipated benefits of acquisitions.





As
of December 31, 2007, a significant majority of our compressor rentals were for
terms of six months or less which, if terminated or not renewed, would adversely
impact our revenue and our ability to recover our initial equipment
costs.





The
length of our compressor rental agreements with our customers varies based on
customer needs, equipment configurations and geographic area.  In most
cases, under currently prevailing rental rates, the initial rental periods are
not long enough to enable us to fully recoup the average cost of acquiring or
fabricating the equipment.  We cannot be sure that a substantial
number of our customers will continue to renew their rental agreements or that
we will be able to re-rent the equipment to new customers or that any renewals
or re-rentals will be at comparable rental rates.  The inability to
timely renew or re-rent a substantial portion of our compressor rental fleet
would have a material adverse effect upon our business, consolidated financial
condition, results of operations and cash flows.





The
loss of one or more of our current customers could adversely affect our results
of operations.





Our
business is dependent not only on securing new customers but also on maintaining
current customers.  We had two customers that accounted for
approximately 40% and 12% of our consolidated revenue for the year ended
December 31, 2007, and approximately 39% and 12% of our consolidated revenue for
the year ended December 31, 2006.  Unless we are able to retain our
existing customers, or secure new customers if we lose one or more of our
significant customers, our revenue and results of operations would be adversely
affected.





Loss
of key members of our management could adversely affect our
business.





We depend
on the continued employment and performance of Stephen C. Taylor, our Chairman
of the Board of Directors, President and Chief Executive Officer, and other key
members of our management.  If any of our key managers resign or
become unable to continue in his present role and is not adequately replaced,
our business operations could be materially adversely affected.


11


Failure
to effectively manage our growth and expansion could adversely affect our
business and operating results and our internal controls.





We have
rapidly and significantly expanded our operations in recent years and anticipate
that our growth will continue if we are able to execute our
strategy.  Our rapid growth has placed significant strain on our
management and other resources which, given our expected future growth rate, is
likely to continue.  To manage our future growth, we must, among other
things:





·
            accurately
      assess the number of additional officers and employees we will require and
      the areas in which they will be
required;





·
            attract,
      hire and retain additional highly skilled and motivated officers and
      employees;





·
            train
      and manage our work force in a timely and effective
  manner;





·
            upgrade
      and expand our office infrastructure so that it is appropriate for our
      level of activity; and





·
            improve
      our financial and management controls, reporting systems and
      procedures.





Liability
to customers under warranties may materially and adversely affect our
earnings.





We
provide warranties as to the proper operation and conformance to specifications
of the equipment we manufacture.  Our equipment is complex and often
deployed in harsh environments.  Failure of this equipment to operate
properly or to meet specifications may increase our costs by requiring
additional engineering resources and services, replacement of parts and
equipment or monetary reimbursement to a customer.  We have in the
past received warranty claims and we expect to continue to receive them in the
future.  To the extent that we incur substantial warranty claims in
any period, our reputation, our ability to obtain future business and our
earnings could be materially and adversely affected.





Failure
to maintain effective internal controls could have a material adverse effect on
our operations.





Section
404 of the Sarbanes-Oxley Act requires annual management assessments of the
effectiveness of our internal control over financial reporting.  If we
fail to maintain effective internal controls, we may not be able to ensure that
we can conclude on an ongoing basis that we have effective internal controls
over financial reporting in accordance with Section 404 of the Sarbanes-Oxley
Act.  Moreover, effective internal controls are necessary for us to
produce reliable financial reports and to help prevent financial
fraud.  If, as a result of deficiencies in our internal controls, we
cannot provide reliable financial reports or prevent fraud, our business
decision process may be adversely affected, our business and operating results
could be harmed, investors could lose confidence in our reported financial
information, and the price of our stock could decrease as a result.





We
must evaluate our intangible assets annually for impairment.





Our
intangible assets are recorded at cost less accumulated amortization and consist
of goodwill and patent costs and other identifiable intangibles acquired as part
of the SCS acquisition.  Through December 31, 2001, goodwill was
amortized using the straight-line method over 15 years and patent costs were
amortized over 13 to 15 years.





In June
2001, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” FAS 142
provides that: (1) goodwill and intangible assets with indefinite lives will no
longer be amortized; (2) goodwill and intangible assets with indefinite lives
must be tested for impairment at least annually; and (3) the amortization period
for intangible assets with finite lives will no longer be limited to 40
years.  If we determine that our intangible assets with indefinite
lives have been impaired, we must record a write-down of those assets on our
consolidated statements of income during the period of
impairment.  Our determination of impairment will be based on various
factors, including any of the following factors, if they
materialize:




·
            significant
      underperformance relative to expected historical or projected future
      operating results;





·
            significant
      changes in the manner of our use of the acquired assets or the strategy
      for our overall business;





·
            significant
      negative industry or economic
trends;





·
            significant
      decline in our stock price for a sustained period;
  and





·
            our
      market capitalization relative to net book
  value.





12




We
adopted FAS 142 as of January 1, 2002.  Based on an independent
valuation as of June 2006 and an internal evaluation in December 2007 of our
reporting units with goodwill, adoption of FAS 142 did not have a material
adverse effect on us in 2006 or 2007.  Future tests under FAS 142
could result in impairments of our intangible assets or goodwill.  We
expect to continue to amortize our intangible assets with finite lives over the
same time periods as previously used, and we will test our intangible assets
with indefinite lives for impairment at least once each year.  In
addition, we are required to assess the consumptive life, or longevity, of our
intangible assets with finite lives and adjust their amortization periods
accordingly.  Our net goodwill and intangible assets were recorded on
our balance sheet at approximately $13.7 million as of December 31, 2006, and at
December 31, 2007, the carrying value of net goodwill and intangible assets
decreased to approximately $13.4 million.  Our identifiable
intangibles are amortized at a rate of $299 thousand per year.  Any
impairment in future periods of those assets, or a reduction in their
consumptive lives, could materially and adversely affect our consolidated
statements of income and financial position.





Risks
Associated With Our Common Stock





The
price of our common stock may fluctuate which may cause our common stock to
trade at a substantially lower price than the price paid for our common
stock.





The
trading price of our common stock and the price at which we may sell securities
in the future is subject to substantial fluctuations in response to various
factors, including our ability to successfully accomplish our business strategy,
the trading volume of our stock, changes in governmental regulations, actual or
anticipated variations in our quarterly or annual financial results, our
involvement in litigation, general market conditions, the prices of oil and
natural gas, announcements by us and our competitors, our liquidity, our ability
to raise additional funds, and other events.





Future
sales of our common stock could adversely affect our stock price.





Substantial
sales of our common stock in the public market, or the perception by the market
that those sales could occur, may lower our stock price or make it difficult for
us to raise additional equity capital in the future.  These potential
sales could include sales of shares of our common stock by our Directors and
officers, who beneficially owned approximately 8.13% of the outstanding shares
of our common stock as of March 5, 2008.





If
securities analysts downgrade our stock or cease coverage of us, the price of
our stock could decline.





The
trading market for our common stock relies in part on the research and reports
that industry or financial analysts publish about us or our
business.  We do not control these analysts.  Furthermore,
there are many large, well-established, publicly traded companies active in our
industry and market, which may mean that it is less likely that we will receive
widespread analyst coverage.  If one or more of the analysts who do
cover us downgrade our stock, our stock price would likely decline
rapidly.  If one or more of these analysts cease coverage of our
company, we could lose visibility in the market, which in turn could cause our
stock price to decline.





If
we issue debt or equity securities, you may lose certain rights and be
diluted.





If we
raise funds in the future through the issuance of debt or equity securities, the
securities issued may have rights and preferences and privileges senior to those
of holders of our common stock, and the terms of the securities may impose
restrictions on our operations or dilute your ownership in Natural Gas Services
Group, Inc.


We
do not intend to pay, and have restrictions upon our ability to pay, dividends
on our common stock.





We have
not paid cash dividends in the past and do not intend to pay dividends on our
common stock in the foreseeable future.  Net income from our
operations, if any, will be used for the development of our business, including
capital expenditures, and to retire debt.  In addition, our bank loan
agreement contains restrictions on our ability to pay cash dividends on our
common stock.





We
have a comparatively low number of shares of common stock outstanding and,
therefore, our common stock may suffer from limited liquidity and its prices
will likely be volatile and its value may be adversely affected.





Because
of our relatively low number of outstanding shares of common stock, the trading
price of our common stock will likely be subject to significant price
fluctuations and limited liquidity.  This may adversely affect the
value of your investment.  In addition, our common stock price could
be subject to fluctuations in response to variations in quarterly operating
results, changes in management, future announcements concerning us, general
trends in the industry and other events or factors as well as those described
above.





13


Provisions
contained in our governing documents could hinder a change in control of
us.





Our
articles of incorporation and bylaws contain provisions that may discourage
acquisition bids and may limit the price investors are willing to pay for our
common stock.  Our articles of incorporation and bylaws provide
that:





·
            directors
      will be elected for three-year terms, with approximately one-third of the
      board of directors standing for election each
  year;





·
            cumulative
      voting is not allowed, which limits the ability of minority shareholders
      to elect any directors;





·
            the
      unanimous vote of the board of directors or the affirmative vote of the
      holders of not less than 80% of the votes entitled to be cast by the
      holders of all shares entitled to vote in the election of directors is
      required to change the size of the board of directors;
  and





·
            directors
      may be removed only for cause and only by the holders of not less than 80%
      of the votes entitled to be cast on the
matter.





Our Board
of Directors has the authority to issue up to five million shares of preferred
stock.  The Board of Directors can fix the terms of the preferred
stock without any action on the part of our stockholders.  The
issuance of shares of preferred stock may delay or prevent a change in control
transaction.  In addition, preferred stock could be used in connection
with the Board of Directors’ adoption of a shareholders’ rights plan (also known
as a poison pill), which would make it much more difficult to effect a change in
control of our company through acquiring or controlling blocks of
stock.  Also, our Directors and officers as a group will continue to
beneficially own stock and although this is not a majority of our stock, it
confers substantial voting power in the election of Directors and management of
our company.  This would make it difficult for other minority
stockholders to effect a change in control or otherwise extend any significant
control over the management of our company.  This may adversely affect
the market price and interfere with the voting and other rights of our common
stock.





ITEM
1B.                      UNRESOLVED
STAFF COMMENTS





We have
not received any written comments from the Staff of the Securities and Exchange
Commission that remain unresolved.





ITEM
2.




PROPERTIES




The table
below describes the material facilities owned or leased by Natural Gas Services
Group as of December 31, 2007:




Location
            
            Status
            
            Square
              Feet
            
            UsesTulsa,
      Oklahoma
            
            Owned
      and Leased
            
            91,780
            
            Fabrication,
      manufacturing, rental and servicesMidland,
      Texas
            
            Owned
            
            58,000
            
            Compressor
      fabrication, rental and servicesMidland,
      Texas
            
            Owned
            
            24,600
            
            Compressor
      fabrication, rental and servicesLewiston,
      Michigan
            
            Owned
            
            15,360
            
            Compressor
      fabrication, rental and servicesBridgeport,
      Texas
            
            Leased
            
            4,500
            
            Office
      and parts and servicesMidland,
      Texas
            
            Owned
            
            4,100
            
            Executive
      offices and parts and servicesBloomfield,
      New Mexico
            
            Leased
            
            4,672
            
            Office
      and parts and services203,012




We
believe that our properties are generally well maintained and in good condition
and adequate for our purposes.




14


ITEM
3.                      LEGAL
PROCEEDINGS




From time
to time, we are a party to various legal proceedings in the ordinary course of
our business.  We have not been a party to any bankruptcy,
receivership, reorganization, adjustment or similar proceeding.
  On
February 21, 2008, we received notice of a lawsuit filed against us in
Montmorency County, Michigan, 26th Circuit Court, Case No.
08-0001901-NZ, styled Dyanna Louise Williams, Plaintiff, v Natural Gas Services
Group, Inc. and Great Lakes Compression, Defendants.  In this lawsuit,
plaintiff alleges breach of contract, breach of fiduciary duty and negligence.
Plaintiff seeks damages in the amount of $100 thousand for lost insurance
benefits and an unspecified amount of exemplary damages. As the basis for her
claims, plaintiff generally alleges that she is the third party beneficiary of a
life insurance policy obtained by her deceased ex-husband through Natural Gas
Services Group's insurance program, and that as a result of Natural Gas Service
Group's negligence and failure to use due care in processing an application for
life insurance prior to her ex-husband's death, she was denied $100
thousand of life insurance proceeds. Plaintiff now seeks to recover $100
thousand from Natural Gas Services Group, plus an unspecified amount of
exemplary damages. Due to the early stages of this lawsuit, and the absence of
any discovery proceedings, we are unable to accurately predict its outcome, but
we intend to file an answer denying all of plaintiff's claims and intend to
vigorously contest the plaintiff's claims. We have not established a reserve
with respect to plaintiff's claims.




ITEM
4.                      SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS




We did
not submit any matters to a vote of our stockholders during the fourth quarter
of 2007.




15


PART
II




ITEM
5.                      MARKET
FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
OF EQUITY SECURITIES


Our
common stock trades on the American Stock Exchange under the symbol
“NGS”.  The following table sets forth for the periods indicated the
high and low sales prices for our common stock as reported by the American Stock
Exchange.





2005
            
            Low
            
            
            HighFirst
      Quarter
            
            $
            9.08
            
            
            $
            11.11Second
      Quarter
            
            
            9.51
            
            
            
            11.85Third
      Quarter
            
            
            11.55
            
            
            
            36.00Fourth
      Quarter
            
            
            15.67
            
            
            
            39.992006First
      Quarter
            
            $
            16.57
            
            
            $
            22.80Second
      Quarter
            
            
            13.77
            
            
            
            18.00Third
      Quarter
            
            
            12.01
            
            
            
            16.69Fourth
      Quarter
            
            
            12.76
            
            
            
            16.432007First
      Quarter
            
            $
            11.68
            
            
            $
            15.00Second
      Quarter
            
            
            13.55
            
            
            
            19.90Third
      Quarter
            
            
            13.55
            
            
            
            18.81Fourth
      Quarter
            
            
            16.45
            
            
            
            19.61








As of
December 31, 2007, there were approximately 26 holders of record of our
common stock.  This number does not include any beneficial owners for
whom shares of common stock may be held in “nominee” or “street”
name.  On March 5, 2008, the last reported sale price of our common
stock as reported by the American Stock Exchange was $22.30 per
share.





16




Dividends





We have
never declared or paid any dividends on our common stock.  We
currently intend to continue our policy of retaining earnings for use in our
business and we do not anticipate paying cash dividends on our common
stock.  Our ability to pay cash dividends in the future on the common
stock will be dependent upon our:




·
            financial
      condition,




·
            results
      of operations,




·
            current
      and anticipated cash requirements,




·
            plans
      for expansion, and




·
            restrictions
      under our debt obligations,




as well
as other factors that our Board of Directors deems relevant.  The loan
agreement with our bank lender contains provisions that prohibit us from paying
cash dividends on our common stock.




Equity
Compensation Plans





The
following table summarizes certain information regarding our equity compensation
plans as of December 31, 2007:





Plan
      Category
            
            (a)
              Number
      of Securities to be Issued Upon Exercise of Outstanding Options, Warrants
      and Rights
            
            
            (b)
              Weighted-average
              Exercise
      Price of
              Outstanding
      Options, Warrants and Rights
            
            
            (c)
              Number
      of Securities Remaining Available for Future Issuance Under Equity
      Compensation Plans
              (Excluding
      Securities Reflected in Column (a))Equity
      compensation plans approved by security holders
            
            
            122,502
            (1)
            
            $
            11.99
            
            
            
            337,500Equity
      compensation plans not approved by security holders
            
            
            45,000
            (2)
            
            $
            9.22
            
            
            
            —Total
            
            
            167,502
            
            
            $
            11.25
            
            
            
            337,500





(1)
            Total
      number of shares to be issued upon exercise of options granted to
      employees, officers, and directors under our 1998 stock option
      plan.


(2)
            Total
      number of shares to be issued upon exercise of options granted outside of
      our 1998 stock option plan to Stephen C. Taylor, our Chief
      Executive Officer, under the terms of his employment
      agreement.





Repurchase
of Equity Securities





No
repurchases of our securities were made by or on our behalf or any “affiliated
purchaser” during the fourth quarter of the fiscal year ended December 31,
2007.





Sale
of Unregistered Securities





There were no sales of unregistered
securities during the year ended December 31, 2007.





17




ITEM
6.                      SELECTED
FINANCIAL DATA




In the
table below, we provide you with selected historical financial
data.  We have derived this information from our audited consolidated
financial statements for each of the years in the five-year period ended
December 31, 2007.  This information is only a summary and it is
important that you read this information along with our audited consolidated
financial statements and related notes, and “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” under Item 7 below,
which discusses factors affecting the comparability of the information
presented.  The selected financial information provided is not
necessarily indicative of our future results of operations or financial
performance.





Year
      Ended December 31,2003
                    
                    
                    2004
                    
                    
                    2005(1)
                    
                    
                    2006
                    
                    
                    2007(in
      thousands, except per share amounts)CONSOLIDATED
      STATEMENTS OF INCOME AND OTHER INFORMATION:Revenues
                    
                    $
                    12,750
                    
                    
                    $
                    15,958
                    
                    
                    $
                    49,311
                    
                    
                    $
                    62,729
                    
                    
                    $
                    72,489Costs
      of revenue, exclusive of depreciation shown separately
    below
                    
                    
                    6,057
                    
                    
                    
                    6,951
                    
                    
                    
                    31,338
                    
                    
                    
                    39,308
                    
                    
                    
                    41,106Gross
      margin(2)
                    
                    
                    6,693
                    
                    
                    
                    9,007
                    
                    
                    
                    17,973
                    
                    
                    
                    23,421
                    
                    
                    
                    31,383Depreciation
      and amortization
                    
                    
                    1,726
                    
                    
                    
                    2,444
                    
                    
                    
                    4,224
                    
                    
                    
                    6,020
                    
                    
                    
                    7,470Other
      operating expenses
                    
                    
                    2,292
                    
                    
                    
                    2,652
                    
                    
                    
                    4,890
                    
                    
                    
                    5,270
                    
                    
                    
                    5,324Operating
      income
                    
                    
                    2,675
                    
                    
                    
                    3,911
                    
                    
                    
                    8,859
                    
                    
                    
                    12,131
                    
                    
                    
                    18,589Total
      other income (expense)(3)
                    
                    
                    (671
                    )
                    
                    
                    603
                    
                    
                    
                    (1,798
                    )
                    
                    
                    (256
                    )
                    
                    
                    144Income
      before income taxes
                    
                    
                    2,004
                    
                    
                    
                    4,514
                    
                    
                    
                    7,061
                    
                    
                    
                    11,875
                    
                    
                    
                    18,733Income
      tax expense
                    
                    
                    697
                    
                    
                    
                    1,140
                    
                    
                    
                    2,615
                    
                    
                    
                    4,287
                    
                    
                    
                    6,455Net
      income
                    
                    
                    1,307
                    
                    
                    
                    3,374
                    
                    
                    
                    4,446
                    
                    
                    
                    7,588
                    
                    
                    
                    12,278Preferred
      dividends
                    
                    
                    121
                    
                    
                    
                    53
                    
                    
                    ─
                    
                    
                    ─
                    
                    
                    ─Net
      income available to common stockholders
                    
                    $
                    1,186
                    
                    
                    $
                    3,321
                    
                    
                    $
                    4,446
                    
                    
                    $
                    7,588
                    
                    
                    $
                    12,278Net
      income per common share:Basic
                    
                    $
                    0.24
                    
                    
                    $
                    0.59
                    
                    
                    $
                    0.59
                    
                    
                    $
                    0.67
                    
                    
                    $
                    1.02Diluted
                    
                    $
                    0.23
                    
                    
                    $
                    0.52
                    
                    
                    $
                    0.52
                    
                    
                    $
                    0.66
                    
                    
                    $
                    1.01Weighted
      average shares of common stock outstanding:Basic
                    
                    
                    4,947
                    
                    
                    
                    5,591
                    
                    
                    
                    7,564
                    
                    
                    
                    11,405
                    
                    
                    
                    12,071Diluted
                    
                    
                    5,253
                    
                    
                    
                    6,383
                    
                    
                    
                    8,481
                    
                    
                    
                    11,472
                    
                    
                    
                    12,114EBITDA(4)
                    
                    $
                    4,397
                    
                    
                    $
                    7,796
                    
                    
                    $
                    13,282
                    
                    
                    $
                    19,541
                    
                    
                    $
                    27,358As
      of December 31,2003
                    
                    
                    2004
                    
                    
                    2005
                    
                    
                    2006
                    
                    
                    2007(in
      thousands)BALANCE
      SHEET INFORMATION:Current
      assets
                    
                    $
                    3,654
                    
                    
                    $
                    7,295
                    
                    
                    $
                    24,642
                    
                    
                    $
                    55,170
                    
                    
                    $
                    55,222Total
      assets
                    
                    
                    28,270
                    
                    
                    
                    43,255
                    
                    
                    
                    86,369
                    
                    
                    
                    135,552
                    
                    
                    
                    153,233Long-term
      debt (including current portion)
                    
                    
                    10,724
                    
                    
                    
                    15,017
                    
                    
                    
                    28,205
                    
                    
                    
                    18,392
                    
                    
                    
                    13,950Stockholders’
      equity
                    
                    
                    14,425
                    
                    
                    
                    22,903
                    
                    
                    
                    45,690
                    
                    
                    
                    101,201
                    
                    
                    
                    114,380








(1)
            The
      information for the periods presented may not be comparable because of our
      acquisition of SCS in January 2005.  For additional information
      regarding this acquisition, you should read the information under “Item 7.
      Management’s Discussion and Analysis of Financial Condition and Results of
      Operations” and “Item 13. Certain Relationships, Related Transactions and
      Director Independence – Acquisition of Screw Compression Systems, Inc.” in
      this Annual Report on Form 10-K.


(2)
            Gross
      margin is defined, reconciled to net income and discussed further below
      under “ -- Non-GAAP Financial
Measures”.


(3)
            Total
      other income (expense) for the year ended December 31, 2004 includes $1.5
      million in life insurance proceeds paid to us upon the death of our former
      Chief Executive Officer.


(4)
            EBITDA
      is defined, reconciled to net income and discussed further below under “
      -- Non-GAAP Financial Measures”.





