##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarter Ended September 30, 2007
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF EXCHANGE ACT
 Commission File No. 0-12185
 NGAS Resources, Inc.
 (Exact name of registrant as specified in its charter)
 Province of British Columbia
(State or other jurisdiction of 
incorporation or organization)
    
    Not Applicable
(I.R.S. Employer
Identification No.)
 120 Prosperous Place, Suite 201
Lexington, Kentucky
(Address of principal executive offices)
    
    40509-1844
(Zip Code)
 Registrants telephone number, including area code: (859) 263-3948
  þ o
  o þ o
 o þ
  Title of Class 
Common Stock
    
    Outstanding at November 1, 2007
21,912,731




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##### 



NGAS Resources, Inc.
 INDEX
 PagePart I. Financial InformationItem 1. Financial Statements:Condensed Consolidated Balance Sheets  September 30, 2007 (unaudited) and December 31, 2006
    
    
    1Condensed Consolidated Statement of Operations  Three months and nine months ended
September 30, 2007 and 2006
    
    
    2Condensed Consolidated Statement of Cash Flows  Three months and nine months ended
September 30, 2007 and 2006
    
    
    3Notes to Condensed Consolidated Financial Statements
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    20Item 4. Controls and Procedures
    
    
    21PART II. OTHER INFORMATIONItem 6. Exhibits
    
    
    21EX-31.1EX-31.2EX-32.1EX-32.2
  
 Forward-Looking Statements
  
 Additional Information