18


Non-GAAP
Financial Measures





Our
definition and use of EBITDA





“EBITDA”
is a non-GAAP financial measure of earnings (net income) from continuing
operations before interest, taxes, depreciation, and
amortization.  This term, as used and defined by us, may not be
comparable to similarly titled measures employed by other companies and is not a
measure of performance calculated in accordance with GAAP.  EBITDA
should not be considered in isolation or as a substitute for operating income,
net income or loss, cash flows provided by operating, investing and financing
activities, or other income or cash flow statement data prepared in accordance
with GAAP.  However, management believes EBITDA is useful to an
investor in evaluating our operating performance because:





·
            it
      is widely used by investors in the energy industry to measure a company’s
      operating performance without regard to items excluded from the
      calculation of EBITDA, which can vary substantially from company to
      company depending upon accounting methods and book value of assets,
      capital structure and the method by which assets were acquired, among
      other factors;





·
            it
      helps investors to more meaningfully evaluate and compare the results of
      our operations from period to period by removing the impact of our capital
      structure and asset base from our operating structure;
  and





·
            it
      is used by our management for various purposes, including as a measure of
      operating performance, in presentations to our Board of Directors, as a
      basis for strategic planning and forecasting, and as a component for
      setting incentive compensation.





There are
material limitations to using EBITDA as a measure of performance, including the
inability to analyze the impact of certain recurring items that materially
affect our net income or loss, and the lack of comparability of results of
operations of different companies.  Please read the table below under
“Reconciliation” to see how  EBITDA reconciles to our net income, the
most directly comparable GAAP financial measure.





Our
definition and use of gross margin





We define gross margin as total revenue
less cost of sales (excluding depreciation and amortization
expense).  Gross margin is included as a supplemental disclosure
because it is a primary measure used by our management as it represents the
results of revenue and cost of sales (excluding depreciation and amortization
expense), which are key components of our operations.  Gross margin
differs from gross profit, in that gross profit includes depreciation
expense.  We believe gross margin is important because it focuses on
the current operating performance of our operations and excludes the impact of
the prior historical costs of the assets acquired or constructed that are
utilized in those operations, the indirect costs associated with our selling,
general and administrative activities, the impact of our financing methods and
income taxes.  Depreciation expense may not accurately reflect the
costs required to maintain and replenish the operational usage of our assets and
therefore may not portray the costs from current operating
activity.  Rather, depreciation expense reflects the systematic
allocation of historical fixed asset values over the estimated useful
lives.





Gross margin has certain material
limitations associated with its use as compared to net income.  These
limitations are primarily due to the exclusion of certain
expenses.  Each of these excluded expenses is material to our
consolidated results of operations.  Because we use capital assets,
depreciation expense is a necessary element of our costs and our ability to
generate revenue and selling, general and administrative expense is a necessary
cost to support our operations and required corporate activities.  In
order to compensate for these limitations, management uses this non-GAAP measure
as a supplemental measure to other GAAP results to provide a more complete
understanding of our performance.





As an
indicator of our operating performance, gross margin should not be considered an
alternative to, or more meaningful than, net income as determined in accordance
with GAAP.  Our gross margin may not be comparable to a similarly
titled measure of another company because other entities may not calculate gross
margin in the same manner.





19


Reconciliation





The following table reconciles EBITDA
and gross margin to our net income, the most directly comparable GAAP financial
measure:





Year
      Ended December 31,2003
            
            
            2004
            
            
            2005
            
            
            2006
            
            
            2007(in
      thousands)Net
      Income
            
            $
            1,307
            
            
            $
            3,374
            
            
            $
            4,446
            
            
            $
            7,588
            
            
            $
            12,278Interest
      expense,
      net
            
            
            667
            
            
            
            838
            
            
            
            1,997
            
            
            
            1,646
            
            
            
            1,155Income
      taxes
            
            
            697
            
            
            
            1,140
            
            
            
            2,615
            
            
            
            4,287
            
            
            
            6,455Depreciation
      and amortization
            
            
            1,726
            
            
            
            2,444
            
            
            
            4,224
            
            
            
            6,020
            
            
            
            7,470EBITDA
            
            $
            4,397
            
            
            $
            7,796
            
            
            $
            13,282
            
            
            $
            19,541
            
            
            $
            27,358Other
      operating expenses
            
            
            2,292
            
            
            
            2,652
            
            
            
            4,890
            
            
            
            5,270
            
            
            
            5,324Other
      expense (income)
            
            
            4
            
            
            
            (1,441
            )
            
            
            (199
            )
            
            
            (1,390
            )
            
            
            (1,299
            )Gross
      Margin
            
            $
            6,693
            
            
            $
            9,007
            
            
            $
            17,973
            
            
            $
            23,421
            
            
            $
            31,383








ITEM
7.                      MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS




The
following discussion is intended to assist you in understanding our financial
position and results of operations for each of the years ended December 31,
2005, 2006, and 2007.  You should read the following discussion and
analysis in conjunction with our audited consolidated financial statements and
the related notes.





The
following discussion contains forward-looking statements.  For a
description of limitations inherent in forward-looking statements, see “Special
Note Regarding Forward-Looking Statements”.





Overview





We
fabricate, manufacture, rent and sell natural gas compressors and related
equipment.  Our primary focus is on the rental of natural gas
compressors.  Our rental contracts generally provide for initial terms
of six to 24 months.  After the initial term of our rental contracts,
most of our customers have continued to rent our compressors on a month-to-month
basis.  Rental amounts are paid monthly in advance and include
maintenance of the rented compressors.  As of December 31, 2007, we
had 1,194 natural gas compressors totaling approximately 140,853 horsepower
rented to 94 third parties, compared to 974 natural gas compressors totaling
approximately 112,718 horsepower rented to 84 third parties at December 31,
2006.





We also
fabricate natural gas compressors for sale to our customers, designing
compressors to meet unique specifications dictated by well pressures, production
characteristics and particular applications for which compression is
sought.  Fabrication of compressors involves the purchase by us of
engines, compressors, coolers and other components, and then assembling these
components on skids for delivery to customer locations.  These major
components of our compressors are acquired through periodic purchase orders
placed with third-party suppliers on an “as needed” basis, which presently
requires a three to four month lead time with delivery dates scheduled to
coincide with our estimated production schedules.  Although we do not
have formal continuing supply contracts with any major supplier, we believe we
have adequate alternative sources available.  In the past, we have not
experienced any sudden and dramatic increases in the prices of the major
components for our compressors.  However, the occurrence of such an
event could have a material adverse effect on the results of our operations and
financial condition, particularly if we were unable to increase our rental rates
and sales prices proportionate to any such component price
increases.




We also
manufacture a proprietary line of compressor frames, cylinders and parts, known
as our CiP (Cylinder-in-Plane) product line.  We use finished CiP
component products in the fabrication of compressor units for sale or rental by
us or sell the finished component products to other compressor
fabricators.  We also design, fabricate, sell, install and service
flare stacks and related ignition and control devices for onshore and offshore
incineration of gas compounds such as hydrogen sulfide, carbon dioxide, natural
gas and liquefied petroleum gases.  To provide customer support for
our compressor and flare sales businesses, we stock varying levels of
replacement parts at our Midland, Texas facility and at field service
locations.  We also provide an exchange and rebuild program for screw
compressors and maintain an inventory of new and used compressors to facilitate
this business.


20




We
provide service and maintenance to our customers under written maintenance
contracts or on an as required basis in the absence of a service
contract.  Maintenance agreements typically have terms of six months
to one year and require payment of a monthly fee.





The
following table sets forth our revenues from each of our three business segments
for the periods presented:




Year
      Ended December 31,2005
              
              
              2006
              
              
              2007(in
      thousands)Sales
              
              $
              30,278
              
              
              $
              38,214
              
              
              $
              41,088Service
      and maintenance
              
              
              2,424
              
              
              
              979
              
              
              
              964Rental
              
              
              16,609
              
              
              
              23,536
              
              
              
              30,437Total
              
              $
              49,311
              
              
              $
              62,729
              
              
              $
              72,489





Historically,
the majority of our revenues and income from operations has come from our
compressor rental business.  The acquisition of SCS in January 2005,
which prior to being merged into us on June 30, 2007 was engaged primarily in
the business of custom fabrication of compressors for sale to third parties,
significantly altered the mix of our revenues, with compressor sales now
contributing a large percentage of our revenues.  Margins for our
rental business have recently averaged 59% to 62%, while margins for the
compressor sales business have recently averaged approximately 25% to
29%.  Our strategy for growth is focused on our compressor rental
business, and we intend to use the additional fabrication capacity available
from our acquisition of SCS to expand our rental fleet while continuing the core
custom fabrication business that SCS established.  As our rental
business grows and contributes a larger percentage of our total revenues, we
expect our overall margins to improve from those experienced in
2007.





The oil
and gas equipment rental and services industry is cyclical in
nature.  The most critical factor in assessing the outlook for the
industry is the worldwide supply and demand for natural gas and the
corresponding changes in commodity prices.  As demand and prices
increase, oil and gas producers increase their capital expenditures for
drilling, development and production activities.  Generally, the
increased capital expenditures ultimately result in greater revenues and profits
for service and equipment companies.





In
general, we expect our overall business activity and revenues to track the level
of activity in the natural gas industry, with changes in domestic natural gas
production and consumption levels and prices more significantly affecting our
business than changes in crude oil and condensate production and consumption
levels and prices.  We also believe that demand for compression
services and products is driven by declining reservoir pressure in maturing
natural gas producing fields and, more recently, by increased focus by producers
on non-conventional natural gas production, such as coalbed methane, gas shales
and tight gas, which typically requires more compression than production from
conventional natural gas reservoirs.





Demand
for our products and services has been strong throughout 2006 and
2007.  We believe demand will remain strong throughout 2008 due to
high oil and natural gas prices and increased demand for natural
gas.  Because of these market fundamentals for natural gas, we believe
the long-term trend of activity in our markets is favorable.  However,
these factors could be more than offset by other developments affecting the
worldwide supply and demand for natural gas.  Additionally, activity
created by recent increases in the price of natural gas may make it difficult to
meet the demands of our markets.





For
fiscal year 2008, our forecasted capital expenditures are approximately $35
million, primarily for additions to our compressor rental fleet.  We
believe that the proceeds from our public offering of common stock we completed
in March 2006, together with funds available to us under our bank credit
facility and cash flows from operations will be sufficient to satisfy our
capital and liquidity requirements through 2008.  We may require
additional capital to fund any unanticipated expenditures, including any
acquisitions of other businesses.  Additional capital may not be
available to us when we need it or on acceptable terms.


21




Results
of Operations





Year
Ended December 31, 2007 Compared to the Year Ended December 31,
2006





The table
below shows our revenues, percentage of total revenues, gross margin, exclusive
of depreciation, and gross margin percentage of each of our segments for the
years ended December 31, 2007 and December 31, 2006.  Gross margin is
the difference between revenue and cost of sales, exclusive of
depreciation.





Revenue
                    
                    Gross
      Margin, Exclusive of Depreciation(1)Year
      Ended December 31,
                    
                    Year
      Ended December 31,2006
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    
                    
                    2007(dollars
      in thousands)Sales
                    
                    $
                    38,214
                    
                    
                    
                    60.9
                    %
                    
                    $
                    41,088
                    
                    
                    
                    56.7
                    %
                    
                    $
                    8,585
                    
                    
                    
                    22.5
                    %
                    
                    $
                    12,964
                    
                    
                    
                    31.6
                    %Service and
      maintenance
                    
                    
                    979
                    
                    
                    
                    1.6
                    %
                    
                    
                    964
                    
                    
                    
                    1.3
                    %
                    
                    
                    244
                    
                    
                    
                    24.9
                    %
                    
                    
                    364
                    
                    
                    
                    37.8
                    %Rental
                    
                    
                    23,536
                    
                    
                    
                    37.5
                    %
                    
                    
                    30,437
                    
                    
                    
                    42.0
                    %
                    
                    
                    14,592
                    
                    
                    
                    62.0
                    %
                    
                    
                    18,055
                    
                    
                    
                    59.3
                    %Total
                    
                    $
                    62,729
                    
                    
                    
                    
                    
                    
                    $
                    72,489
                    
                    
                    
                    
                    
                    
                    $
                    23,421
                    
                    
                    
                    37.3
                    %
                    
                    $
                    31,383
                    
                    
                    
                    43.3
                    %





(1)
            For
      a reconciliation of gross margin to its most directly comparable financial
      measure calculated and presented in accordance with GAAP, please read
      “Item 6. Selected Financial Data – Non-GAAP Financial Measures” in this
      report.





Total
revenues for the year ended December 31, 2007 increased 15.6% to $72.5 million,
as compared to $62.7 million for the year ended December 31,
2006.  The increase in revenue reflects the increase in our rental
revenue and unit sales to third parties.





Sales
revenue increased from $38.2 million to $41.1 million, or 7.5%, for the year
ended December 31, 2007, compared to the year ended December 31, 2006. This
increase is mainly sales of natural gas compressor units from our Tulsa
location, but this category includes (1) compressor unit sales (including used
rental equipment), (2) flare sales, (3) parts sales, (4) compressor
rebuilds.





Service
and maintenance revenue decreased from $979 thousand to $964 thousand, or 1.5%,
for the year ended December 31, 2007, compared to the year ended December 31,
2006.  This reduction is mainly a result of our strategy implemented
in 2006 to move away from pursuing third party service work.





Rental
revenue increased from $23.5 million to $30.4 million, or 29.3%, for the year
ended December 31, 2007, compared to the year ended December 31,
2006.  The increase is mainly the result of units added to our rental
fleet and rented to third parties.  As of December 31, 2007, we had
1,353 natural gas compressors in our rental fleet totaling approximately 160,733
horsepower, as compared to 1,111 natural gas compressors totaling approximately
129,158 horsepower at December 31, 2006.  As of December 31, 2007, we
had 1,194 natural gas compressors compared to 974 at December 31,
2006.  The average monthly rental rate per unit increased to $2.4
thousand at December 31, 2007 compared to $2.3 thousand at December 31,
2006.  This increase resulted from the addition of larger units to our
rental fleet, which command higher rental rates.




The
overall gross margin percentage, exclusive of depreciation, increased to 43.3%
for the year ended December 31, 2007, as compared to 37.3% for the year ended
December 31, 2006.  This increase is mainly the result of higher
margin from our natural gas compressor unit sales. Our natural gas compressor
unit sales gross margins increased to 28.7% for the year ended December 31,
2007, as compared to 17.1% for the year ended December 31, 2006, as a result of
our improvement in labor efficiencies.





Selling,
general and administrative expense remained flat at $5.3 million for the years
ended December 31, 2006 and 2007.  Our selling expenses decreased
34.9%, but were offset by an increase of 8.8% in general and administrative
expenses for year ended December 31, 2007, compared to same period in 2006.
Selling expenses decreased as a result of changes in the sales staff, department
manager and sales commission structure. General and administrative expenses
increased mainly as result of additions to the administrative staff, salary
increases and stock option expense.





Depreciation
and amortization expense increased 24.1% from $6.0 million to $7.5 million for
the year ended December 31, 2007, compared to the same period in
2006.  There was a net increase of 242 natural gas compressor units to
our rental fleet between December 31, 2006 and 2007, thus increasing our
depreciable base.


22




Other
income decreased approximately $91 thousand for the year ended December 31,
2007, compared to the same period in 2006. This decrease was mainly the result
of reduced interest income from our short-term investment account. Our
short-term investments decreased to $18.7 million at December 31, 2007, compared
to $25.1 million at December 31, 2006.  This reduction resulted from
the capital funding of our natural gas compressor rental fleet.





Interest
expense decreased by $491 thousand, or 29.8%, for the year ended December 31,
2007, compared to the same period in 2006, mainly due to a decrease in our loan
balance. Our loan balance decreased $3.8 million during the year ended December
31, 2007.





Provision
for income tax increased by $2.2 million, or 50.6%, and is the result of the
increase in taxable income, and offset by a lower income tax rate. Our effective
income tax rate decreased from 36% in 2006 to 34% in 2007. This decrease was
driven by a higher federal domestic production activity deduction and a lower
state tax assessment.





Year
Ended December 31, 2006 Compared to the Year Ended December 31,
2005





The table
below shows our revenues, percentage of total revenues, gross margin, exclusive
of depreciation, and gross margin percentage of each of our segments for the
years ended December 31, 2006 and December 31, 2005. Gross margin is the
difference between revenue and cost of sales, exclusive of
depreciation.





Revenue
              
              Gross
      Margin, Exclusive of Depreciation(1)Year
      Ended December 31,
              
              Year
      Ended December 31,2005
              
              
              2006
              
              
              2005
              
              
              
              
              2006(dollars
      in thousands)Sales
              
              $
              30,278
              
              
              
              61.4
              %
              
              $
              38,214
              
              
              
              60.9
              %
              
              $
              6,947
              
              
              
              22.9
              %
              
              $
              8,585
              
              
              
              22.5
              %Service and
      maintenance
              
              
              2,424
              
              
              
              4.9
              %
              
              
              979
              
              
              
              1.6
              %
              
              
              945
              
              
              
              39.0
              %
              
              
              244
              
              
              
              24.9
              %Rental
              
              
              16,609
              
              
              
              33.7
              %
              
              
              23,536
              
              
              
              37.5
              %
              
              
              10,081
              
              
              
              60.7
              %
              
              
              14,592
              
              
              
              62.0
              %Total
              
              $
              49,311
              
              
              
              
              
              
              $
              62,729
              
              
              
              
              
              
              $
              17,973
              
              
              
              36.4
              %
              
              $
              23,421
              
              
              
              37.3
              %





(1)
            For
      a reconciliation of gross margin to its most directly comparable financial
      measure calculated and presented in accordance with GAAP, please read
      “Item 6. Selected Financial Data -- Non-GAAP Financial Measures” in this
      report.





Total
revenues for the year ended December 31, 2006 increased 27.2% to $62.7 million,
as compared to $49.3 million for the year ended December 31, 2005. The increase
in revenue reflects the increase in our rental revenue and unit sales to third
parties, offset by a decline in service revenue.




Sales
revenue increased from $30.3 million to $38.2 million, or 26.2%, for the year
ended December 31, 2006, compared to the year ended December 31, 2005. This
increase was mainly the result of $4.1 million in sales of rental equipment to
an existing rental customer and additional sales of compressor units from our
Tulsa, Oklahoma location. Sales to third parties included (1) compressor unit
sales (including used rental equipment), (2) flare sales, (3) parts sales, (4)
compressor rebuilds and (5) sale of rental units.
 
 Service
and maintenance revenue decreased from $2.4 million to $979 thousand, or 59.6%,
for the year ended December 31, 2006, compared to the year ended December 31,
2005. This decrease was mainly the result of the change in our maintenance
contract with Dominion Exploration & Production, Inc. beginning January 1,
2006. Our five-year rental and maintenance agreement with Dominion Exploration
expired on December 31, 2005. In August 2005, we were advised by Dominion
Exploration that it would seek competing proposals from us as well as other
third parties to continue the rental and maintenance services required for its
northern Michigan operations. We submitted a bid to rent screw compressors to
Dominion Exploration and to provide maintenance and service on certain screw
compressors owned by Dominion Exploration. We also submitted a proposal to
continue service and maintenance of reciprocating compressors owned by Dominion
Exploration. In October 2005, we were advised by Dominion Exploration that we
would retain the screw compressor rental, maintenance and service businesses,
but that a third party was successful in bidding for the maintenance and service
of Dominion Exploration’s reciprocating compressors.
 
 Rental
revenue increased from $16.6 million to $23.5 million, or 41.7%, for the year
ended December 31, 2006, compared to the year ended December 31, 2005. The
increase is mainly the result of units added to our rental fleet and rented to
third parties. At December 31, 2006, we had 1,111 compressor packages in our
rental fleet, up from 865 units at December 31, 2005. The average monthly rental
rate per unit at December 31, 2006 was $2.3 thousand, as compared to $2.1
thousand at December 31, 2005. This increase resulted from normal price
increases throughout the year and the addition of larger units to our rental
fleet, which command higher rental rates.


23




The
overall gross margin percentage, exclusive of depreciation, increased to 37.3%
for the year ended December 31, 2006, as compared to 36.4% for the year ended
December 31, 2005. This increase resulted mainly from the relative increase in
compressor rental revenue as a percentage of the total revenue. Our rental fleet
carried a gross margin averaging 62.0% for 2006, and compressor and parts sales
margins averaged 22.5%.





Selling
expense increased from $1.0 million to $1.3 million, or 23.1%, for the year
ended December 31, 2006, as compared to the year ended December 31, 2005. This
increase is mainly the result of increased commissions paid to salesmen for the
increase in rental activity.





General
and administrative expenses remained relatively flat at $4.0 million for the
year ended December 31, 2006, as compared to $3.9 million for the year ended
December 31, 2005. While there was an increase in the expense to comply with SOX
404, this was offset by a decrease in officer salary and bonus expenses due to
the departure of personnel.





Depreciation
and amortization expense increased 42.5% from $4.2 million to $6.0 million for
the year ended December 31, 2006, compared to the year ended December 31, 2005.
There was a net increase of 246 natural gas compressor units to our rental fleet
between December 31, 2005 and 2006, thus increasing our depreciable
base.





Other
income increased approximately $1.2 million for the year ended December 31,
2006, compared to the same period in 2005. This increase was mainly the result
of additional interest income from our short-term investment account as a result
of increased cash balances from our March 2006 public offering.





Interest
expense decreased by $351 thousand, or 17.6%, for the year ended December 31,
2006, compared to the year ended December 31, 2005, mainly due to decreases in
our loan balances. In March 2006, we reduced our bank debt by $5.0 million with
proceeds from our March 2006 public offering of common stock and continued our
normal amortization of the remaining debt.





Provision
for income tax increased by $1.7 million, or 64.0%, and is the result of the
increase in taxable income.




Critical
Accounting Policies and Practices





We have
identified the policies below as critical to our business operations and the
understanding of our results of operations.  In the ordinary course of
business, we have made a number of estimates and assumptions relating to the
reporting of results of operations and financial condition in the preparation of
our consolidated financial statements in conformity with accounting principles
generally accepted in the United States.  Actual results could differ
significantly from those estimates under different assumptions and
conditions.  We believe that the following discussion addresses our
most critical accounting policies, which are those that are most important to
the portrayal of our financial condition and results of operations and require
our most difficult, subjective, and complex judgments, often as a result of the
need to make estimates about the effect of matters that are inherently
uncertain.





Our
critical accounting policies are as follows:





·
            revenue
      recognition;





·
            estimating
      the allowance for doubtful accounts
receivable;





·
            accounting
      for income taxes;





·
            valuation
      of long-lived and intangible assets and goodwill;
  and





·
            valuation
      of inventory





Revenue
Recognition





Revenue
from the sales of custom and fabricated compressors and flare systems is
recognized upon shipment of the equipment to customers.  Revenue from
sale of rental units is included in sales revenue when equipment is shipped or
title is transferred to the customer.  Exchange and rebuild compressor
revenue is recognized when both the replacement compressor has been delivered
and the rebuild assessment has been completed.  Revenue from
compressor services is recognized upon providing services to the
customer.  Maintenance agreement revenue is recognized as services are
rendered.  Rental revenue is recognized over the terms of the
respective rental agreements based upon the classification of the rental
agreement.  Deferred income represents payments received before a
product is shipped.


24


Allowance
for Doubtful Accounts Receivable





We
perform ongoing credit evaluations of our customers and adjust credit limits
based upon payment history and the customer’s current credit worthiness, as
determined by our review of their current credit information.  We
continuously monitor collections and payments from our customers and maintain a
provision for estimated credit losses based upon our historical experience and
any specific customer collection issues that we have
identified.  While such credit losses have historically been within
our expectations and the provisions established, we cannot guarantee that we
will continue to experience the same credit loss rates that we have in the
past.  At December 31, 2007 and December 31, 2006, one customer
accounted for approximately 64% and 54%, respectively, of our accounts
receivable.  A significant change in the liquidity or financial
position of this customer could have a material adverse impact on the
collectibility of our accounts receivables and our future operating
results.





Accounting
for Income Taxes





As part
of the process of preparing our consolidated financial statements, we are
required to estimate our federal income taxes as well as income taxes in each of
the states in which we operate.  This process involves us estimating
our actual current tax exposure together with assessing temporary differences
resulting from differing treatment of items for tax and accounting
purposes.  These differences result in deferred tax assets and
liabilities, which are included in our consolidated balance sheet.  We
must then assess the likelihood that our deferred tax assets will be recovered
from future taxable income and, to the extent we believe that recovery is not
probable, we must establish a valuation allowance.  To the extent we
establish a valuation allowance or increase this allowance in a period, we must
include an expense in the tax provision in the statement of
operations.




Significant
management judgment is required in determining our provision for income taxes,
our deferred tax assets and liabilities and any valuation allowance recorded
against our net deferred tax assets.





Valuation
of Long-Lived and Intangible Assets and Goodwill





We assess
the impairment of identifiable intangibles, long-lived assets and related
goodwill whenever events or changes in circumstances indicate that the carrying
value may not be recoverable.  Factors we consider important which
could trigger an impairment review include the following:





·
            significant
      underperformance relative to expected historical or projected future
      operating results;





·
            significant
      changes in the manner of our use of the acquired assets or the strategy
      for our overall business; and





·
            significant
      negative industry or economic
trends.





When we
determine that the carrying value of intangibles, long-lived assets and related
goodwill may not be recoverable based upon the existence of one or more of the
above indicators of impairment, we measure any impairment based on a projected
discounted cash flow method using a discount rate determined by our management
to be commensurate with the risk inherent in our current business
model.





We
adopted FAS 142 as of January 1, 2002.  Based on an independent
valuation as of June 2006 and an internal evaluation in December 2007 of our
reporting units with goodwill, adoption of FAS 142 did not have a material
adverse effect on us in 2006 or 2007.  Future tests under FAS 142
could result in impairments of our intangible assets or goodwill.  We
expect to continue to amortize our intangible assets with finite lives over the
same time periods as previously used, and we will test our intangible assets
with indefinite lives for impairment at least once each year.  In
addition, we are required to assess the consumptive life, or longevity, of our
intangible assets  including goodwill with finite lives and adjust
their amortization periods accordingly.  Our net goodwill and
intangible assets were recorded on our balance sheet at approximately $13.7
million as of December 31, 2006, and at December 31, 2007, the carrying value of
net goodwill and intangible assets decreased to approximately $13.4
million.  Our intangibles are amortized at a rate of $299 thousand per
year.  Any impairment in future periods of those assets, or a
reduction in their consumptive lives, could materially and adversely affect our
consolidated statements of income and financial position.





Inventories





We value
our inventory at the lower of the actual cost to purchase and/or manufacture the
inventory or the current estimated market value of the inventory.  We
regularly review inventory quantities on hand and record a provision for excess
and obsolete inventory based primarily on our estimated forecast of product
demand and production requirements.




25




Recently
Issued Accounting Pronouncements





In July
2006, the FASB issued FASB Interpretation ("FIN") No.  48, Accounting for Uncertainty in Income
Taxes – an interpretation of FASB Statement 109.  FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with FASB Statement
No.  109, Accounting
for Income Taxes.  FIN 48 prescribes a comprehensive model for
recognizing, measuring, presenting and disclosing in the financial statements
tax positions taken or expected to be taken on a tax return.  FIN 48
is effective for fiscal years beginning after December 15, 2006.  We
adopted FIN 48 on January 1, 2007, and its adoption did not have a
material impact on our consolidated financial position and results of
operations.  See Note 7 of our Consolidated Financial Statements for
additional information regarding income taxes.




In
September 2006, the FASB issued Statement of Financial Accounting Standards
(“SFAS”) No. 157, Fair Value
Measurements, which defines fair value, establishes a framework for
measuring fair value in GAAP, and expands disclosures about fair value
measurements.  This Statement applies under other accounting
pronouncements that require or permit fair value measurements and is effective
for fiscal years beginning after November 15, 2007.  In February 2008,
the FASB issued FASB Staff Position No. FAS 157-2, which defers the effective
date of SFAS 157 for nonfinnacial assets and non financial liabilities, except
for items that are recognized or disclosed at fair value in the financial
statemetns on a recurring basis (at least annually) to fiscal years beginning
after November 15, 2008 and interim periods within those fiscal years.  We
adopted the required provisions of SFAS 157 on January 1, 2008 and the adoption
did not have a significant impact on our financial statements.





In
February 2007, the FASB issued Statement of Financial Accounting Standards
(“SFAS”) No. 159, The Fair
Value Option for Financial Assets and Financial Liabilities-Including an
amendment of FASB Statement No. 115(“SFAS 159”).  SFAS 159
permits entities to measure eligible assets and liabilities at fair
value.  Unrealized gains and losses on items for which the fair value
option has been elected are reported in earnings.  SFAS 159 is
effective for fiscal years beginning after November 15, 2007.  We
adopted SFAS 159 on January 1, 2008 and the adoption did not have a significant
impact on our financial statements.





In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations(SFAS
No. 141(R)), which replaces SFAS No. 141, Business Combinations,
requires an acquirer to recognize the assets acquired, the liabilities assumed,
and any non-controlling interest in the acquiree at the acquisition date,
measured at their fair values as of that date, with limited exceptions. This
Statement also requires the acquirer in a business combination achieved in
stages to recognize the identifiable assets and liabilities, as well as the
non-controlling interest in the acquiree, at the full amounts of their fair
values. SFAS No. 141(R) makes various other amendments to authoritative
literature intended to provide additional guidance or to confirm the guidance in
that literature to that provided in this Statement. This Statement applies
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. We do not expect this will have a significant impact on
our financial statements.





In
December 2007, FASB issued SFAS No. 160, Non-controlling Interests in
Consolidated Financial Statements(SFAS No. 160), which amends
Accounting Research Bulletin No. 51, Consolidated Financial
Statements, to improve the relevance, comparability, and transparency of
the financial information that a reporting entity provides in its consolidated
financial statements. SFAS No. 160 establishes accounting and reporting
standards that require the ownership interests in subsidiaries not held by the
parent to be clearly identified, labeled and presented in the consolidated
statement of financial position within equity, but separate from the parent’s
equity. This statement also requires the amount of consolidated net income
attributable to the parent and to the non-controlling interest to be clearly
identified and presented on the face of the consolidated statement of income.
Changes in a parent’s ownership interest while the parent retains its
controlling financial interest must be accounted for consistently, and when a
subsidiary is deconsolidated, any retained non-controlling equity investment in
the former subsidiary must be initially measured at fair value. The gain or loss
on the deconsolidation of the subsidiary is measured using the fair value of any
non-controlling equity investment. The Statement also requires entities to
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. This
Statement applies prospectively to all entities that prepare consolidated
financial statements and applies prospectively for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008.
We do not expect this will have a significant impact on our financial
statements.




26




Environmental
Regulations




Various
federal, state and local laws and regulations covering the discharge of
materials into the environment, or otherwise relating to protection of human
safety and health and the environment, affect our operations and
costs.  Compliance with these laws and regulations could cause us to
incur remediation or other corrective action costs or result in the assessment
of administrative, civil and criminal penalties and the issuance of injunctions
delaying or prohibiting operations.  In addition, we have acquired
certain properties and plant facilities from third parties whose actions with
respect to the management and disposal or release of hydrocarbons or other
wastes were not under our control.  Under environmental laws and
regulations, we could be required to remove or remediate wastes disposed of or
released by prior owners.  In addition, we could be responsible under
environmental laws and regulations for properties and plant facilities we lease,
but do not own.  Compliance with such laws and regulations increases
our overall cost of business, but has not had a material adverse effect on our
operations or financial condition.  It is not anticipated, based on
current laws and regulations, that we will be required in the near future to
expend amounts that are material in relation to our total expenditure budget in
order to comply with environmental laws and regulations but such laws and
regulations are frequently changed and we are unable to predict the ultimate
cost of compliance.  We also could incur costs related to the clean up
of sites to which we send equipment and for damages to natural resources or
other claims related to releases of regulated substances at such
sites.


Liquidity
and Capital Resources





The
Company's working capital position as of December 31, 2006 and 2007 is set forth
below.




2006
            
            
            2007Current
      Assets:Cash
      and cash equivalents
            
            $
            4,391
            
            
            $
            245Short-term
      investments
            
            
            25,052
            
            
            
            18,661Trade
      accounts receivable, net
            
            
            8,463
            
            
            
            11,322Inventory,
      net
            
            
            16,943
            
            
            
            20,769Prepaid
      income taxes
            
            
            −
            
            
            
            3,584Prepaid
      expenses and other
            
            
            321
            
            
            
            641Total
      current assets
            
            
            55,170
            
            
            
            55,222Current
      Liabilities:Current
      portion of long-term debt
              and
      subordinated notes
            
            
            4,442
            
            
            
            4,378Line
      of credit
            
            
            −
            
            
            
            600Accounts
      payable
            
            
            2,837
            
            
            
            4,072Accrued
      liabilities
            
            
            2,077
            
            
            
            3,990Current
      portion of tax liability
            
            
            1,056
            
            
            
            3,525Deferred
      income
            
            
            225
            
            
            
            81Total
      current liabilities
            
            
            10,637
            
            
            
            16,646Total
      working capital
            
            $
            44,533
            
            
            $
            38,576











Historically,
we have funded our operations through public and private offerings of our equity
securities, subordinated debt, bank borrowings and cash flow from operations.
Proceeds of financings have been primarily used to repay debt, to fund the
manufacture and fabrication of additional units for our rental fleet of natural
gas compressors and for acquisitions.





For the
year ended December 31, 2007, we invested approximately $25.3 million in
equipment for our rental fleet, service vehicles and additions to our
facilities.  We financed this activity with the proceeds from our
March 2006 public offering of common stock and funds from
operations.  We borrowed approximately $600 thousand from our bank in
2007.  We also repaid approximately $4.4 million of our existing debt
during 2007.




27


Cash
flows





At
December 31, 2006, we had cash and cash equivalents of approximately $4.4
million, working capital of $44.5 million and total debt of $18.4 million, of
which approximately $4.4 million was classified as current. At that same date,
we also had letters of credit outstanding in the aggregate face amount of $2.0
million. We had positive net cash flow from operating activities of
approximately $16.1 million during 2006. This was primarily from net income of
$7.6 million, plus depreciation and amortization of $6.0 million, an increase in
deferred taxes of $2.5 million and offset by an increase in trade accounts
receivable of $2.3 million.





At
December 31, 2007, we had cash and cash equivalents of approximately $245
thousand, working capital of $38.6 million and total debt of $14.6 million, of
which approximately $5.0 million was classified as current. At that same date,
we also had letters of credit outstanding in the aggregate face amount of $1.0
million. We had positive net cash flow from operating activities of
approximately $18.3 million during 2007. This was primarily from net income of
$12.3 million, plus depreciation and amortization of $7.5 million, an increase
in deferred taxes of $2.9 million, an increase in accounts payable and accrued
liabilities including income taxes of $5.8 million , offset by an increase in
trade accounts receivable of $2.9 million , an increase in inventory
of  $3.8 million and an increase in prepaid expense of  $3.9
million.


Short
term investments decreased to $18.7 million from December 31, 2006 to December
31, 2007.  This  amount is the remaining  proceeds
from our March 2006 secondary public offering. The initial net proceeds from the
offering were $47.1 million, from which we used $5.0 million to repay bank debt
and the remainder of which has been used for capital expenditures invested in
our natural gas compressor rental fleet.





Trade
accounts receivable increased $2.9 million to $11.3 million at December 31,
2007, as compared to $8.5 million at December 31, 2006, largely reflecting the
impact of higher sales and timing of payments from our larger
customers.





Inventory
and work in progress increased $3.8 million to $20.8 million as of the end of
2007, as compared to $16.9 million as of the end of 2006. This increase is
mainly a reflection of increased sales activity in both manufacturing and
rental.




Long-term
debt decreased $3.8 million to $14.6 million at December 31, 2007, compared to
$18.4 million at December 31, 2006. The current portion of long-term debt
increased $536 thousand to $5.0 million at December 31, 2007 compared to
$4.4 million at December 31, 2006, mainly the result of normal amortization of
debt and a draw of $600 thousand from our line of credit.





Contractual
Obligations and Commitments





We have
contractual obligations and commitments that affect our consolidated results of
operations, financial condition and liquidity.  The following table is
a summary of our significant cash contractual obligations:





Obligation
      Due in PeriodCash
      Contractual Obligations
            
            2008
            
            
            2009
            
            
            2010
            
            
            2011
            
            
            2012
            
            
            Thereafter
            
            
            Total(in
      thousands)Credit
      facility (secured)
            
            $
            3,978
            
            
            $
            3,378
            
            
            $
            3,378
            
            
            $
            2,816
            
            
            $ ─
            
            
            $ ─
            
            
            $
            13,550Interest
      on credit facility
            
            
            885
            
            
            
            591
            
            
            
            338
            
            
            
            106
            
            
            ─
            
            
            ─
            
            
            
            1,920Subordinated
      debt
            
            
            1,000
            
            
            ─
            
            
            ─
            
            
            ─
            
            
            ─
            
            
            ─
            
            
            
            1,000Facilities
      and office leases
            
            
            76
            
            
            
            28
            
            
            
            28
            
            
            
            29
            
            
            
            30
            
            
            
            44
            
            
            
            235Purchase
      obligations
            
            ─
            
            
            ─
            
            
            ─
            
            
            ─
            
            
            ─
            
            
            ─
            
            
            ─Total
            
            $
            5,939
            
            
            $
            3,997
            
            
            $
            3,744
            
            
            $
            2,951
            
            
            $
            30
            
            
            $
            44
            
            
            $
            16,705







28




Senior
Bank Borrowings





On
October 15, 2006, we entered into a Seventh Amended and Restated Loan Agreement,
or “Loan Agreement,” with Western National Bank, Midland, Texas, which provides
us with a revolving line of credit facility and multiple advance term loan
facilities, as further are described below.




Revolving Line of Credit
Facility.Our revolving line of credit facility allows us to
borrow, repay and reborrow funds drawn under this facility.  The total
amount that we can borrow and have outstanding at any one time is the lesser of
$40.0 million or the amount available for advances under a “borrowing base”
calculation established by the bank.  As of December 31, 2007, the
amount available for revolving line of credit advances under our borrowing base
was $39.6 million, and the principal amount outstanding under the revolving line
of credit at that same date was $600 thousand.  The amount of the
borrowing base is based primarily upon our receivables, equipment and
inventory.  The borrowing base is redetermined by the bank on a
monthly basis.  If, as a result of the redetermination of the
borrowing base, the aggregate outstanding principal amount of the notes payable
to the bank under the Loan Agreement exceeds the borrowing base, we must prepay
the principal of the revolving line of credit note in an amount equal to such
excess.  Interest only on borrowings under our revolving line of
credit facility is payable monthly on the first day of each
month.  All outstanding principal and unpaid interest is due on
October 1, 2008.  As of December 31, 2007, our interest rate on the
revolving line of credit was 7.5%.





$16.9 Million Multiple Advance Term
Loan Facility.This multiple advance term loan facility
represents the consolidation of our previously existing advancing line of credit
and term loan facilities.  Reborrowings are not permitted under this
facility.  Principal under this credit facility is due and payable in
59 monthly installments of $282 thousand each, which commenced on November 1,
2006 and will continue through September 1, 2011.  The interest rate
is fixed at 7.5%.  Interest on the unpaid principal balance is due and
payable on the same dates as principal payments.  All outstanding
principal and unpaid interest is due on October 1, 2011.  As of
December 31, 2007, this term loan facility had a principal balance of $13.0
million.





Our
obligations under the Loan Agreement are secured by substantially all of our
properties and assets, including our equipment, trade accounts receivable and
other personal property.  The maturity dates of the loan facilities
may be accelerated by the bank upon the occurrence of an event of default under
the Loan Agreement.





The Loan
Agreement contains various restrictive covenants and compliance
requirements.  These requirements provide that we must
have:





·
            at
      the end of each month, a consolidated current ratio (as defined in the
      Loan Agreement) of at least 1.4 to
1.0;





·
            at
      the end of each month, consolidated tangible net worth (as defined in the
      Loan Agreement) of at least $70.0
million;





·
            at
      the end of each fiscal quarter, a debt service coverage ratio (as defined
      in the Loan Agreement) of at least 1.50 to 1.00;
  and





·
            at
      the end of each month, a ratio of consolidated debt to consolidated
      tangible net worth (as defined in the Loan Agreement) of less than 2.0 to
      1.0.





The Loan
Agreement also contains restrictions on incurring additional debt and paying
dividends.





As of
December 31, 2007, we were in compliance with all covenants in our Loan
Agreement.  A default under our bank credit facility could trigger the
acceleration of our bank debt so that it is immediately due and
payable.  Such default would have a material adverse effect on our
liquidity, financial position and operations.





Subordinated
Debt and Related Letters of Credit





The
principal amount of the promissory notes we issued to the three former
stockholders of SCS when we acquired SCS were payable in three equal annual
installments, commencing on January 3, 2006.  Accrued and unpaid
interest on the unpaid principal balance of the notes was payable on the same
dates as, and in addition to, the installments of principal.  These
notes were paid in full on January 3, 2008.





To secure
payment of these notes, our bank lender issued for our account three separate
letters of credit for the benefit of the holders of the notes in the initial
aggregate face amount of $1.0 million.  The letters of credit expired
February 3, 2008.




29


Components
of Our Principal Capital Expenditures





The table
below shows the components of our principal capital expenditures for the three
years ended December 31, 2007, along with the total budgeted for 2008, excluding
acquisitions:





ActualBudgeted
      for 2008Expenditure Category
            
            2005
            
            
            2006
            
            
            2007
            
            (excluding acquisitions)(in
      thousands)Rental
      equipment, vehicles andshop
      equipment
            
            $
            17,708
            
            
            $
            27,684
            
            
            $
            25,307
            
            Approximately  $35,000





The level
of our expenditures will vary in future periods depending on energy market
conditions and other related economic factors.  Based upon existing
economic and market conditions, we believe that the proceeds from our March 2006
public offering of common stock, our operating cash flow and available bank
borrowings will be sufficient to fully fund our net investing cash requirements
for 2008.  We also believe we have significant flexibility with
respect to our financing alternatives and adjustment of our expenditure plans if
circumstances warrant.  When considered in relation to our total
financial capacity, we do not have any material continuing commitments
associated with expenditure plans related to our current
operations.





Off-Balance
Sheet Arrangements





From
time-to-time, we enter into off-balance sheet arrangements and transactions that
can give rise to off-balance sheet obligations.  As of December 31,
2007, the off-balance sheet arrangements and transactions that we have entered
into include an undrawn letter of credit and operating lease
agreements.  We do not believe that these arrangements are reasonably
likely to materially affect our liquidity or availability of, or requirements
for, capital resources.





ITEM
7A.                      QUANTITATIVE
AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK




Commodity
Risk




Our
commodity risk exposure is the pricing applicable to oil and natural gas
production.  Realized commodity prices received for such production
are primarily driven by the prevailing worldwide price for crude oil and spot
prices applicable to natural gas.  Depending on the market prices of
oil and natural gas, companies exploring for oil and natural gas may cancel or
curtail their drilling programs, thereby reducing demand for our equipment and
services.




Interest
Rate Risk




Our Loan
Agreement provides for a fixed interest rate of 7.5% for our term loan facility
and our revolving line of credit facility.  Consequently, our exposure
to interest rates relates primarily to interest earned on short-term investments
and paying above market rates if such rates are below the fixed rate on our bank
borrowings.  As of December 31, 2007, we were not using any
derivatives to manage interest rate risk.


Financial
Instruments and Debt Maturities





Our
financial instruments consist of cash and cash equivalents, short-term
investments, accounts receivable, accounts payable, bank borrowings, and
notes.  The carrying amounts of cash and cash equivalents, accounts
receivable, and accounts payable approximate fair value because of the highly
liquid nature of these short-term instruments.  The fair value of our
bank borrowings approximate the carrying amounts as of December 31, 2007 and
2006, and were determined based upon interest rates currently available to
us.




Customer
Credit Risk




We are
exposed to the risk of financial non-performance by our
customers.  Our ability to collect on sales to our customers is
dependent on the liquidity of our customer base.  To manage customer
credit risk, we monitor credit ratings of our customers.  Unless we
are able to retain our existing customers, or secure new customers if we lose
one or more of our significant customers, our revenue and results of operations
would be adversely affected.  See “Item 7. Management’s Discussion and
Analysis of Financial Condition and Results of Operations – Critical Accounting
Policies and Procedures – Allowance For Doubtful Accounts Receivable” on page
25.




ITEM
8.                      FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA




Our
audited consolidated financial statements and supplementary financial data are
included in this Annual Report on Form 10-K beginning on page F-1.




30




ITEM
9.                      CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE


None.




ITEM
9A.                      CONTROLS
AND PROCEDURES





Evaluation
of Disclosure Controls and Procedures





An
evaluation was carried out under the supervision and with the participation of
our management, including our President and Chief Executive Officer and our
Principal Accounting Officer And Treasurer, of the effectiveness of the design
of our “disclosure controls and procedures” (as such term is defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
or, the “Exchange Act”) as of December 31, 2007, pursuant to Exchange Act Rule
13a-15.  Based upon that evaluation, the President and Chief Executive
Officer and our Principal Accounting Officer And Treasurer have concluded that
Natural Gas Services Group, Inc.’s disclosure controls and procedures as of
December 31, 2007, are effective to ensure that information required to be
disclosed by us in the reports filed or submitted by us under the Exchange Act
is recorded, processed, summarized, and reported within the time periods
specified in the SEC’s rules and forms and include controls and procedures
designed to ensure that information required to be disclosed by us in such
reports is accumulated and communicated to our management, including our
principal executive and financial officers as appropriate to allow timely
decisions regarding required disclosures.  Due to the inherent
limitations of control systems, not all misstatements may be
detected.  Those inherent limitations include the realities that
judgments in decision-making can be faulty and that breakdowns can occur because
of simple errors or mistakes.  Additionally, controls could be
circumvented by the individual acts of some persons or by collusion of two or
more people.  Our controls and procedures can only provide reasonable,
not absolute, assurance that the above objectives have been met.





Changes
in Internal Control Over Financial Reporting





There
were no changes in our internal control over financial reporting identified in
connection with the evaluation required by paragraph (d) of Exchange Act Rules
13a-15 or 15d-15 that occurred during our last quarter that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.





Management’s
Report on Internal Control Over Financial Reporting





Our
management, including the President and Chief Executive Officer and our
Principal Accounting Officer and Treasurer, is responsible for establishing and
maintaining adequate internal control over financial reporting, as defined in
Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as
amended.  Our internal control system is designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles.  Our internal control over
financial reporting includes those policies and procedures that:





·
            pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of our
      assets;





·
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with accounting
      principles generally accepted in the United States of America, and that
      our receipt and expenditures are being made only in accordance with
      authorizations of management and our Board of Directors;
    and





·
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of our assets that could have
      a material effect on the financial
statements.








All
internal control systems, no matter how well designed, have inherent
limitations.  A system of internal control may become inadequate over
time because of changes in conditions or deterioration in the degree of
compliance with the policies or procedures.  Therefore, even those
systems determined to be effective can provide only reasonable assurance with
respect to financial statement preparation and presentation.





Our
management assessed the effectiveness of our internal control over financial
reporting as December 31, 2007 using the criteria set forth by the Commission of
Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated
Framework.  Based on this assessment, our management concluded
that, as of December 31, 2007, our internal control over financial reporting was
effective.


31


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors and Stockholders


Natural
Gas Services Group, Inc.


Midland,
Texas





We have
audited Natural Gas Services Group, Inc. and Subsidiary's (the “Company”)
internal control over financial reporting as of December 31, 2007, based on
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (the COSO
criteria).  Natural Gas Services Group, Inc.’s management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Management’s Report on Internal Control
over Financial Reporting.  Our responsibility is to express an opinion
on the Company’s internal control over financial reporting based on our
audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects.  Our audit included obtaining an understanding of
internal control over financial reporting, assessing the risk that a material
weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our audit also
included performing such other procedures as we considered necessary in the
circumstances.  We believe that our audit provides a reasonable basis
for our opinion.





A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles.  A company’s internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or the degree of compliance
with the policies or procedures may deteriorate.





In our
opinion, Natural Gas Services Group, Inc. and Subsidiary maintained, in all
material respects, effective internal control over financial reporting as of
December 31, 2007, based on the COSO criteria.





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Natural Gas
Services Group, Inc. and Subsidiary as of December 31, 2006 and 2007, and the
related consolidated statements of income, stockholders’ equity and cash flows
for each of the three years in the period ended December 31, 2007 of Natural Gas
Services Group, Inc. and Subsidiary and our report dated March 5, 2008 expressed
an unqualified opinion thereon.











HEIN & ASSOCIATES
LLP


Dallas,
Texas


March 5,
2008





32


ITEM
9B.                      OTHER
INFORMATION




None.




ITEM
10.                      
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE




Executive
Officers and Directors





Our
executive officers and Directors at March 5, 2008 are:




Name
              Age
              PositionStephen
      C. Taylor
              54
              Chairman,
      President and Chief Executive OfficerEarl
      R. Wait
              64
              Vice
      President — Accounting and TreasurerPaul
      D. Hensley
              55
              Director,
      Senior Vice President — Technical ServicesJames
      R. Hazlett
              52
              Vice
      President — Technical ServicesCharles
      G. Curtis(1)(3)(4)
              74
              DirectorWilliam
      F. Hughes, Jr.(1)(2)
              55
              DirectorGene
      A. Strasheim(1)(4)
              67
              DirectorRichard
      L. Yadon(2)(3)(4)
              49
              DirectorAlan
      A. Baker(2)(3)
              76
              DirectorJohn
      W.  Chisholm(2)(3)
              53
              Director








(1)
            Member
      of our audit committee


(2)
            Member
      of our compensation committee


(3)
            Member
      of our governance and personnel development
  committee


(4)
            Member
      of our nominating committee





Stephen
C. Taylor was elected by the Board of Directors of Natural Gas Services Group to
assume the position of President and Chief Executive Officer in January
2005.  Mr. Taylor was first elected as a Director at the annual
meeting of stockholders in June 2005.  Effective January 1, 2006, Mr.
Taylor was appointed Chairman of the Board of Directors.  Immediately
prior to joining Natural Gas Services Group, Mr. Taylor held the position of
General Manager — US Operations for Trican Production Services,
Inc.  from 2002 through 2004.  Mr. Taylor joined Halliburton
Resource Management in 1976, becoming its Vice President — Operations in
1989.  Beginning in 1993, he held multiple senior level management
positions with Halliburton Energy Services until 2000 when he was elected Senior
Vice President/Chief Operating Officer of Enventure Global Technology, LLC, a
joint-venture deep water drilling technology company owned by Halliburton
Company and Shell Oil Company.  Mr. Taylor elected early retirement
from Halliburton Company in 2002 to join Trican Production Services,
Inc.  Mr. Taylor holds a Bachelor of Science degree in Mechanical
Engineering from Texas Tech University and a Master of Business Administration
degree from the University of Texas at Austin.





Earl R.
Wait became Vice President — Accounting in January 2006.  He served as
our Chief Financial Officer from May 2000 to January 2006.  He has
also served as our Treasurer since 1998.  Mr. Wait was our Chief
Accounting Officer from 1998 to May 2000.  During the period from 1993
to 2003, he also served as an officer or director of our former
subsidiaries.  Mr. Wait is a certified public accountant, has a
Bachelor of Business Administration degree from Texas A&M University —
Kingsville and holds a Master of Business Administration degree from Texas
A&M University — Corpus Christi and has more than 25 years of experience in
the energy industry.


33


Paul D.
Hensley was appointed as a Director of Natural Gas Services Group in January
2005 to fill a vacancy on the Board of Directors and was first elected as a
Director at the annual meeting of stockholders held in June 2005.  He
was the founder of and served as President and a director of SCS from 1997 until
June 30,  2007, when SCS was merged into us.  As of June 30,
2007, Mr. Hensley became the Senior Vice President — Technical
Services.  Mr. Hensley has over 30 years of industry
experience.





James R.
Hazlett has served as Vice President — Technical Services since June
2005.  He also served as Vice President of Sales of SCS from 1997
until June 30, 2007, when SCS was merged into us.  Mr. Hazlett holds
an Industrial Engineering degree from Texas A&M University and has over 27
years of industry experience.





Charles
G. Curtis has served as a Director since April 2001.  Since 2002,
substantially all of Mr. Curtis’ business activities have been devoted to
managing personal investments.  From 1992 until 2002, Mr. Curtis was
the President and Chief Executive Officer of Curtis One, Inc., a manufacturer of
aluminum and steel mobile stools and mobile ladders.  From 1988 to
1992, Mr. Curtis was the President and Chief Executive Officer of Cramer,
Inc.  a manufacturer of office furniture.  Mr. Curtis holds
a Bachelor of Science degree from the United States Naval Academy and a Master
of Science in Aeronautical Engineering degree from the University of Southern
California.





William
F. Hughes, Jr. has served as a Director since December 2003.  Since
1983, Mr. Hughes has been co-owner of The Whole Wheatery, LLC, a natural foods
store located in Lancaster, California.  Mr. Hughes holds a Bachelor
of Science degree in Civil Engineering from the United States Air Force Academy
and a Master of Science in Engineering from the University of California at Los
Angeles.





Gene A.
Strasheim has served as a Director since 2003.  From 2001 to 2004, Mr.
Strasheim was a financial consultant to Skyline Electronics/Products, a
manufacturer of circuit boards and large remotely controlled digital interstate
highway signs.  From 1992 to 2001, Mr. Strasheim was the Chief
Financial Officer of Skyline Electronics/Products.  From 1985 to 1992,
Mr. Strasheim was the Vice President — Finance and Treasurer of CF&I Steel
Corporation.  Prior to that, Mr. Strasheim was the Vice President —
Finance for two companies and was a partner with the public accounting firm of
Deloitte Haskins & Sells.  Mr. Strasheim holds a Bachelor degree
in Business from the University of Wyoming.





Richard
L. Yadon has served as a Director since 2003.  Mr. Yadon is one of the
founders of Rotary Gas Systems, Inc., a former subsidiary of Natural Gas
Services Group, and served as an advisor to the Board of Directors of Natural
Gas Services Group from June 2002 to June 2003.  Since 1981, Mr. Yadon
has owned and operated Yadeco Pipe & Equipment.  Since December
1994, he has co-owned and served as President of Midland Pipe & Equipment,
Inc.  Both companies are engaged in the business of providing oil and
gas well drilling and completion services and equipment to oil and gas producers
conducting operations in Texas, New Mexico, Louisiana and
Oklahoma.  Since 1981, he has owned Yadon Properties, which owns and
operates real estate in Midland, Texas.  Mr. Yadon has 22 years of
experience in the energy service industry.





Alan A.
Baker was appointed as a Director of Natural Gas Services Group on March 20,
2006 to fill a vacancy on the Board of Directors.  Mr. Baker was first
elected as a Director at the annual meeting of stockholders in June
2006.  He has served as a consultant to Halliburton Company and
previously served as President, Chairman and Chief Executive Officer of
Halliburton Company’s Energy Services Group, Houston, Texas, from 1991 until his
retirement in 1995.  Mr. Baker joined Halliburton Services in 1954
after graduating with a degree in Petroleum Engineering from Marietta College in
Ohio.  Mr. Baker served Halliburton Services as Senior Vice President
for U.S. Operations, Senior Vice President for International Operations and as
President of the Vann Systems Division of Halliburton Company.  He
also served as a member of Halliburton’s executive committee.  Mr.
Baker has served on the Boards of Noble Affiliates, Natural Gas and Oil, Crestar
Energy of Canada and the Mid-Continent Oil and Gas Association.  He is
Trustee Emeritus of Marietta College and is a registered professional
engineer.





John
W.  Chisholm was appointed as a Director of Natural Gas Services Group
on December 19, 2006 and was first elected as a Director at the annual meeting
of stockholders in June of 2007.  Mr. Chisholm is the founder of
Wellogix, an oil and gas software company that develops software aimed at
expediting the exchange of enterprise data and communication of complex
engineered services.  Mr. Chisholm has served on the Board of
Directors of Flotek Industries, Inc.  since 2002 and is a member of
its Compensation Committee.  Prior to founding Wellogix, Mr. Chisholm
co-founded and served as President of ProTechnics Company from 1985 until its
sale to Core Laboratories in December 1996.  Mr. Chisholm served as
Senior Vice President of Global Sales and Marketing of Core Laboratories until
1998, when he started Chisholm Energy Partners, an investment fund focused on
mid-size energy service companies.  Mr. Chisholm holds a Business
Administration degree from Fort Lewis College in Colorado.  He
currently serves on the Editorial Advisory Board on Middle East Technology of
the Oil & Gas Journal.


34
  Section  16(a)
Beneficial Ownership Reporting Compliance





Section
16(a) of the Securities Exchange Act of 1934, as amended, requires our Directors
and officers to file periodic reports of beneficial ownership with the
Securities and Exchange Commission.  These reports show the Directors
and officers’ ownership, and the changes in ownership, of common stock and other
equity securities of Natural Gas Services Group.





Based on
a review of Section 16(a) filings, all transactions in our equity securities
required to be reported by Section 16(a) of the Securities Exchange Act of 1934
were reported on a timely basis, except that one Form 4 report was filed one day
late by Mr. Strasheim.  This report, filed on May 18, 2007, reported
Mr. Strasheim’s purchase on May 15, 2007 of 1,500 shares of our common
stock.





Board
of Directors





The Board
of Directors is divided into three classes with Directors serving staggered
three-year terms.  The terms of Messrs.  Hensley, Chisholm,
and Yadon expire in 2010; the terms of Messrs.  Curtis, Strasheim and
Taylor expire in 2008; and the terms of Messrs. Hughes and Baker expire in
2009.





Our Board of Director has four standing
committees, as follows:





·
            Audit
      Committee,





·
            Compensation
      Committee,





·
            Governance
      and Personnel Development, and





·
            Nominating
      Committee.





Audit
Committee





Our Audit
Committee is composed of Gene A. Strasheim (Chairman), Charles G. Curtis and
William F. Hughes, Jr. Our common stock is listed for trading on the American
Stock Exchange.  Under rules of the American Stock Exchange, the Audit
Committee is to be comprised of three or more directors, each of whom must be
“independent”.  Our Board has determined that all of the members of
the Audit Committee are independent, as defined in the listing standards of AMEX
and the rules of the SEC, and that Gene A. Strasheim is qualified as an “audit
committee financial expert” as that term is defined in the rules of the
SEC.


The
primary functions of the Audit Committee include:





·
            assisting
      the Board in fulfilling its oversight responsibilities as they relate to
      our accounting policies, internal controls, financial reporting practices
      and legal and regulatory
compliance;





·
            hiring
      independent auditors;





·
            monitoring
      the independence and performance of our independent
    auditors;





·
            maintaining,
      through regularly scheduled meetings, a line of communication between the
      Board, our financial management and independent auditors;
    and





·
            overseeing
      compliance with our policies for conducting business, including ethical
      business standards.





The
      Board of Directors has adopted an Audit Committee Charter which can be
      found on our website at www.ngsgi.com.





Compensation
Committee





The
Compensation Committee of the Board of Directors includes William F. Hughes, Jr.
(Chairman), Alan A. Baker, John W. Chisholm and Richard L. Yadon.  Our
Board has determined that all of the members of the Compensation Committee are
independent, as defined in the listing standards of AMEX and the rules of the
SEC.





The
functions of the Compensation Committee include:





·
            assisting
      the Board in overseeing the management of our human resources, including
      compensation and benefits programs, and evaluating the performance and
      compensation of our Chief Executive Officer;
and





·
            overseeing
      the evaluation of management.





35









A copy of our Compensation Committee
Charter is available on our website at www.ngsgi.com





Governance
and Personnel Development Committee





Our
Governance and Personnel Development Committee is composed of Charles G. Curtis
(Chairman), John W. Chisholm, Alan A. Baker and Richard L. Yadon.





The
functions of this Committee include:





·
            assisting
      the Board in interpreting the Board Governance Guidelines, the Board’s
      Code of Business Conduct and Ethics and any other similar governance
      documents adopted by the Board;





·
            overseeing
      the evaluation of the Board and its
committees;





·
            generally
      overseeing the governance of the Board;
and





·
            overseeing
      executive development and succession and diversity
  efforts.


Our Board
of Directors has determined that all of the members of the Governance and
Personnel Development Committee are independent, as defined in the listing
standards of AMEX and the rules of the SEC.





A copy of
our Governance and Personnel Development Committee Charter is available on our
website at www.ngsgi.com.





Nominating
Committee





Our Nominating Committee is composed of
Richard L. Yadon (Chairman), Gene A. Strasheim and Charles G.
Curtis.





The
functions of this Committee include:





·
            identifying
      individuals qualified to become board members, consistent with the
      criteria approved by the Board; and





·
            recommending
      director nominees and individuals to fill vacant
  positions;





Our
Nominating Committee will consider director candidates recommended by
stockholders.  The Committee will evaluate nominees for directors
recommended by stockholders in the same manner in which it evaluates other
nominees for directors.  Our Board of Directors has determined that
all of the members of the Nominating Committee are independent, as defined in
the listing standards of AMEX and the rules of the SEC.





A copy of
our Nominating Committee Charter is available on our website at www.ngsgi.com.





Code
of Ethics




Our Board
of Directors has adopted a Code of Business Conduct and Ethics, or “Code”, which
is posted on our web site located at www.ngsgi.com.  You
may also obtain a copy of our Code by requesting a copy in writing at 2911 SCR
1260, Midland, Texas  79706 or by calling us at (432)
563-3974.




36


Our Code
provides general statements of our expectations regarding ethical standards that
we expect our directors, officers and employees, including our Chief Executive
Officer and Chief Financial Officer, to adhere to while acting on our
behalf.  Among other things, the Code provides that:




·
            we
      will comply with all laws, rules and
  regulations;





·
            our
      Directors, officers and employees are to avoid conflicts of interest and
      are prohibited from competing with us or personally exploiting our
      corporate opportunities;





·
            our
      Directors, officers and employees are to protect our assets and maintain
      our confidentiality;





·
            we
      are committed to promoting values of integrity and fair dealing;
      and





·
            we
      are committed to accurately maintaining our accounting records under
      generally accepted accounting principles and timely filing our periodic
      reports.





Our Code
also contains procedures for our employees to report, anonymously or otherwise,
violations of the Code.




ITEM
11.                      EXECUTIVE
COMPENSATION




The
information required by this item is incorporated herein by reference to our
definitive proxy statement which will be filed with the Securities and Exchange
Commission with 120 days after December 31, 2007.




The
following table sets forth, as of March 5, 2008, the beneficial ownership of our
common stock by (i) each of our directors and executive officers; (ii) all of
our executive officers and directors as a group; and (iii) all persons known by
us to beneficially own more than five percent of our common stock.




Name
      and Address
                of
                Beneficial
      Owner
              
              Amount
      and Nature
                of
                Beneficial
      Ownership(1)
              
              Percent
                of
                ClassCharles
      G. Curtis
              
              78,857(2)
              
              
              *William
      F. Hughes
              
              205,000(3)
              
              
              1.68%Gene
      A. Strasheim
              
              15,000(4)
              
              
              *Stephen
      C. Taylor
              
              53,500(5)
              
              
              *Richard
      L. Yadon
              
              212,000(6)
              
              
              1.74%Paul
      D. Hensley
              
              326,829(7)
              
              
              2.68%Alan
      A. Baker
              
              5,000(8)
              
              
              *John
      Chisholm
              
              5,000(9)
              
              
              *Earl
      R. Wait
              
              40,036(10)
              
              
              *James
      R. Hazlett
              
              51,976(11)
              
              
              *Keeley
      Asset Management Corp
              
              1,560,000(12)
              
              
              12.91%All
      directors and executive  officers as a
                group
      (10  persons)
              
              993,198(13)
              
              
              8.13%




*
      Less than one percent




37




(1)
            The
      number of shares listed includes all shares of common stock owned by, or
      which may be acquired within 60 days of March 5, 2008 upon the exercise of
      warrants and options held by the stockholder (or
      group).  Beneficial ownership is calculated in accordance with
      the rules of the Securities and Exchange Commission.  Unless
      otherwise indicated, all shares of common stock are held directly with
      sole voting and investment powers.  As of March 5, 2008, none of
      the shares of common stock owned by our officers and directors had been
      pledged as collateral to secure repayment of
  loans.


(2)
            Includes
      15 thousand shares that may be acquired upon the exercise of stock options
      granted under our 1998 Stock Option Plan.  Mr. Curtis’ address
      is 1 Penrose Lane, Colorado Springs, Colorado
  80906.


(3)
            Includes
      190,500 shares indirectly owned by Mr. Hughes through the William and
      Cheryl Hughes Family Trust and 12.5 thousand shares that may be acquired
      upon the exercise of stock options granted under our 1998 Stock Option
      Plan.  Mr. and Mrs. Hughes are co-trustees of the William and
      Cheryl Hughes Family Trust and have shared voting and investment powers
      with respect to the shares held by the trust.  Mr. and Mrs.
      Hughes are beneficiaries of the trust along with their two
      children.  Mr. Hughes’ address is 42921 Normandy Lane,
      Lancaster, California 93536.


(4)
            Includes
      10 thousand shares that may be acquired upon exercise of stock options
      granted under our 1998 Stock Option Plan.  Mr. Strasheim’s
      address is 165 Huntington Place, Colorado Springs, Colorado
      80906.


(5)
            Includes
      52.5 thousand shares that may be acquired upon exercise of stock options
      granted to Mr. Taylor as an inducement for his employment and under our
      1998 Sock Option Plan.  Mr. Taylor’s address is 2911 South
      County Road 1260, Midland, Texas
79706.


(6)
            Includes
      12.5 thousand shares that may be acquired upon the exercise of stock
      options granted under our 1998 Stock Option Plan.  Mr. Yadon’s
      address is 4444 Verde Glen Ct., Midland, Texas
  79707.


(7)
            Mr.
      Hensley’s address is 3005 N.  15th
      Street, Broken Arrow, Oklahoma
74012.


(8)
            Includes
      2.5 thousand shares that may be acquired upon the exercise of stock
      options granted under our 1998 Stock Option Plan.  Mr. Baker’s
      address is 2702 Briar Knoll Ct., Sugar Land, Texas
  77479.


(9)
            All
      of such shares may be acquired upon exercise of stock options granted
      under our 1998 Stock Option Plan.  Mr. Chisholm’s address is 539
      Green Isle Beach, Montgomery, Texas
77356


(10)
            Includes
      16,666 shares that may be acquired upon exercise of stock options granted
      under our 1998 Stock Option Plan.  Mr. Wait’s address is 2911
      South County Road 1260, Midland, Texas
79706.


(11)
            Mr.
      Hazlett’s address is 2911 South County Road 1260, Midland, Texas
      79706.


(12)
            As
      reported in Schedule 13G filed with the Securities and Exchange Commission
      on February 14, 2008, Keeley Asset Management Corp., an investment
      adviser, and Keeley Small Cap Value Fund, Inc., an investment company,
      have shared voting and dispositive powers with respect to such
      shares.


(13)
            Includes
      126,666 shares of common stock that may be acquired upon the exercise of
      stock options.





ITEM
13.                      CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE




Acquisition
of Screw Compression Systems, Inc.





In
October 2004, we entered into a Stock Purchase Agreement with Screw Compression
Systems, Inc., or “SCS”, and the three stockholders of SCS, Paul D. Hensley,
James R. Hazlett and Tony Vohjesus.  Under this agreement, we
purchased all of the outstanding shares of capital stock of SCS from
Messrs.  Hensley, Hazlett and Vohjesus.  Mr. Hensley is
currently the president of SCS and a Director of Natural Gas Services
Group.  Mr. Hazlett became Vice President ─ Technical Services of
Natural Gas Services Group in June 2005 and also continues to serve as a vice
President of SCS.  Mr. Vohjesus remains employed by SCS as a vice
president.  The acquisition was completed on January 3, 2005 and SCS
is now operated as a wholly owned subsidiary of Natural Gas Services
Group.





Under
terms of the Stock Purchase Agreement, we appointed Mr. Hensley as a Director of
Natural Gas in January, 2005 to fill a vacancy existing on its Board of
Directors, to hold office until the 2005 annual meeting of
stockholders.  Mr. Hensley was elected as a Director at the annual
meeting of stockholders held in June 2005.




38


Based on
Mr. Hensley’s pro rata ownership of SCS, he received $5.6 million in cash;
426,829 shares of Natural Gas Services Group common stock; and a promissory note
issued by Natural Gas Services Group in the principal amount of $2.1 million,
bearing interest at the rate of 4.00% per annum, maturing January 3, 2008 and
secured by a letter of credit in the initial aggregate face amount of $1.4
million.  Mr. Hazlett received $800 thousand in cash; 60,976 shares of
Natural Gas Services Group common stock; and a promissory note in the principal
amount of $300 thousand, bearing interest at the rate of 4.00% per annum,
maturing January 3, 2008 and secured by a letter of credit in the initial
aggregate face amount of $200 thousand.  Mr. Vohjesus received $1.6
million thousand in cash 121,951 shares of Natural Gas Services Group common
stock; and a promissory note in the principal amount of $600 thousand, bearing
interest at the rate of 4.00% per annum, maturing January 3, 2008 and secured by
a letter of credit in the initial aggregate face amount of $400
thousand.  The promissory notes are payable in three equal annual
installments, with the first installment due and payable on January 3,
2006.  Subject to the consent of the holder of each respective note,
principal payments could be made by Natural Gas Services Group in shares of
common stock valued at the average daily closing prices of the common stock on
the American Stock Exchange for the twenty consecutive trading days commencing
thirty days before the due date of the principal payment, or by combination of
cash and shares of common stock.  On January 3, 2006, Mr. Hensley
received $700 thousand in principal and $84 thousand in interest; Mr. Hazlett
received $100 thousand in principal and $12 thousand in interest; and Mr.
Vohjesus received $200 thousand in principal and $24 thousand in
interest.  On January 3, 2007, Mr. Hensley received $700 thousand in
principal and $56 thousand in interest; Mr. Hazlett received $100 thousand in
principal and $8 thousand in interest; and Mr. Vohjesus received $200 thousand
in principal and $16 thousand in interest.  On January 3, 2008, Mr.
Hensley received $700 thousand in principal and $28 thousand in interest; Mr.
Hazlett received $100 thousand in principal and $4 thousand in interest; and Mr.
Vohjesus received $200 thousand in principal and $8 thousand in
interest.  After the January 3, 2008 payments, the promissory notes
held by Messrs. Hensley, Hazlett, and Vohjesus were fully paid and discharged
and the letters of credit expired by their own terms.


Under
terms of a Stockholders’ Agreement entered into as required by the Stock
Purchase Agreement, for a period of two years following the closing, each of
Messrs.  Hensley, Hazlett and Vohjesus had the right, subject to
certain limitations, to include or “piggyback” the shares of common stock he
received in the transaction in any registration statement we filed with the
Securities and Exchange Commission.  The Stockholders’ Agreement also
provides that Messrs.  Hensley, Hazlett and Vohjesus will not for a
period of three years acquire or agree, offer, seek or propose to acquire
beneficial ownership of any assets or businesses or any additional securities
issued by us, or any rights or options to acquire such ownership; contest any
election of directors by the stockholders of Natural Gas Services Group; or
induce or attempt to induce any other person to initiate any stockholder
proposal or a tender offer for any of our voting securities; or enter into any
discussions, negotiations, arrangements or understandings with any third party
with respect to any of the foregoing.





Director
Independence





Our business, property and affairs are
managed by or under the direction of the Board of Directors.  Members
of the Board are kept informed of our business through discussions with Mr.
Taylor, our Chairman of the Board, Chief Executive Officer and President, and
other officers, by reviewing materials provided to them and by participating in
meetings of the Board and its committees.  Six non-employee directors,
Charles G. Curtis, William F. Hughes, Jr., Gene A. Strasheim, Richard L. Yadon,
Alan A. Baker and John W. Chisholm served on our Board of Directors throughout
fiscal year 2007.





Messrs. Curtis, Hughes, Strasheim,
Yadon, Baker and Chisholm have been determined to meet the definition of an
"independent director" under rules of the American Stock Exchange, the
independence standards applicable to us. These determinations are based
primarily on responses of the Directors to questions regarding employment and
compensation history, affiliations and family and other relationships,
comparisons of the independence criteria under the AMEX rules to the particular
circumstances of each Director and on discussions among the
Directors.





Procedures
for Reviewing Certain Transactions





On March 7, 2007, we adopted a written
policy for the review, approval or ratification of related party transactions.
All of our officers, directors and employees are subject to the policy. Under
this policy, the Audit Committee will review all related party transactions for
potential conflict of interest situations. Generally, our policy defines a
"related party transaction" as a transaction in which we are a participant and
in which a related party has an interest. A "related party" is:





·
            a
      director, officer or employee of Natural Gas Services  or a
      nominee to become a director;





·
            an
      owner of more than 5% of our outstanding common
  stock;





·
            certain
      family members of any of the above persons;
and





·
            any
      entity in which any of the above persons is employed or is a partner or
      principal or in which such person has a 5% or greater ownership
      interest.





39


Approval
Procedures





Before entering into a related party
transaction, the related party or the department within Natural Gas Services
responsible for the potential transaction must notify the Chief Executive
Officer or the Audit Committee of the facts and circumstances of the proposed
transaction.  If the amount involved is equal to or less than $100
thousand, the proposed transaction will be submitted to the Chief Executive
Officer.  If the amount involved exceeds $100 thousand, the proposed
transaction will be submitted to the Audit Committee.  Matters to be
submitted will include:





·
            the
      related party's relationship to Natural Gas Services and interest in the
      transaction;





·
            the
      material terms of the proposed
transaction;





·
            the
      benefits to Natural Gas Services of the proposed
    transaction;





·
            the
      availability of other sources of comparable properties or services;
      and





·
            whether
      the proposed transaction is on terms comparable to terms available to an
      unrelated third party or to employees
generally.





The Chief Executive Officer or the
Audit Committee, as applicable, will then consider all of the relevant facts and
circumstances available, including the matters described above and, if
applicable, the impact on a director's independence.  Neither the
Chief Executive Officer nor any member of the Audit Committee is permitted to
participate in any review, consideration or approval of any related party
transaction if such person or any of his or her immediate family members is the
related party. After review, the Chief Executive Officer or the Audit Committee,
as applicable, may approve, modify or disapprove the proposed transaction. Only
those related party transactions that are in, or are not inconsistent with, the
best interests of Natural Gas Services and its stockholders will be
approved.





Ratification
Procedures





If an
officer or director of Natural Gas Services becomes aware of a related party
transaction that has not been previously approved or ratified by the Chief
Executive Officer or the Audit Committee then, if the transaction is pending or
ongoing, the transaction must be submitted, based on the amount involved, to
either the Chief Executive Officer or the Audit Committee and the Chief
Executive Officer or the Audit Committee will consider the matters described
above. Based on the conclusions reached, the Chief Executive Officer or the
Audit Committee, as applicable, will evaluate all options, including
ratification, amendment or termination of the related party transaction. If the
transaction is completed, the Chief Executive Officer or the Audit Committee
will evaluate the transaction, taking into account the same factors as described
above, to determine if rescission of the transaction or any disciplinary action
is appropriate, and will request that we evaluate our controls and procedures to
determine the reason the transaction was not submitted to the Chief Executive
Officer or the Audit Committee for prior approval and whether any changes to the
procedures are recommended.





ITEM
14.                      PRINCIPAL
ACCOUNTANT FEES AND SERVICES




Our
principal accountant for the fiscal years ended December 31, 2007 and 2006 was
Hein & Associates LLP.




Audit
Fees




The
aggregate fees billed for professional services rendered by Hein &
Associates LLP for the audit of our financial statements for our fiscal years
ended December 31, 2007 and 2006 and the review of the financial statements on
Forms 10-Q for the fiscal quarters in such fiscal years were approximately $312
thousand and $265 thousand, respectively.  These fees also include
update audit procedures performed by Hein & Associates LLP for the issuance
of consents for the inclusion of audit opinions in various registration
statements we filed with the Securities and Exchange Commission during these
years and consultation regarding Sarbanes-Oxley internal controls
implementation.




Audit
Related Fees




During
the year ended December 31, 2007, there were no audit related
fees.  The aggregate fees billed for assurance and related services by
Hein & Associates LLP during our fiscal year ended December 31, 2006 was
approximately $50 thousand.  These fees were mainly related to the
procedures performed in connection with a registration statement on Form S-1
filed with the Securities and Exchange Commission.




40


Tax
Fees





We were
not billed by Hein & Associates LLP for any tax services during the year
ended December 31, 2006 or December 31, 2007.





All
Other Fees





No other
fees were billed by Hein & Associates LLP, during our fiscal years ended
December 31, 2006 and 2007, other than as described above.





Audit
Committees Pre-Approval Policies and Procedures





As of
December 31, 2007, our Audit Committee had not established pre-approval policies
and procedures for the engagement of our principal accountant to render audit or
non-audit services.  However, in accordance with Section 10A(i) of the
Exchange Act, our Audit Committee, as a whole, approves the engagement of our
principal accountant prior to the accountant rendering audit or non-audit
services.





Certain
rules of the Securities and Exchange Commission provide that an auditor is not
independent of an audit client if the services it provides to the client are not
appropriately approved, subject, however, to a de minimusexception
contained in the rules.  The Audit Committee pre-approved all services
provided by Hein & Associates LLP in 2007 and the de minimusexception was not
used.





41


PART
IV




ITEM
15.                      EXHIBITS
AND FINANCIAL STATEMENT SCHEDULES




The
following documents are filed as part of this Annual Report on Form
10-K:




(a)(1)
and (a)(2) Financial Statement and Financial Statement Schedules




For a
list of Consolidated Financial Statements and Schedules, see “Index
to


Financial
Statements” on page F-1, and incorporated herein by reference.





(a)(3)
Exhibits





See Item
15(b) below.





(b)           Exhibits:





A list of
exhibits to this Annual Report on Form 10-K is set forth below:





Exhibit
No.                                                                           Description





3.1
            Articles
      of Incorporation, as amended (Incorporated by reference to Exhibit 3.1 of
      the 10QSB filed and dated November 10,
2004)





3.2
            Bylaws
      (Incorporated by reference to Exhibit 3.4 of the Registrant's Registration
      Statement on Form SB-2,
  No.  333-88314)





4.1
            Form
      of warrant certificate (Incorporated by reference to Exhibit 4.1 of the
      Registrant's Registration Statement on Form SB-2,
      No.  333-88314)





4.2
            Form
      of warrant agent agreement (Incorporated by reference to Exhibit 4.2 of
      the Registrant's Registration Statement on Form SB-2,
      No.  333-88314)





4.3
            Form
      of representative's option for the purchase of common stock (Incorporated
      by reference to Exhibit 4.4 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





4.4
            Form
      of representative's option for the purchase of warrants (Incorporated by
      reference to Exhibit 4.5 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





4.5
            Stockholders
      Agreement, dated January 3, 2005 among Paul D. Hensley, Tony Vohjesus, Jim
      Hazlett and Natural Gas Services Group, Inc.  (Incorporated by
      reference to Exhibit 4.3 of the Registrant's From 8-K Report, dated
      January 3, 2005, as filed with the Securities and Exchange Commission on
      January 7, 2005)





Executive
      Compensation Plans and Arrangements (Exhibits 10.1, 10.14, 10.15, 10.16,
      10.23, 10.24, 10.26 and 10.27).





10.1
            1998
      Stock Option Plan, as amended (Incorporated by reference to Exhibit 10.1
      of the Registrant’s Form 8-K Report dated June 20, 2006 on file with the
      SEC June 26, 2006)





10.2
            Form
      of Series A 10% Subordinated Notes due December 31, 2006 (Incorporated by
      reference to Exhibit 10.8 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





10.3
            Form
      of Five-Year Warrants to Purchase Common Stock (Incorporated by reference
      to Exhibit 10.9 of the Registrant's Registration Statement on Form SB-2,
      No.  333-88314)





10.4
            Warrants
      issued to Berry-Shino Securities, Inc.  (Incorporated by
      reference to Exhibit 10.10 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





10.5
            Warrants
      issued to Neidiger, Tucker, Bruner, Inc.  (Incorporated by
      reference to Exhibit 10.11 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





10.6
            Form
      of warrant issued in March 2001 for guaranteeing debt (Incorporated by
      reference to Exhibit 10.12 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)


E-1




Exhibit
      No.
            Description




10.7
            Form
      of warrant issued in April 2002 for guaranteeing debt (Incorporated by
      reference to Exhibit10.13 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





10.8
            Lease
      Agreement, dated March 1, 2004, between the Registrant and the City of
      Midland, Texas (Incorporated by reference to Exhibit 10.19 of the
      Registrant's Form 10-QSB for the fiscal quarter ended June 30,
      2004)





10.9
            Second
      Amended and Restated Loan Agreement, dated November 3, 2003, between the
      Registrant and Western National Bank (Incorporated by reference to Exhibit
      10.20 of the Registrant's Form 10-QSB for the fiscal quarter ended June
      30, 2004)





10.10
            Securities
      Purchase Agreement, dated July 20, 2004, between the Registrant and
      CBarney Investments, Ltd.  (Incorporated by reference to Exhibit
      4.1 of the Registrant's Current Report on Form 8-K dated July 20, 2004 and
      filed with the Securities and Exchange Commission on July 27,
      2004)





10.11
            Stock
      Purchase Agreement, dated October 18, 2004, by and among the Registrant,
      Screw Compression Systems, Inc., Paul D. Hensley, Jim Hazlett and Tony
      Vohjesus (Incorporated by reference to Exhibit 4.1 of the Registrant's
      Current Report on Form 8-K dated October 18, 2004 and filed with the
      Securities and Exchange Commission on October 21,
  2004)





10.12
            Third
      Amended and Restated Loan Agreement, dated as of January 3, 2005, among
      Natural Gas Services Group, Inc., Screw Compression Systems,
      Inc.  and Western National Bank (Incorporated by reference to
      Exhibit 10.1 of the Registrant’s Current Report on Form 8-K, dated January
      3, 2005, and filed with the Securities and Exchange Commission on January
      7, 2005)





10.13
            Employment
      Agreement between Paul D. Hensley and Natural Gas Services Group,
      Inc.  (Incorporated by reference to Exhibit 10.1 of the
      Registrants Form 8-K Report, dated January 3, 2005, as filed with the
      Securities and Exchange Commission on January 7,
  2005)





10.14
            Employment
      Agreement between William R. Larkin and Natural Gas Services Group,
      Inc.  (Incorporated by reference to Exhibit 10.25 of the
      Registrant's Form 10-KSB for the fiscal year ended December 31, 2004, and
      filed with the Securities and Exchange Commission on March 30,
      2005)





10.15
            Promissory
      Note, dated January 3, 2005, in the original principal amount of $2.1
      million made by Natural Gas Services Group, Inc.  payable to
      Paul D. Hensley (Incorporated by reference to Exhibit 10.26 of the
      Registrant's Form 10-KSB for the fiscal year ended December 31, 2004, and
      filed with the Securities and Exchange Commission on March 30,
      2005)





10.16
            Fourth
      Amended and Restated Loan Agreement (Incorporated by reference to Exhibit
      10.1 of the Registrant’s Current Report on Form 8-K, dated March 14, 2005,
      and filed with the Securities and Exchange Commission on March 18,
      2005)





10.17
            Modification
      Agreement, dated as of  January 3, 2005, by and between Natural
      Gas Services Group, Inc.  and Western National
      Bank  (Incorporated by reference to Exhibit 10.2 of the
      Registrant’s Current Report on Form 8-K, dated January 3, 2005, and filed
      with the Securities and Exchange Commission on January 7,
      2005)




10.18
            Guaranty
      Agreement, dated as of January 3, 2005, made by Natural Gas Service Group,
      Inc., for the benefit of Western National Bank (Incorporated by reference
      to Exhibit 10.3 of the Registrant’s Current Report on Form 8-K, dated
      January 3, 2005, and filed with the Securities and Exchange Commission on
      January 7, 2005)





10.19
            Guaranty
      Agreement, dated as of January 3, 2005, made by Screw Compression Systems,
      Inc., for the benefit of Western National Bank (Incorporated by reference
      to Exhibit 10.4 of the Registrant’s Current Report on Form 8-K, dated
      January 3, 2005, and filed with the Securities and Exchange Commission on
      January 7, 2005)





10.20
            Fifth
      Amended and Restated Loan Agreement (Incorporated by reference to Exhibit
      10.2 of the Registrant’s Form 8-K dated January 3, 2006 and filed with the
      Securities and Exchange Commission January 6,
  2006)





10.21
            First
      Modification to Fourth Amended and Restated Loan Agreement (Incorporated
      by reference Exhibit 10.1 of the Registrant’s Form 8-K dated May 1, 2005
      and filed with Securities and Exchange Commission May 13,
      2005)




E-2


Exhibit
      No.
            Description





10.22
            Employment
      Agreement between Stephen C. Taylor and Natural Gas Services Group,
      Inc.  (Incorporated by reference to Exhibit 10.1 of the
      Registrant’s Form 8-K Report, dated August 24, 2005, and filed with the
      Securities and Exchange Commission on August 30,
  2005)





10.23
            Employment
      Agreement between James R. Hazlett and Natural Gas Services Group,
      Inc.  (Incorporated by reference to Exhibit 10.1 of the
      Registrant’s Form 8-K Report, dated June 14, 2005, and filed with the
      Securities and Exchange Commission on November 14,
  2005)





10.24
            Stockholders
      Agreement, dated January 3, 2005 among Paul D. Hensley, Tony Vohjesus, Jim
      Hazlett and Natural Gas Services Group, Inc.  (Incorporated by
      reference to Exhibit 4.3 of the Registrant’s Form 8-K Report, dated
      January 3, 2005, and filed with the Securities and Exchange Commission on
      January 7, 2005)





10.25
            Promissory
      Note, dated January 3, 2005, in the original principal amount of $300
      thousand made by Natural Gas Services Group, Inc.  payable to
      Jim Hazlett (Incorporated by reference to Exhibit 10.3 of the Registrant’s
      Form 8-K Report, dated June 14, 2005, and filed with the Securities and
      Exchange Commission on November 14,
2005)





10.26
            Retirement
      Agreement, dated December 14, 2005, between Wallace C. Sparkman and
      Natural Gas Services Group, Inc.  (Incorporated by reference to
      Exhibit 10.1 of the Registrant’s Form 8-K Report, dated December 14, 2005,
      and filed with the Securities and Exchange Commission on December 15,
      2005)





10.27
            Sixth
      Amended and Restated Loan Agreement, dated as of January 3, 2006
      (Incorporated by reference to Exhibit 10.3 of the Registrant’s Current
      Report on Form 8-K, dated January 3, 2006, and filed with the Securities
      and Exchange Commission on January 6,
2006)





10.28
            Guaranty
      Agreement, dated as of January 3, 2006, and made by Screw Compression
      Systems, Inc.  for the benefit of Western National Bank
      (Incorporated by reference to Exhibit 10.4 of the Registrant’s Current
      Report on Form 8-K, dated January 3, 2006, and filed with the Securities
      and Exchange Commission on January 6,
2006)





10.29
            Seventh
      Amended and Restated Loan Agreement (Incorporated by reference to Exhibit
      10.1 of the Registrant’s Form 8-K dated October 26, 2006 and filed with
      the Securities and Exchange Commission on November 1,
  2006





14.0
            Code
      of Ethics (Incorporated by reference to Exhibit 14.0 of the Registrant's
      Form 10-KSB for the fiscal year ended December 31, 2004, and filed with
      the Securities and Exchange Commission on March 30,
  2005)




21.0
            Subsidiaries
      (Incorporated by reference to Exhibit 21.0 of the Registrant's Form 10-KSB
      for the fiscal year ended December 31, 2004, and filed with the Securities
      and Exchange Commission on March 30,
2005)





*23.1
            Consent
      of Hein & Associates LLP.





*31.1
            Certifications





*31.2
            Certifications





*32.1
            Certification
      required by Section 906 of the Sarbanes-Oxley Act of
  2002





*32.2
            Certification
      required by Section 906 of the Sarbanes-Oxley Act of
  2002




*
      Filed herewith.





E-3


SIGNATURES




In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.




NATURAL GAS SERVICES GROUP,
      INC.Date: 
      March 6, 2008
              By:
              /s/ Stephen
      C. TaylorStephen
      C. TaylorChairman
      of the Board, President and Chief Executive Officer(Principal
      Executive Officer)








In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated:







Signature
            Title
            Date/s/ Stephen C.
      Taylor
              Stephen
      C. Taylor
            Chairman
      of the Board of Directors, Chief Executive Officer and President
      (Principal Executive Officer)
            March
      5, 2008/s/ Earl R.
      Wait
              Earl
      R. Wait
            Vice
      President – Accounting (Principal Accounting Officer)
            March
      5, 2008/s/Charles G.
      Curtis
              Charles
      G. Curtis
            Director
            March
      5, 2008/s/William F. Hughes,
      Jr.
              William
      F. Hughes, Jr.
            Director
            March
      5, 2008/s/Richard L.
      Yadon
              Richard
      L. Yadon
            Director
            March
      5, 2008/s/Paul D.
      Hensley
              Paul
      D. Hensley
            Director
            March
      5, 2008/s/Gene A.
      Strasheim
              Gene
      A. Strasheim
            Director
            March
      5, 2008/s/Alan A.
      Baker
              Alan
      A. Baker
            Director
            March
      5, 2008/s/John W.
      Chisholm
              John
      W. Chisholm
            Director
            March
      5, 2008




















INDEX
TO FINANCIAL STATEMENTS






PageReport
      of Independent Registered Public Accounting Firm
            F-1Consolidated
      Balance Sheets as of December 31, 2006 and 2007
            F-2Consolidated
      Statements of Income for the Years Ended December 31, 2005, 2006 and
      2007
            F-3Consolidated
      Statements of Stockholders' Equity for the Years Ended December 31, 2005,
      2006, and 2007
            F-4Consolidated
      Statements of Cash Flows for the Years Ended December 31, 2005, 2006 and
      2007
            F-5Notes
      to Consolidated Financial Statements
            F-6












REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








To the
Board of Directors and Stockholders


Natural
Gas Services Group, Inc.


Midland,
Texas








We have
audited the consolidated balance sheets of Natural Gas Services Group, Inc. and
Subsidiary (the “Company”) as of December 31, 2006 and 2007, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the years in the three-year period ended December 31, 2007. These
consolidated financial statements are the responsibility of the Company’s
management.  Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of the Company as of December
31, 2006 and 2007, and the results of its operations and its cash flows for each
of the years in the three-year period ended December 31, 2007, in conformity
with U.S. generally accepted accounting principles.





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Natural Gas Services
Group, Inc. and Subsidiary's internal control over financial reporting as of
December 31, 2007, based oncriteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO)
and our report dated March 5, 2008 expressed an unqualified opinion on the
effectiveness of the Company’s internal control over financial
reporting.








HEIN & ASSOCIATES
LLP


Dallas,
Texas


March 5,
2008


F-1
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 CONSOLIDATED
BALANCE SHEETS
 (amounts
in thousands, except per share data)





December 31,2006
            
            
            2007ASSETSCurrent
      Assets:Cash
      and cash equivalents
            
            $
            4,391
            
            
            $
            245Short-term
      investments
            
            
            25,052
            
            
            
            18,661Trade
      accounts receivable, net of doubtful accounts of $110, both
      periods
            
            
            8,463
            
            
            
            11,322Inventory,
      net of allowance for obsolescence of $347 and $273,
      respectively
            
            
            16,943
            
            
            
            20,769Prepaid
      income taxes
            
            
            —
            
            
            
            3,584Prepaid
      expenses and other
            
            
            321
            
            
            
            641Total
      current assets
            
            
            55,170
            
            
            
            55,222Rental
      equipment,net of
      accumulated depreciation of $11,320 and $16,810,
    respectively
            
            
            59,866
            
            
            
            76,025Property
      and equipment, net
      of accumulated depreciation of $3,679 and $4,792,
    respectively
            
            
            6,714
            
            
            
            8,580Goodwill, net of accumulated
      amortization of $325, both periods
            
            
            10,039
            
            
            
            10,039Intangibles,
      net of accumulated amortization of $819 and $1,145,
      respectively
            
            
            3,650
            
            
            
            3,324Other
      assets
            
            
            113
            
            
            
            43Total
      assets
            
            $
            135,552
            
            
            $
            153,233LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      Liabilities:Current
      portion of long-term debt and subordinated notes
            
            $
            4,442
            
            
            $
            4,378Line
      of credit
            
            
            —
            
            
            
            600Accounts
      payable
            
            
            2,837
            
            
            
            4,072Accrued
      liabilities
            
            
            2,077
            
            
            
            3,990Current
      income tax liability
            
            
            1,056
            
            
            
            3,525Deferred
      income
            
            
            225
            
            
            
            81Total
      current liabilities
            
            
            10,637
            
            
            
            16,646Long
      term debt, less current portion
            
            
            12,950
            
            
            
            9,572Subordinated
      notes-related parties, less current portion
            
            
            1,000
            
            
            
            —Deferred
      income tax payable
            
            
            9,764
            
            
            
            12,635Total
      liabilities
            
            
            34,351
            
            
            
            38,853Commitments
      (Note 10)Stockholders’
      equity:Preferred
      stock, 5,000 shares authorized, no shares outstanding
            
            
            —
            
            
            
            —Common
      stock, 30,000 shares authorized, par value $0.01;12,046 and 12,085 shares
      issued and outstanding, respectively
            
            
            120
            
            
            
            121Additional
      paid-in capital
            
            
            82,560
            
            
            
            83,460Retained
      earnings
            
            
            18,521
            
            
            
            30,799Total
      stockholders' equity
            
            
            101,201
            
            
            
            114,380Total
      liabilities and stockholders' equity
            
            $
            135,552
            
            
            $
            153,233





See
accompanying notes to these consolidated financial statements.


F-2
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF INCOME
 (amounts
in thousands, except per share data)








For the Years Ended December
      31,2005
            
            
            2006
            
            
            2007Revenue:Sales,
      net
            
            $
            30,278
            
            
            $
            38,214
            
            
            $
            41,088Service
      and maintenance income
            
            
            2,424
            
            
            
            979
            
            
            
            964Rental
      income
            
            
            16,609
            
            
            
            23,536
            
            
            
            30,437Total
      revenue
            
            
            49,311
            
            
            
            62,729
            
            
            
            72,489Operating
      costs and expenses:Cost
      of sales, exclusive of depreciation stated separately
below
            
            
            23,331
            
            
            
            29,629
            
            
            
            28,124Cost
      of service, exclusive of depreciation stated separately
    below
            
            
            1,479
            
            
            
            735
            
            
            
            600Cost
      of rental, exclusive of depreciation stated separately
    below
            
            
            6,528
            
            
            
            8,944
            
            
            
            12,382Selling,
      general and administrative expense
            
            
            4,890
            
            
            
            5,270
            
            
            
            5,324Depreciation
      and amortization
            
            
            4,224
            
            
            
            6,020
            
            
            
            7,470Total
      operating costs and expenses
            
            
            40,452
            
            
            
            50,598
            
            
            
            53,900Operating
      income
            
            
            8,859
            
            
            
            12,131
            
            
            
            18,589Other
      income (expense):Interest
      expense
            
            
            (1,997
            )
            
            
            (1,646
            )
            
            
            (1,155
            )Other
      income
            
            
            199
            
            
            
            1,390
            
            
            
            1,299Total
      other income (expense)
            
            
            (1,798
            )
            
            
            (256
            )
            
            
            144Income
      before provision for income taxes
            
            
            7,061
            
            
            
            11,875
            
            
            
            18,733Provision
      for income taxes:Current
            
            
            207
            
            
            
            1,743
            
            
            
            3,525Deferred
            
            
            2,408
            
            
            
            2,544
            
            
            
            2,930Total
      income tax expense
            
            
            2,615
            
            
            
            4,287
            
            
            
            6,455Net
      income
            
            
            4,446
            
            
            
            7,588
            
            
            
            12,278Earnings
      per common share:Basic
            
            $
            0.59
            
            
            $
            0.67
            
            
            $
            1.02Diluted
            
            $
            0.52
            
            
            $
            0.66
            
            
            $
            1.01Weighted
      average common shares outstanding:Basic
            
            
            7,564
            
            
            
            11,405
            
            
            
            12,071Diluted
            
            
            8,481
            
            
            
            11,472
            
            
            
            12,114





See
accompanying notes to these consolidated financial statements.


F-3
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY
 For
the Years Ended December 31, 2005, 2006 and 2007
 (amounts
in thousands)








Preferred
      Stock
            
            
            Common
      Stock
            
            
            Additional
            
            
            
            
            
            TotalPaid-In
            
            
            Retained
            
            
            Stockholders'Shares
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            Capital
            
            
            Earnings
            
            
            EquityBALANCES, January 1,
      2005
            
            
            —
            
            
            $
            —
            
            
            
            6,104
            
            
            $
            61
            
            
            $
            16,355
            
            
            $
            6,487
            
            
            $
            22,903Exercise
      of common stock options and warrants
            
            
            —
            
            
            
            —
            
            
            
            2,308
            
            
            
            23
            
            
            
            13,063
            
            
            
            —
            
            
            
            13,086Compensation
      expense on issuance
              of
      common stock options
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            135
            
            
            
            —
            
            
            
            135Issuance
      of common stock for acquisition
            
            
            —
            
            
            
            —
            
            
            
            610
            
            
            
            6
            
            
            
            5,114
            
            
            
            —
            
            
            
            5,120Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            4,446
            
            
            
            4,446BALANCES,
      December 31, 2005
            
            
            —
            
            
            $
            —
            
            
            
            9,022
            
            
            $
            90
            
            
            $
            34,667
            
            
            $
            10,933
            
            
            $
            45,690Exercise
      of common stock options and warrants
            
            
            —
            
            
            
            —
            
            
            
            129
            
            
            
            1
            
            
            
            356
            
            
            
            —
            
            
            
            357Compensation
      expense on issuance
              of
      common stock options
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            376
            
            
            
            —
            
            
            
            376Income
      tax benefit realized from the exercise of stock
    options
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            27
            
            
            
            —
            
            
            
            27Issuance
      of common stock, net of  offering costs
            
            
            —
            
            
            
            —
            
            
            
            2,895
            
            
            
            29
            
            
            
            47,134
            
            
            
            —
            
            
            
            47,163Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            7,588
            
            
            
            7,588BALANCES,
      December 31, 2006
            
            
            —
            
            
            $
            —
            
            
            
            12,046
            
            
            $
            120
            
            
            $
            82,560
            
            
            $
            18,521
            
            
            $
            101,201Exercise
      of common stock options and warrants
            
            
            —
            
            
            
            —
            
            
            
            39
            
            
            
            1
            
            
            
            247
            
            
            
            —
            
            
            
            248Compensation
      expense on issuance of
              common
      stock options
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            541
            
            
            
            —
            
            
            
            541Income
      tax benefit realized from the exercise of stock options
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            112
            
            
            
            —
            
            
            
            112Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            12,278
            
            
            
            12,278BALANCES, December 31,
      2007
            
            
            —
            
            
            $
            —
            
            
            
            12,085
            
            
            $
            121
            
            
            $
            83,460
            
            
            $
            30,799
            
            
            $
            114,380











See
accompanying notes to these consolidated financial statements.


F-4
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (amounts
in thousands)





For the Years Ended December
      31,2005
            
            
            2006
            
            
            2007CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
            
            $
            4,446
            
            
            $
            7,588
            
            
            $
            12,278Adjustments
      to reconcile net income to net cash provided by
              operating
      activities:Depreciation
      and amortization
            
            
            4,224
            
            
            
            6,020
            
            
            
            7,470Deferred
      taxes
            
            
            2,408
            
            
            
            2,544
            
            
            
            2,930Employee
      stock option expense
            
            
            135
            
            
            
            376
            
            
            
            541Loss
      (gain) on disposal of assets
            
            
            (28
            )
            
            
            13
            
            
            
            (1
            )Changes
      in current assets:Trade
      accounts and other receivables
            
            
            (1,352
            )
            
            
            (2,271
            )
            
            
            (2,859
            )Inventory
            
            
            (5,699
            )
            
            
            749
            
            
            
            (3,826
            )Prepaid
      expenses and other
            
            
            (362
            )
            
            
            135
            
            
            
            (3,904
            )Changes in current
      liabilities:Accounts
      payable and accrued liabilities
            
            
            337
            
            
            
            (3
            )
            
            
            3,228Current
      income tax liability
            
            
            187
            
            
            
            849
            
            
            
            2,581Deferred
      income
            
            
            (855
            )
            
            
            122
            
            
            
            (144
            )Other
      assets
            
            
            348
            
            
            
            (46
            )
            
            
            (25
            )NET
      CASH PROVIDED BY OPERATING ACTIVITIES
            
            
            3,789
            
            
            
            16,076
            
            
            
            18,269CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment
            
            
            (17,708
            )
            
            
            (27,684
            )
            
            
            (25,307
            )Purchase
      of short-term investments
            
            
            —
            
            
            
            (38,252
            )
            
            
            (2,609
            )Redemption
      of short-term investments
            
            
            —
            
            
            
            13,200
            
            
            
            9,000Assets
      acquired, net of cash
            
            
            (7,584
            )
            
            
            —
            
            
            
            —Proceeds
      from sale of property and equipment
            
            
            264
            
            
            
            73
            
            
            
            95Changes
      in restricted cash
            
            
            2,000
            
            
            
            —
            
            
            
            —NET
      CASH USED IN INVESTING ACTIVITIES
            
            
            (23,028
            )
            
            
            (52,663
            )
            
            
            (18,821
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      proceeds from line of credit
            
            
            300
            
            
            
            1,375
            
            
            
            600Proceeds
      from long-term debt
            
            
            21,517
            
            
            
            68
            
            
            
            —Repayments
      of long-term debt
            
            
            (13,077
            )
            
            
            (9,581
            )
            
            
            (4,442
            )Repayment
      of line of credit
            
            
            —
            
            
            
            (1,675
            )
            
            
            —Proceeds
      from exercise of stock options and warrants
            
            
            13,085
            
            
            
            357
            
            
            
            248Proceeds
      from sale of stock, net of transaction costs
            
            
            —
            
            
            
            47,163
            
            
            
            —NET CASH PROVIDED (USED) BY
      FINANCING ACTIVITIES
            
            
            21,825
            
            
            
            37,707
            
            
            
            (3,594
            )NET
      CHANGE IN CASH
            
            
            2,586
            
            
            
            1,120
            
            
            
            (4,146
            )CASH
      AT BEGINNING OF PERIOD
            
            
            685
            
            
            
            3,271
            
            
            
            4,391CASH
      AT END OF PERIOD
            
            $
            3,271
            
            
            $
            4,391
            
            
            $
            245SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW
              INFORMATION:Interest
      paid
            
            $
            1,877
            
            
            $
            1,692
            
            
            $
            1,191Income
      taxes paid
            
            $
            24
            
            
            $
            894
            
            
            $
            4,620SUPPLEMENTAL
      DISCLOSURE OF NON-CASH INVESTING
              AND
      FINANCING ACTIVITIES:Assets
      acquired for issuance of subordinated debt
            
            
            3,000
            
            
            
            —
            
            
            
            —Assets
      acquired for issuance of  common stock
            
            
            5,120
            
            
            
            —
            
            
            
            —





See
accompanying notes to these consolidated financial statements.


F-5
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





1.  Summary
of Significant Accounting Policies





Organization
and Principles of Consolidation





These
notes apply to the consolidated financial statements of Natural Gas Services
Group, Inc.  (the "NGSG", "Natural Gas Services Group", "we" or "our")
(a Colorado corporation).  Natural Gas Services Group,
Inc.  was formed on December 18, 1998 for the purposes of combining
the operations of certain manufacturing, service and leasing
entities.





Effective
January 1, 2004, Rotary Gas Systems, Inc., Great Lakes Compression, Inc., and
NGE Leasing, Inc., were merged into NGSG.





On
January 3, 2005, we purchased all of the outstanding shares of capital stock of
Screw Compression System, Inc.  (“SCS”) a manufacturer of natural gas
compressors, with its principal offices located in Tulsa, Oklahoma for the
purpose of expanding the product line, production capacity and customer
base.  SCS operated as a wholly owned subsidiary until June 30, 2007,
when it was merged into Natural Gas Services Group, Inc.





The
accompanying consolidated financial statements include NGSG and its
subsidiary.  All significant intercompany accounts and transactions
were eliminated in consolidation.





All
amounts are stated in thousands of dollars except per share data.





Nature
of Operations





Natural
Gas Services Group, Inc. is a leading provider of small to medium horsepower
compression equipment to the natural gas industry.  We focus primarily
on the non-conventional natural gas production business in the United States
(such as coalbed methane, gas shales and tight gas).  We manufacture,
fabricate and rent natural gas compressors that enhance the production of
natural gas wells.  NGSG provides maintenance services for its natural
gas compressors.  In addition, we sell custom fabricated natural gas
compressors to meet customer specifications dictated by well pressures,
production characteristics and particular applications.  We also
manufacture and sell flare systems for oil and gas plant and production
facilities.





Use
of Estimates





The
preparation of our consolidated financial statements in conformity with
generally accepted accounting principles requires our management to make
estimates and assumptions that affect the amounts reported in these consolidated
financial statements and accompanying notes.  Actual results could
differ from those estimates.  Significant estimates include the
valuation of identifiable intangible assets and goodwill acquired in
acquisitions, bad debt allowance and the inventory allowance for
obsolescence.  It is at least reasonably possible these estimates
could be revised in the near term and the revisions could be
material.





Cash
Equivalents





For
purposes of reporting cash flows, we consider all short-term investments with an
original maturity of three months or less to be cash equivalents.





Short-term
Investments





We
have short-term investments invested primarily in high grade short term
commercial paper for the maximum return on investment which are held to maturity
and that will coincide with our projected cash requirements and have a maturity
of less than one year.





Accounts
Receivable





Our trade
receivables consist of customer obligations for the sale of compressors and
flare systems due under normal trade terms, and operating leases for the use of
our natural gas compressors.  The receivables are not collateralized
except as provided for under lease agreements.  However, we require
deposits of as much as 50% for large custom contracts.  We extend
credit based on management's assessment of the customer's financial condition,
receivable aging, customer disputes and general business and economic
conditions.  Management believes the allowance for doubtful accounts
for trade receivables of $110 thousand at December 31, 2006 and 2007 is
adequate.


F-6
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Revenue
Recognition





Revenue
from the sales of custom and fabricated compressors, and flare systems is
recognized upon shipment of the equipment to customers.  Exchange and
rebuilt compressor revenue is recognized when both the replacement compressor
has been delivered and the rebuild assessment has been
completed.  Revenue from compressor service and retrofitting services
is recognized upon providing services to the customer.  Maintenance
agreement revenue is recognized as services are rendered.  Rental
revenue is recognized over the terms of the respective rental
agreements.  Deferred income represents payments received before a
product is shipped.  Revenue from the sale of rental units is included
in sales revenue when equipment is shipped or title is transferred to the
customer.





Description
of Rental Arrangements





Our
rental operations principally consist of the rental of natural gas compressor
packages and flare stacks.  These arrangements are classified as
operating leases.  See Note 2.





Major
Customers and Concentration of Credit Risk





Sales to
one customer in the year ended December 31, 2005 amounted to a total of 36% of
consolidated revenue.  Sales to two customers in the year ended
December 31, 2006 amounted to a total of 39% and 12% of consolidated revenue,
respectively.  Sales to two customers in the year ended December 31,
2007 amounted to a total of 40% and 12% of consolidated revenue,
respectively.  No other single customer accounted for more than 10% of
our revenues in 2005, 2006 or 2007.  One customer amounted to 54% and
64% of our accounts receivable as of December 31, 2006 and 2007,
respectively.  No other customer amounted to more than 10% of our
consolidated accounts receivable as of December 31, 2006 and 2007.  We
generally do not obtain collateral, but require deposits of as much as 50% on
large custom contracts.  We extend credit based on management's
assessment of the customer's financial condition, receivable aging, customer
disputes and general business and economic conditions.





Inventory





Inventory
is valued at the lower of cost or market.  The cost of inventories is
determined by the weighted average method.  A reserve is recorded
against inventory balances for estimated obsolescence.  This reserve
is based on specific identification and historical experience and totaled $347
thousand and $273 thousand at December 31, 2006 and 2007,
respectively.  At December 31, 2006 and 2007, respectively, inventory
consisted of the following (in thousands):





2006
            
            
            2007Raw
      materials
            
            $
            12,154
            
            
            $
            17,492Finished
      goods
            
            
            1,084
            
            
            
            —Work
      in process
            
            
            3,705
            
            
            
            3,277$
            16,943
            
            
            $
            20,769





Property
and Equipment





Property
and equipment is recorded at cost less accumulated depreciation and
amortization.  Depreciation and amortization are computed using the
straight-line method over the estimated useful lives of the assets, which range
from three to forty years.  Rental equipment has an estimated useful
life of fifteen years.




Gains and
losses resulting from sales and dispositions of property and equipment are
included in current operations.  Maintenance and repairs are charged
to operations as incurred.





Goodwill





Goodwill
represents the cost in excess of fair value of the identifiable net assets
acquired in three acquisitions.  Goodwill was being amortized on a
straight-line basis over 20 years, but we ceased amortization of goodwill
effective January 1, 2002 in accordance with Statement of Financial Accounting
Standards ("FAS") No.  142.





FAS 142
requires that goodwill be tested for impairment at least annually.  We
completed the most recent test for goodwill impairment as of December 31, 2007,
at which time no impairment was indicated.


F-7
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Intangibles





At
December 31, 2007, NGSG had intangible assets (excluding patents) with a gross
carrying value of $4.2 million, which relate to developed technology, acquired
customer contracts, distribution agreements and non-compete
agreements.  The carrying amount net of accumulated amortization at
December 31, 2007 was $3.3 million.  Intangible assets (excluding
patents) are amortized on a straight-line basis with useful lives ranging from 5
to 20 years with a weighted average life remaining of approximately fourteen
years as of December 31, 2007.  Amortization expense recognized in
each of the years ending December 31, 2005, 2006, and 2007 was $299
thousand.  In addition, NGSG has an intangible asset with a gross
carrying value of $0.7 million at December 31, 2007 related to the trade name of
SCS.  This asset is not being amortized as it has been deemed to have
an indefinite life.





The
following table represents estimated future amortization expense for the years
ending December 31, (in thousands).





2008
            
            $
            2992009
            
            
            2992010
            
            
            2602011
            
            
            1792012
            
            
            125Thereafter
            
            
            1,504$
            2,666





Our
policy is to periodically review the net realizable value of intangibles, other
than goodwill and patents, through an assessment of the estimated future cash
flows related to such assets.  In the event that assets are found to
be carried at amounts in excess of estimated undiscounted future cash flows,
then the assets will be adjusted for impairment to a level commensurate with a
discounted cash flow analysis of the underlying assets.  Based upon
our most recent analysis, we believe no impairment of intangible assets exists
as of December 31, 2007.





Patents





We have
patents for a flare tip ignition device and flare tip burner
pilot.  The costs of the patents are being amortized on a
straight-line basis over nine years, the remaining life of the patents when
acquired.  Amortization expense for patents of $27 thousand was
recognized for each of the years ended December 31, 2005, 2006, and
2007.  The net value of patents was $4 thousand as of December 31,
2007.





Other
Assets





Included
in other assets are debt issuance costs, net of accumulated amortization, and
deposits totaling approximately $113 thousand and $43 thousand at December 31,
2006 and 2007, respectively.  Such costs are amortized over the period
of the respective debt agreements on a straight-line method, which approximates
the effective interest method.





Warranty





We accrue
amounts for estimated warranty claims based upon current and historical product
warranty costs and any other related information known.  The warranty
reserve was $305 thousand and $165 thousand at December 31, 2006 and 2007,
respectively.





Financial
Instruments





Management
believes that generally the fair value of the our cash, short-term investments,
trade receivables, payables and notes payable at December 31, 2006 and 2007
approximate their carrying values due to the short-term nature of the
instruments or the use of prevailing market interest rates.





Advertising
Costs





Advertising
costs are expensed as incurred.  Total advertising expense was $23
thousand, $41 thousand and $13 thousand in 2005, 2006 and 2007,
respectively.


F-8
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Per
Share Data





Basic
earnings per common share is computed using the weighted average number of
common shares outstanding during the period.  Diluted earnings per
common share is computed using the weighted average number of common stock and
common stock equivalent shares outstanding during the period.  There
was no anti-dilutive effect in 2005.  There was an anti-dilutive
effective in 2006 of 10 thousand common stock options and in 2007 of 25 thousand
common stock options.





The
following table sets forth the computation of basic and diluted earnings per
share (in thousands, except per share amounts):





Year
      EndedDecember 31,2005
            
            
            2006
            
            
            2007Numerator:Net
      income
            
            $
            4,446
            
            
            $
            7,588
            
            
            $
            12,278Denominator
      for basic net income per common share:Weighted
      average common shares outstanding
            
            
            7,564
            
            
            
            11,405
            
            
            
            12,071Denominator
      for diluted net income per share:Weighted
      average common shares outstanding
            
            
            7,564
            
            
            
            11,405
            
            
            
            12,071Dilutive
      effect of stock options and warrants
            
            
            917
            
            
            
            67
            
            
            
            43Diluted
      weighted average shares
            
            
            8,481
            
            
            
            11,472
            
            
            
            12,114Earnings
      per common share:Basic
            
            $
            0.59
            
            
            $
            0.67
            
            
            $
            1.02Diluted
            
            $
            0.52
            
            
            $
            0.66
            
            
            $
            1.01





Income
Taxes





Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to temporary differences between the financial statement carrying
amounts of assets and liabilities and their respective tax bases, and operating
losses and tax credit carry-forwards.  Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled.





Reclassification





Certain amounts in prior period
financial statements have been reclassified to conform to the 2007 financial
statement classification.




Recently
Issued Accounting Pronouncements





In July
2006, the FASB issued FASB Interpretation ("FIN") No.  48, Accounting for Uncertainty in Income
Taxes – an interpretation of FASB Statement 109.  FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with FASB Statement
No.  109, Accounting
for Income Taxes.  FIN 48 prescribes a comprehensive model for
recognizing, measuring, presenting and disclosing, in the financial statements,
tax positions taken or expected to be taken on a tax return.  FIN 48
is effective for fiscal years beginning after December 15, 2006.  We
adopted FIN 48 on January 1, 2007, and its adoption did not have a
material impact on our consolidated financial position and results of
operations.  See Note 7 for additional information regarding income
taxes.




In
September 2006, the FASB issued Statement of Financial Accounting Standards
(“SFAS”) No. 157, Fair Value
Measurements, which defines fair value, establishes a framework for
measuring fair value in GAAP, and expands disclosures about fair value
measurements.  This Statement applies under other accounting
pronouncements that require or permit fair value measurements and is effective
for fiscal years beginning after November 15, 2007.  In February 2008,
the FASB issued FASB Staff Position No FAS 157-2, which defers the effective
date of SFAS 157 for nonfinancial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually) to fiscal years beginning after November 15, 2008 and
interim periods within those years.  We adopted the required provisions of
SFAS 157 on January 1, 2008 and the adoption did not have a significant impact
on our financial statements.


F-9
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




In
February 2007, the FASB issued Statement of Financial Accounting Standards
(“SFAS”) No. 159, The Fair
Value Option for Financial Assets and Financial Liabilities-Including an
amendment of FASB Statement No. 115(“SFAS 159”).  SFAS 159
permits entities to measure eligible assets and liabilities at fair
value.  Unrealized gains and losses on items for which the fair value
option has been elected are reported in earnings.  SFAS 159 is
effective for fiscal years beginning after November 15, 2007.  We
adopted SFAS 159 on January 1, 2008 and the adoption did not have a
significant impact on our financial statements.




In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations(SFAS
No. 141(R)), which replaces SFAS No. 141, Business Combinations,
requires an acquirer to recognize the assets acquired, the liabilities assumed,
and any non-controlling interest in the acquiree at the acquisition date,
measured at their fair values as of that date, with limited exceptions. This
Statement also requires the acquirer in a business combination achieved in
stages to recognize the identifiable assets and liabilities, as well as the
non-controlling interest in the acquiree, at the full amounts of their fair
values. SFAS No. 141(R) makes various other amendments to authoritative
literature intended to provide additional guidance or to confirm the guidance in
that literature to that provided in this Statement. This Statement applies
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. We do not expect this will have a significant impact on
our financial statements.





In
December 2007, FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements(SFAS No. 160), which amends
Accounting Research Bulletin No. 51, Consolidated Financial
Statements, to improve the relevance, comparability, and transparency of
the financial information that a reporting entity provides in its consolidated
financial statements. SFAS No. 160 establishes accounting and reporting
standards that require the ownership interests in subsidiaries not held by the
parent to be clearly identified, labeled and presented in the consolidated
statement of financial position within equity, but separate from the parent’s
equity. This statement also requires the amount of consolidated net income
attributable to the parent and to the non-controlling interest to be clearly
identified and presented on the face of the consolidated statement of income.
Changes in a parent’s ownership interest while the parent retains its
controlling financial interest must be accounted for consistently, and when a
subsidiary is deconsolidated, any retained non-controlling equity investment in
the former subsidiary must be initially measured at fair value. The gain or loss
on the deconsolidation of the subsidiary is measured using the fair value of any
non-controlling equity investment. The Statement also requires entities to
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. This
Statement applies prospectively to all entities that prepare consolidated
financial statements and applies prospectively for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008.
We do not expect this will have a significant impact on our financial
statements.





2.  Rental
Activity





We rent
natural gas compressor packages to entities in the petroleum
industry.  Our cost less the accumulated depreciation of $11.3 million
for the rental compressors as of December 31, 2006 was $59.9
million.  Our cost less the accumulated depreciation of $17.0 million
for the rental compressors as of December 31, 2007 was $76.0
million.  These rental arrangements are classified as operating leases
and generally have original terms of six months to two years and continue on a
month-to-month basis thereafter.  Future minimum rent payments for
arrangements not on a month-to-month basis at December 31, 2007 are as follows
(in thousands):





Years Ended December 31,2008
            
            $
            2,5832009
            
            
            48Total
            
            $
            2,631




F-10
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


3.  Property
and Equipment





Property
and equipment consists of the following at December 31, 2006 and 2007 (in
thousands):





2006
            
            
            2007Land
      and building
            
            $
            3,365
            
            
            $
            5,305Leasehold
      improvements
            
            
            398
            
            
            
            431Office
      equipment and furniture
            
            
            501
            
            
            
            1,028Software
            
            
            360
            
            
            
            458Machinery
      and equipment
            
            
            1,447
            
            
            
            1,587Vehicles
            
            
            4,322
            
            
            
            4,563Less
      accumulated depreciation
            
            
            (3,679
            )
            
            
            (4,792
            )Total
            
            $
            6,714
            
            
            $
            8,580





Depreciation
expense for property and equipment and the compressors described in Note 2 was
$3.9 million, $5.7 million and $7.1 million for the years ended December 31,
2005, 2006 and 2007, respectively.





We
purchased a manufacturing facility in Midland, Texas on November 11, 2007 for
$1.9 million.





4.  Line
of Credit





We
entered into a line of credit on October 15, 2006, which allows for borrowings
up to $40.0 million, bears a fixed interest rate of 7.5% and requires monthly
interest payments, which began on November 1, 2006 and principal payments on
October 1, 2008.  The line of credit is collateralized by
substantially all of our assets.  As of December 31, 2007, there was a
balance of $600 thousand outstanding on line of credit.





The line
of credit and note listed in Note 5 below are with the same bank and include
certain covenants, the most restrictive of which require that we maintain
certain working capital, debt to equity and cash flow ratios and certain minimum
net worth.  We were in compliance with covenants at December 31, 2006
and 2007, respectively.





5.  Long-term
Debt





Long-term
debt at December 31, 2006 and 2007, respectively, consisted of the following (in
thousands):





2006
            
            
            2007Note
      payable to a bank, interest at a fixed rate of 7.5%.  Principal
      and interest payment due and payable on the 1st day of each month
      commencing November 1, 2006 and continuing through September 1,
      2011.  Principal under this credit facility is due and payable
      in 59 monthly installments of $281,500 each.  The note is
      collateralized by substantially all of our assets.  See Note 4
      regarding loan covenants.
            
            $
            16,328
            
            
            $
            12,950Other
      notes payable for vehicles, various terms
            
            
            64
            
            
            
            —Total
            
            
            16,392
            
            
            
            12,950Less
      current portion
            
            
            (3,442
            )
            
            
            (3,378
            )Total
            
            $
            12,950
            
            
            $
            9,572





Maturities
of long-term debt based on contractual requirements for the years ending
December 31 are as follows (in thousands):





2008
            
            $
            3,3782009
            
            
            3,3782010
            
            
            3,3782011
            
            
            2,816Total
            
            $
            12,950




F-11
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


6.  Subordinated
Notes





In 2001,
we completed an offering of units consisting of subordinated debt and
warrants.  The balance of the subordinated debt, net of unamortized
discount of $90 thousand, was $1.4 million at December 31, 2004.  All
amounts due on the notes were paid in full during 2005.  Each unit
consisted of a $25 thousand 10% subordinated note due December 31, 2006 and a
five-year warrant to purchase 10 thousand shares of our common stock at $3.25
per share.  Interest only was payable annually, with all principal due
at maturity.  Warrants to purchase 61.6 thousand shares were also
granted on the same terms to a placement agent in connection with the
offering.  Certain stockholders, officers and directors purchased
units in the subordinated debt offering, (totaling $259 thousand in notes and
warrants representing 104 thousand shares) on the same terms and conditions as
non-affiliated purchasers in the offering.  As of December 31, 2007,
none of the warrants remained outstanding.





On
January 3, 2005, we issued subordinated promissory notes to Paul D. Hensley,
James R. Hazlett and Tony Vohjesus, the owners of SCS, as part of the
consideration for the acquisition of Screw Compression Systems, Inc. As of
January 3, 2005, Screw Compression Systems, Inc. became a wholly owned
subsidiary of NGSG.  Mr. Hensley is currently the Senior Vice
President of Technical Services and a Director of Natural Gas Services Group,
Inc. Mr. Hazlett is the Vice President of Technical Services. Mr. Vohjesus is a
Manager of Product Services. The aggregate principal amount was $3 million
bearing interest at the rate of 4.00% per annum. Beginning January 3, 2006, a
principal payment of $1 million is due and payable each year until maturity on
January 3, 2008, plus the current outstanding interest. The subordinated
promissory notes are secured by a letter of credit in the face amount of $2
million. As of December 31, 2006 and 2007, $2 million and $1 million was
outstanding on these notes, respectively.  We repaid these notes in full at
maturity in January 2008.




7.  Income
Taxes





The
provision for income taxes consists of the following (in
thousands):





2005
            
            
            2006
            
            2007Current
      provision:Federal
            
            $
            91
            
            
            $
            1,475
            
            
            $
            3,168State
            
            
            116
            
            
            
            268
            
            
            
            357207
            
            
            
            1,743
            
            
            
            3,525Deferred
      provision:Federal
            
            
            2,310
            
            
            
            2,403
            
            
            
            2,775State
            
            
            98
            
            
            
            141
            
            
            
            1552,408
            
            
            
            2,544
            
            
            
            2,930$
            2,615
            
            
            $
            4,287
            
            
            $
            6,455





The
income tax effects of temporary differences that give rise to significant
portions of deferred income tax assets and (liabilities) are as follows (in
thousands):





2005
            
            
            2006
            
            
            2007Deferred
      income tax assets:Net
      operating loss
            
            $
            984
            
            
            $
            —
            
            
            $
            —Alternative
      minimum tax credit
            
            
            91
            
            
            
            99
            
            
            
            —Other
            
            
            60
            
            
            
            242
            
            
            
            362Total
      deferred income tax assets
            
            
            1,135
            
            
            
            341
            
            
            
            362Deferred
      income tax liabilities:Property
      and equipment
            
            
            (6,736
            )
            
            
            (8,571
            )
            
            
            (11,623
            )Goodwill
      and other intangible assets
            
            
            (1,575
            )
            
            
            (1,508
            )
            
            
            (1,407
            )Other
            
            
            (71
            )
            
            
            (26
            )
            
            
            33Total
      deferred income tax liabilities
            
            
            (8,382
            )
            
            
            (10,105
            )
            
            
            (12,997
            )Net
      deferred income tax liabilities
            
            $
            (7,247
            )
            
            $
            (9,764
            )
            
            $
            (12,635
            )




F-12
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


The
effective tax rate differs from the statutory rate as follows:





2005
            
            
            2006
            
            
            2007Statutory
      rate
            
            
            34
            %
            
            
            34
            %
            
            
            34
            %State
      and local taxes
            
            
            3
            %
            
            
            3
            %
            
            
            2
            %Other
            
            
            —
            
            
            
            (1
            )%
            
            
            (2
            )%Effective
      rate
            
            
            37
            %
            
            
            36
            %
            
            
            34
            %





We
adopted the provisions of FIN 48, Accounting for Uncertainty in Income Taxes, on
January 1, 2007. We had no material unrecognized income tax assets or
liabilities at the date of adoption or during the twelve months ended December
31, 2007.





Our
policy regarding income tax interest and penalties is to expense those items as
general and administrative expense but to identify them for tax purposes. During
the twelve months ended December 31, 2007, there were no income tax interest and
penalty items in the income statement, or as a liability on the balance
sheet.




We file
income tax returns in the U.S. federal jurisdiction and various state
jurisdictions.  With few exceptions, we are no longer subject to U.S.
federal or state income tax examination by tax authorities for years before
2004.  We are not currently involved in any income tax
examinations.





8.  Stockholders'
Equity





Initial
Public Offering





In
October, 2002, we closed an initial public offering in which it sold 1.5 million
shares of common stock and warrants to purchase 1.5 million shares of common
stock for a total of $7.9 million.  Costs and commissions associated
with the offering totaled $1.3 million.  The warrants were exercisable
anytime through October 21, 2006 at $6.25 per share.  In connection
with this offering, the underwriter received options to purchase 150 thousand
shares of common stock at $6.25 per share and warrants at $0.3125 per
share.  The warrants, if purchased by the underwriter, will contain an
exercise price of $7.81 per share.  The underwriter's options expired
in October 2007 and included a cashless exercise provision utilizing the our
common stock.  The underwriter’s warrants expire in October
2008.  As of December 31, 2007, there were no underwriter options or
warrants outstanding.





Secondary
Public Offering





On March 8, 2006, we sold 2.5 million
shares of our common stock pursuant to a public offering at a price of $17.50
per share, resulting in net proceeds to us of $40.7 million.  We did
not receive any proceeds from sales by certain selling
stockholders.  We granted the underwriter an option for a period of 30
days to purchase up to an additional 428 thousand shares to cover
over-allotments, if any.  On March 27, 2006, the underwriter exercised
its over-allotment option and on March 30, 2006, we sold an additional 428
thousand shares, resulting in proceeds to NGSG of $7.1 million, in addition to
the net proceeds of $40.7 million from the sale of the 2.5 million shares of
common stock on March 8, 2006.  The net proceeds after offering costs
to us were $47.1 million and a portion was used to reduce our bank debt by $5.0
million.





Conversion





On July
28, 2005, Natural Gas Services Group, Inc.  announced that it would
redeem its outstanding common stock purchase warrants that were issued in
connection with its initial public offering in October 2002 (the "IPO
Warrants").  Holders of the IPO Warrants were required to exercise the
IPO Warrants by 5:00 p.m., Mountain Daylight Savings Time on Tuesday, September
6, 2005 (the "Redemption Date").  The IPO Warrants had an exercise
price of $6.25 per share and were subject to redemption at the redemption price
of $0.25 per IPO Warrant.  IPO Warrants that were not properly
exercised by the Redemption Date ceased to be exercisable and were redeemed for
$0.25 per IPO Warrant, without interest.  A total of 1.5 million IPO
Warrants were initially issued in conjunction with our initial public
offering.  We received a total of $9.4 million in proceeds from IPO
Warrants exercised in 2005.  Approximately 2.4 thousand IPO Warrants
were not exercised by the Redemption Date and were redeemed for the aggregate
redemption amount of $.6 thousand.




F-13
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


Warrants





In March
2001 and April 2002, five-year warrants to purchase 68.5 thousand shares of
common stock at $2.50 per share and 16.5 thousand shares at $3.25 per share,
respectively, were issued to certain board members and stockholders as
compensation for their debt guarantees.  All of these warrants were
exercised as of December 31, 2006.





Preferred
Stock





We have a
total of 5.0 million authorized preferred shares, with rights and preferences as
designated by the Board of Directors.  As of December 31, 2006 and
2007, there were no outstanding preferred shares.





Other





In 2001,
we completed an offering of units consisting of subordinated debt and
warrants.  Each unit consisted of a $25 thousand 10% subordinated note
due December 31, 2006 and a five-year warrant to purchase 10 thousand shares of
our common stock at $3.25 per share.  On August 26, 2005, we prepaid
all of the outstanding 10% subordinated notes that were due December 31,
2006.  As of December 31, 2006, none of these warrants were
outstanding.


On
August  26, 2005, we entered into a non-statutory Stock Option
Agreement with Mr. Stephen C. Taylor, our Chief Executive Officer and
President.  The Stock Option Agreement grants to Mr. Taylor a ten-year
option to purchase 45 thousand shares of our common stock at an exercise price
equal to $9.22 (the fair market value of our common stock on January 13, 2005,
the date we initially hired Mr. Taylor), with 15 thousand shares vesting on each
of January 13, 2006, 2007 and 2008.  The options expire ten years from
the date of grant.





9.  Stock-Based
Compensation





Stock
Options





Effective
January 1, 2006, we adopted the fair value recognition provisions of Statement
of Financial Accounting Standard 123(R) “Share-Based Payment”(“SFAS
123(R)”) using the modified prospective transition method.  In
addition, the Securities and Exchange Commission issued Staff Accounting
Bulletin No.  107 “Share-Based Payment”(“SAB
107”) in March, 2005, which provides supplemental SFAS 123(R) application
guidance based on the views of the SEC. Under the modified prospective
transition method, compensation cost recognized in the year ended December 31,
2006 includes: (a) compensation cost for all share-based payments granted prior
to, but not yet vested as of January 1, 2006, based on the grant date fair value
estimated in accordance with the original provisions of SFAS No.  123,
and (b) compensation cost for all share-based payments granted beginning January
1, 2006, based on the grant date fair value estimated in accordance with the
provisions of SFAS 123(R).  In accordance with the modified
prospective transition method, results for prior periods have not been
restated.  The adoption of SFAS 123(R) resulted in stock compensation
expense of $376 thousand for the year ended December 31, 2006 and $541 thousand
for the year ended December 31, 2007, to income before income
taxes.





The
Black-Scholes option-pricing model was used to estimate the option fair
values.  The option-pricing model requires a number of assumptions, of
which the most significant are expected stock price volatility, the expected
pre-vesting forfeiture rate and the expected option term (the amount of time
from the grant date until the options are exercised or
expire).  Expected volatility was calculated based upon actual
historical stock price movements over the most recent periods ending December
31, 2007.  The expected option term was calculated based on the
vesting period and historical exercise and post vesting employment termination
behavior for similar grants.  The expected forfeiture rate is based on
historical experience and expectations about future forfeitures.





Prior to
the adoption of SFAS 123(R), we accounted for stock-based awards to employees
using the intrinsic value method described in Accounting Principles Board
Opinion (APB) No.  25, Accounting for Stock Issued to
Employees, and its related interpretations.  Accordingly, no
compensation expense has been recognized in the accompanying consolidated
financial statements for stock-based awards to employees or directors when the
exercise price of the award is equal to or greater than the quoted market price
of the stock on the date of the grant.


F-14
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Pro-Forma
Stock Compensation Expense for the Year Ended December 31, 2005





For the
year ended December 31, 2005, we applied the intrinsic value method of
accounting for stock options as prescribed by APB 25.  If compensation
expense had been recognized based on the estimated fair value of each option
granted in accordance with the provisions of SFAS 123 as amended SFAS 148, our
net income and net income per share would have been reduced to the following
pro-forma amounts (in thousands, except per share amounts):





Year
      Ended
              December 31, 2005Net
      income, as reported
            
            $
            4,446Compensation
      expenses regained under Opinion 25
            
            
            135Deduct:
      Total stock-based employee compensation expense determined under fair
      value method for all awards (net of  tax)
            
            
            (295
            )Income
      available to common stockholders, pro forma
            
            $
            4,286Earnings
      per common share:Basic,
      as reported
            
            $
            0.59Basic,
      pro forma
            
            $
            0.57Diluted,
      as reported
            
            $
            0.52Diluted,
      pro forma
            
            $
            0.51Weighted
      average fair value of options granted during
      the  year
            
            $
            10.37





Pro-forma
compensation expense under SFAS 123, among other computational differences, does
not consider potential pre-vesting forfeitures.  Because of these
differences, the pro-forma stock compensation expense presented above for the
year ended December 31, 2005 under SFAS 123 and the stock compensation expense
recognized during the years ended December 31, 2006 and 2007 under SFAS 123(R)
are not directly comparable.  In accordance with the modified
prospective transition method of SFAS 123(R), the prior comparative results have
not been restated.





Stock
Option Plan





Our 1998
Stock Option Plan (the Plan), which is stockholder approved, permits the grant
of options to its employees for up to 550 thousand shares of common
stock.  We believe that such awards better align the interests of our
employees with our stockholders.  Option awards are generally granted
with an exercise price equal to the market price of our stock at the date of
grant; those option awards generally vest based on three years of continuous
service and have ten-year contractual terms.  Certain option and share
awards provide for accelerated vesting if there is a change in control of NGSG
(as defined in the Plan).





On June
20, 2006, the 1998 Stock Option Plan was amended and approved by the
stockholders.  The number of shares of common stock authorized for
issuance under the 1998 Plan was increased from 150 thousand to 550
thousand.  The last date that grants could be made was extended from
December 17, 2008 to March 1, 2016.  The exercise price of incentive
stock options granted to employees who do not own more that 10% of our common
stock was changed from not less than 140% of the fair market value per share of
our common stock on the date of grant to not less than 100% of the fair market
value of our common stock on the date of grant.  The provision
allowing the Compensation Committee to increase, without stockholder approval,
the number of shares of stock subject to the 1998 Plan from 150 thousand shares
to 400 thousand shares was eliminated.  Also eliminated was a
provision allowing the Compensation Committee, in its sole discretion, to
provide an optionee with the right to exchange, in a cashless transaction, all
or part of a stock option for shares of our common stock on terms and conditions
determined by the Compensation Committee.


F-15
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




The fair
value of each option award is estimated on the date of grant using the
Black-Scholes option valuation model that uses the assumptions noted in the
following table.  The risk-free rate for periods within the
contractual life of the option is based on the U.S.  Treasury yield
curve in effect at the time of grant.  The expected life of options
granted is based on the vesting period and historical exercise and post vesting
employment termination behavior for similar grants.  We use historical
stock data to estimate option exercise and employee termination within the
valuation model; separate groups of employees that have similar historical
exercise behavior are considered separately for valuation purposes.





Weighted
      average Black-Scholes fair value assumptions:
              
              2005
              
              
              2006
              
              
              2007Risk
      free rate
              
              
              7.25
              %
              
              
              8.25
              %
              
              
              5.83
              %Expected
      life
              
              10
              yrs
              
              4
              yrs
              
              5
              yrsExpected
      volatility
              
              
              47.0
              %
              
              
              50.3
              %
              
              
              47.6
              %Expected
      dividend yield
              
              
              0.0
              %
              
              
              0.0
              %
              
              
              0.0
              %




A summary
of option activity under the plan as of December 31, 2007 is presented
below.





Number
      of
              Stock
      Options
            
            
            Weighted
      Average
              ExercisePrice
            
            
            Weighted
              Average
              Remaining
              Contractual
      Life (years)
            
            
            Aggregate
      Intrinsic Value(in
      thousands)Outstanding,
      January 1, 2007
            
            
            174,170
            
            
            $
            9.63
            
            
            
            8.22
            
            
            $
            744Granted
            
            
            22,500
            
            
            
            18.27Exercised
            
            
            (24,834
            )
            
            
            6.12Forfeited
      or expired
            
            
            (4,334
            )
            
            
            12.15Outstanding,
      December 31, 2007
            
            
            167,502
            
            
            $
            11.25
            
            
            
            7.77
            
            
            $
            1,401Exercisable,
      December 31, 2007
            
            
            126,502
            
            
            $
            10.80
            
            
            
            7.51
            
            
            $
            1,115





During
the year ended December 31, 2007, 22,500 options were granted.  The
total intrinsic value or the difference between the exercise price and the
market price on the date of exercise, of options exercised during the year ended
December 31, 2007, was approximately $213 thousand.  Cash received
from stock options exercised during the year ended December 31, 2007 was $152
thousand.





The
following table summarizes information about the options outstanding at December
31, 2007:




Options
      Outstanding
            
            
            Options
      ExercisableRange
      of Exercise Prices
            
            
            Shares
            
            
            Weighted
              Average
              Remaining
              Contractual
              Life
      (years)
            
            
            Weighted
              Average
              Exercise
              Price
            
            
            Shares
            
            
            Weighted
              Average
              Exercise
              Price$
            0.00
      – 5.58
            
            
            
            28,000
            
            
            
            4.99
            
            
            $
            4.17
            
            
            
            28,000
            
            
            $
            4.175.59
      – 9.43
            
            
            
            63,668
            
            
            
            7.42
            
            
            
            9.02
            
            
            
            48,668
            
            
            
            8.969.44
      – 19.61
            
            
            
            75,834
            
            
            
            9.09
            
            
            
            15.73
            
            
            
            49,834
            
            
            
            16.31$
            0.00
      - 19.61
            
            
            
            167,502
            
            
            
            7.77
            
            
            $
            11.25
            
            
            
            126,502
            
            
            $
            10.80




F-16
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


The
summary of the status of our unvested stock options as of December 31, 2007 and
changes during the year ended December 31, 2007 is presented below.





Unvested
      stock options:
            
            Shares
            
            
            Weighted
      Average GrantDate Fair ValueUnvested
      at January 1, 2007
            
            
            85,838
            
            
            $
            9.32Granted
            
            
            22,500
            
            
            
            8.49Vested
            
            
            (63,671
            )
            
            
            9.35Forfeited
            
            
            (3,667
            )
            
            
            5.12Unvested
      at December 31, 2007
            
            
            41,000
            
            
            $
            9.19





As of
December 31, 2007, there was approximately $160 thousand of unrecognized
compensation cost related to unvested options.  We expect to recognize
such cost over a weighted-average period of 1.2 years.  Total
compensation expense for stock options was $376 thousand and $541 thousand for
the years ended December 31, 2006 and 2007, respectively.  An income
tax benefit was realized from the exercise of stock options of approximately $27
thousand and $112 thousand for the years ended December 31, 2006 and 2007,
respectively.





10.  Commitments





401(k)
Plan





We offer
a 401(k) Plan to all employees that have reached the age of eighteen and have
completed six months of service.  The participants may contribute up
to 100% of their salary subject to IRS limitations.  Employer
contributions are subject to Board discretion and are subject to a vesting
schedule of 20% each year after the first year and 100% after six
years.  We contributed $96 thousand, $125 thousand, and $161 thousand
to the 401(k) Plan in 2005, 2006 and 2007, respectively.





Rented
Facilities





We lease
certain of our facilities under operating leases with terms generally ranging
from month to month to five years.  Most facility leases contain
renewal options.  Remaining future minimum rental payments due under
these leases for the years ended December 31 are as follows (in
thousands):




2008
            
            $
            762009
            
            
            282010
            
            
            282011
            
            
            292012
            
            
            30Thereafter
            
            
            44Total
            
            $
            235




Rent expense under such leases was $196
thousand, $212 thousand, and $244 thousand for the years ended December 31,
2005, 2006, and 2007, respectively.





11.  Other
Income





Other
income in 2006 and 2007 primarily consisted of interest income from our
short-term investment account.


F-17
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


12.  Segment
Information





FAS
No.  131, Disclosures About Segments of an
Enterprise and Related Information, establishes standards for public
companies relating to the reporting of financial and descriptive information
about their operating segments in financial statements.  Operating
segments are components of an enterprise which separate financial information is
available and is evaluated regularly by chief operating decision makers in
deciding how to allocate resources and in assessing performance.





NGSG
identifies its segments based upon major revenue sources as
follows:




For
the Year Ended December 31, 2005





Sales
            
            
            Service
      &
              Maintenance
            
            
            Rental
            
            
            Corporate
            
            
            Total(in
      thousands of dollars)Revenue
            
            $
            30,278
            
            
            $
            2,424
            
            
            $
            16,609
            
            
            $
            —
            
            
            $
            49,311Operating
      costs and expenses
            
            
            23,331
            
            
            
            1,479
            
            
            
            6,528
            
            
            
            9,114
            
            
            
            40,452Operating
      income
            
            
            6,947
            
            
            
            945
            
            
            
            10,081
            
            
            
            (9,114
            )
            
            
            8,859Other
      income/(expense)
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,798
            )
            
            
            (1,798
            )Income
      before provision for  income taxes
            
            
            6,947
            
            
            
            945
            
            
            
            10,081
            
            
            $
            (10,912
            )
            
            
            7,061*Segment
      assets
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            86,369
            
            
            $
            86,369




For
the Year Ended December 31, 2006


Sales
            
            
            Service
      &
              Maintenance
            
            
            Rental
            
            
            Corporate
            
            
            Total(in
      thousands of dollars)Revenue
            
            $
            38,214
            
            
            $
            979
            
            
            $
            23,536
            
            
            $
            —
            
            
            $
            62,729Operating
      costs and expenses
            
            
            29,629
            
            
            
            735
            
            
            
            8,944
            
            
            
            11,290
            
            
            
            50,598Operating
      income
            
            
            8,585
            
            
            
            244
            
            
            
            14,592
            
            
            
            (11,290
            )
            
            
            12,131Other
      income/(expense)
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (256
            )
            
            
            (256
            )Income
      before provision for  income taxes
            
            
            8,585
            
            
            
            244
            
            
            
            14,592
            
            
            
            (11,546
            )
            
            
            11,875*Segment
      assets
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            135,552
            
            
            $
            135,552




For
the Year Ended December 31, 2007





Sales
            
            
            Service
      &
              Maintenance
            
            
            Rental
            
            
            Corporate
            
            
            Total(in
      thousands of dollars)Revenue
            
            $
            41,088
            
            
            $
            964
            
            
            $
            30,437
            
            
            $
            —
            
            
            $
            72,489Operating
      costs and expenses
            
            
            28,124
            
            
            
            600
            
            
            
            12,382
            
            
            
            12,794
            
            
            
            53,900Operating
      income
            
            
            12,964
            
            
            
            364
            
            
            
            18,055
            
            
            
            (12,794
            )
            
            
            18,589Other
      income/(expense)
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            144
            
            
            
            144Income
      before provision for  income taxes
            
            
            12,964
            
            
            
            364
            
            
            
            18,055
            
            
            
            (12,650
            )
            
            
            18,733*Segment
      assets
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            153,233
            
            
            $
            153,233





*
Management does not track assets by segment.





F-18
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


13.           Quarterly
Financial Data (In thousands, except per share data) - Unaudited








2005
            
            
            Q1
            
            
            
            Q2
            
            
            
            Q3
            
            
            
            Q4
            
            
            TotalTotal
      revenue
            
            $
            11,041
            
            
            $
            12,031
            
            
            $
            12,460
            
            
            $
            13,779
            
            
            $
            49,311Operating
      income
            
            
            1,837
            
            
            
            2,200
            
            
            
            2,207
            
            
            
            2,615
            
            
            
            8,859Net
      income applicable to common shares
            
            
            898
            
            
            
            1,070
            
            
            
            1,091
            
            
            
            1,387
            
            
            
            4,446Net
      income per share - Basic
            
            
            0.13
            
            
            
            0.16
            
            
            
            0.14
            
            
            
            0.15
            
            
            
            0.59Net
      income per share - Diluted
            
            
            0.11
            
            
            
            0.13
            
            
            
            0.12
            
            
            
            0.15
            
            
            
            0.52




2006
            
            
            Q1
            
            
            
            Q2
            
            
            
            Q3
            
            
            
            Q4
            
            
            TotalTotal
      revenue
            
            $
            13,578
            
            
            $
            15,458
            
            
            $
            17,130
            
            
            $
            16,563
            
            
            $
            62,729Operating
      income
            
            
            3,053
            
            
            
            1,912
            
            
            
            3,690
            
            
            
            3,476
            
            
            
            12,131Net
      income applicable to common shares
            
            
            1,696
            
            
            
            1,208
            
            
            
            2,364
            
            
            
            2,320
            
            
            
            7,588Net
      income per share - Basic
            
            
            0.18
            
            
            
            0.10
            
            
            
            0.20
            
            
            
            0.19
            
            
            
            0.67Net
      income per share - Diluted
            
            
            0.17
            
            
            
            0.10
            
            
            
            0.20
            
            
            
            0.19
            
            
            
            0.66




2007
              
              
              Q1
              
              
              
              Q2
              
              
              
              Q3
              
              
              
              Q4
              
              
              TotalTotal
      revenue
              
              $
              16,712
              
              
              $
              17,624
              
              
              $
              18,651
              
              
              $
              19,502
              
              
              $
              72,489Operating
      income
              
              
              4,203
              
              
              
              4,134
              
              
              
              5,232
              
              
              
              5,020
              
              
              
              18,589Net
      income applicable to common shares
              
              
              2,681
              
              
              
              2,646
              
              
              
              3,337
              
              
              
              3,614
              
              
              
              12,278Net
      income per share - Basic
              
              
              0.22
              
              
              
              0.22
              
              
              
              0.28
              
              
              
              0.30
              
              
              
              1.02Net
      income per share - Diluted
              
              
              0.22
              
              
              
              0.22
              
              
              
              0.28
              
              
              
              0.30
              
              
              
              1.01


14.
            Legal
      Proceedings





On
February 21, 2008, we received notice of a lawsuit filed against us in
Montmorency County, Michigan, 26th Circuit Court, Case No.
08-0001901-NZ, styled Dyanna Louise Williams, Plaintiff, v Natural Gas Services
Group, Inc. and Great Lakes Compression, Defendants.  In this lawsuit,
plaintiff alleges breach of contract, breach of fiduciary duty and negligence.
Plaintiff seeks damages in the amount of $100 thousand for lost insurance
benefits and an unspecified amount of exemplary damages. As the basis for her
claims, plaintiff generally alleges that she is the third party beneficiary of a
life insurance policy obtained by her deceased ex-husband through Natural Gas
Services Group's insurance program, and that as a result of Natural Gas Service
Group's negligence and failure to use due care in processing an application for
life insurance prior to her ex-husband's death, she was denied $100
thousand of life insurance proceeds. Plaintiff now seeks to recover $100
thousand from Natural Gas Services Group, plus an unspecified amount of
exemplary damages. Due to the early stages of this lawsuit, and the absence of
any discovery proceedings, we are unable to accurately predict its outcome, but
we intend to file an answer denying all of plaintiff's claims and intend to
vigorously contest the plaintiff's claims. We have not established a reserve
with respect to plaintiff's claims.


From time
to time, we are a party to various other legal proceedings in the ordinary
course of our business.  While management is unable to predict the
ultimate outcome of these actions, it believes that any ultimate liability
arising from these actions will not have a material adverse effect on our
consolidated financial position, results of operations or cash flow. 
Except as discussed herein, we are not currently a party to any other legal
proceedings and we are not aware of any other threatened
litigation.








********


F-19
 NATURAL
GAS SERVICES GROUP, INC. AND SUBSIDIARY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




INDEX TO
EXHIBITS





(a)           Exhibits





Exhibit
No.                                                                           Description





3.1
            Articles
      of Incorporation, as amended (Incorporated by reference to Exhibit 3.1 of
      the 10QSB filed and dated November 10,
2004)





3.2
            Bylaws
      (Incorporated by reference to Exhibit 3.4 of the Registrant's Registration
      Statement on Form SB-2,
  No.  333-88314)





4.1
            Form
      of warrant certificate (Incorporated by reference to Exhibit 4.1 of the
      Registrant's Registration Statement on Form SB-2,
      No.  333-88314)





4.2
            Form
      of warrant agent agreement (Incorporated by reference to Exhibit 4.2 of
      the Registrant's Registration Statement on Form SB-2,
      No.  333-88314)





4.3
            Form
      of representative's option for the purchase of common stock (Incorporated
      by reference to Exhibit 4.4 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





4.4
            Form
      of representative's option for the purchase of warrants (Incorporated by
      reference to Exhibit 4.5 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





4.5
            Stockholders
      Agreement, dated January 3, 2005 among Paul D. Hensley, Tony Vohjesus, Jim
      Hazlett and Natural Gas Services Group, Inc.  (Incorporated by
      reference to Exhibit 4.3 of the Registrant's Form 8-K Report, dated
      January 3, 2005, as filed with the Securities and Exchange Commission on
      January 7, 2005)





Executive
      Compensation Plans and Arrangements (Exhibits 10.1, 10.14, 10.15, 10.16,
      10.23, 10.24, 10.26 and 10.27).





10.1
            1998
      Stock Option Plan, as amended (Incorporated by reference to Exhibit 10.1
      of the Registrant’s Form 8-K Report dated June 20, 2006 on file with the
      SEC June 26, 2006)





10.2
            Form
      of Series A 10% Subordinated Notes due December 31, 2006 (Incorporated by
      reference to Exhibit 10.8 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





10.3
            Form
      of Five-Year Warrants to Purchase Common Stock (Incorporated by reference
      to Exhibit 10.9 of the Registrant's Registration Statement on Form SB-2,
      No.  333-88314)





10.4
            Warrants
      issued to Berry-Shino Securities, Inc.  (Incorporated by
      reference to Exhibit 10.10 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





10.5
            Warrants
      issued to Neidiger, Tucker, Bruner, Inc.  (Incorporated by
      reference to Exhibit 10.11 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





10.6
            Form
      of warrant issued in March 2001 for guaranteeing debt (Incorporated by
      reference to Exhibit 10.12 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





10.7
            Form
      of warrant issued in April 2002 for guaranteeing debt (Incorporated by
      reference to Exhibit10.13 of the Registrant's Registration Statement on
      Form SB-2,
No.  333-88314)





10.8
            Lease
      Agreement, dated March 1, 2004, between the Registrant and the City of
      Midland, Texas (Incorporated by reference to Exhibit 10.19 of the
      Registrant's Form 10-QSB for the fiscal quarter ended June 30,
      2004)


10.9
              Second
      Amended and Restated Loan Agreement, dated November 3, 2003, between the
      Registrant and Western National Bank (Incorporated by reference to Exhibit
      10.20 of the Registrant's Form 10-QSB for the fiscal quarter ended June
      30, 2004)
 
 10.10
              Securities
      Purchase Agreement, dated July 20, 2004, between the Registrant and
      CBarney Investments, Ltd.  (Incorporated by reference to Exhibit
      4.1 of the Registrant's Current Report on Form 8-K dated July 20, 2004 and
      filed with the Securities and Exchange Commission on July 27,
      2004)





Exhibit
      No.
            Description




10.11
            Stock
      Purchase Agreement, dated October 18, 2004, by and among the Registrant,
      Screw Compression Systems, Inc., Paul D. Hensley, Jim Hazlett and Tony
      Vohjesus (Incorporated by reference to Exhibit 4.1 of the Registrant's
      Current Report on Form 8-K dated October 18, 2004 and filed with the
      Securities and Exchange Commission on October 21,
  2004)





10.12
            Third
      Amended and Restated Loan Agreement dated as of January 3, 2005, among
      Natural Gas Services Group, Inc., Screw Compression Systems,
      Inc.  and Western National Bank (Incorporated by reference to
      Exhibit 10.1 of the Registrant’s Current Report on Form 8-K, dated January
      3, 2005, and filed with the Securities and Exchange Commission on January
      7, 2005)





10.13
            Employment
      Agreement between Paul D. Hensley and Natural Gas Services Group,
      Inc.  (Incorporated by reference to Exhibit 10.1 of the
      Registrants Form 8-K Report, dated January 3, 2005, as filed with the
      Securities and Exchange Commission on January 7,
  2005)





10.14
            Employment
      Agreement between William R. Larkin and Natural Gas Services Group,
      Inc.  (Incorporated by reference to Exhibit 10.25 of the
      Registrant's Form 10-KSB for the fiscal year ended December 31, 2004, and
      filed with the Securities and Exchange Commission on March 30,
      2005)





10.15
            Promissory
      Note, dated January 3, 2005, in the original principal amount of $2.1
      million made by Natural Gas Services Group, Inc.  payable to
      Paul D. Hensley (Incorporated by reference to Exhibit 10.26 of the
      Registrant's Form 10-KSB for the fiscal year ended December 31, 2004, and
      filed with the Securities and Exchange Commission on March 30,
      2005)





10.16
            Fourth
      Amended and Restated Loan Agreement (Incorporated by reference to Exhibit
      10.1 of the Registrant’s Current Report on Form 8-K, dated March 14, 2005,
      and filed with the Securities and Exchange Commission on March 18,
      2005)





10.17
            Modification
      Agreement, dated as of January 3, 2005, by and between Natural Gas
      Services Group, Inc.  and Western National
      Bank  (Incorporated by reference to Exhibit 10.2 of the
      Registrant’s Current Report on Form 8-K, dated January 3, 2005, and filed
      with the Securities and Exchange Commission on January 7,
      2005)





10.18
            Guaranty
      Agreement, dated as of January 3, 2005, made by Natural Gas Service Group,
      Inc., for the benefit of Western National Bank (Incorporated by reference
      to Exhibit 10.3 of the Registrant’s Current Report on Form 8-K, dated
      January 3, 2005, and filed with the Securities and Exchange Commission on
      January 7, 2005)





10.19
            Guaranty
      Agreement, dated as of January 3, 2005, made by Screw Compression Systems,
      Inc., for the benefit of Western National Bank (Incorporated by reference
      to Exhibit 10.4 of the Registrant’s Current Report on Form 8-K, dated
      January 3, 2005, and filed with the Securities and Exchange Commission on
      January 7, 2005)





10.20
            Fifth
      Amended and Restated Loan Agreement (Incorporated by reference to Exhibit
      10.2 of the Registrant’s Form 8-K dated January 3, 2006 and filed with the
      Securities and Exchange Commission January 6,
  2006)




10.21
            First
      Modification to Fourth Amended and Restated Loan Agreement (Incorporated
      by reference Exhibit 10.1 of the Registrant’s Form 8-K dated May 1, 2005
      and filed with Securities and Exchange Commission May 13,
      2005)





10.22
            Employment
      Agreement between Stephen C. Taylor and Natural Gas Services Group,
      Inc.  (Incorporated by reference to Exhibit 10.1 of the
      Registrant’s Form 8-K Report, dated August 24, 2005, and filed with the
      Securities and Exchange Commission on August 30,
  2005)





10.23
            Employment
      Agreement between James R. Hazlett and Natural Gas Services Group,
      Inc.  (Incorporated by reference to Exhibit 10.1 of the
      Registrant’s Form 8-K Report, dated June 14, 2005, and filed with the
      Securities and Exchange Commission on November 14,
  2005)





10.24
            Stockholders
      Agreement, dated January 3, 2005 among Paul D. Hensley, Tony Vohjesus, Jim
      Hazlett and Natural Gas Services Group, Inc.  (Incorporated by
      reference to Exhibit 4.3 of the Registrant’s Form 8-K Report, dated
      January 3, 2005, and filed with the Securities and Exchange Commission on
      January 7, 2005)





Exhibit
      No.
            Description




10.25
            Promissory
      Note, dated January 3, 2005, in the original principal amount of $300
      thousand made by Natural Gas Services Group, Inc.  payable to
      Jim Hazlett (Incorporated by reference to Exhibit 10.3 of the Registrant’s
      Form 8-K Report, dated June 14, 2005, and filed with the Securities and
      Exchange Commission on November 14,
2005)





10.26
            Retirement
      Agreement, dated December 14, 2005, between Wallace C. Sparkman and
      Natural Gas Services Group, Inc.  (Incorporated by reference to
      Exhibit 10.1 of the Registrant’s Form 8-K Report, dated December 14, 2005,
      and filed with the Securities and Exchange Commission on December 15,
      2005)





10.27
            Sixth
      Amended and Restated Loan Agreement, dated as of January 3, 2006
      (Incorporated by reference to Exhibit 10.3 of the Registrant’s Current
      Report on Form 8-K, dated January 3, 2006, and filed with the Securities
      and Exchange Commission on January 6,
2006)





10.28
            Guaranty
      Agreement dated as of January 3, 2006, and made by Screw Compression
      Systems, Inc.  for the benefit of Western National Bank
      (Incorporated by reference to Exhibit 10.4 of the Registrant’s Current
      Report on Form 8-K, dated January 3, 2006, and filed with the Securities
      and Exchange Commission on January 6,
2006)





10.29
            Seventh
      Amended and Restated Loan Agreement (Incorporated by reference to Exhibit
      10.1 of the Registrant’s Form 8-K dated October 26, 2006 and filed with
      the Securities and Exchange Commission on November 1,
  2006





14.0
            Code
      of Ethics (Incorporated by reference to Exhibit 14.0 of the Registrant's
      Form 10-KSB for the fiscal year ended December 31, 2004, and filed with
      the Securities and Exchange Commission on March 30,
  2005)





21.0
            Subsidiaries
      (Incorporated by reference to Exhibit 21.0 of the Registrant's Form 10-KSB
      for the fiscal year ended December 31, 2004, and filed with the Securities
      and Exchange Commission on March 30,
2005)




*23.1
            Consent
      of Hein & Associates LLP.





*31.1
            Certifications





*31.2
            Certifications





*32.1
            Certification
      required by Section 906 of the Sarbanes-Oxley Act of
  2002





*32.2
            Certification
      required by Section 906 of the Sarbanes-Oxley Act of
  2002




*
      Filed herewith.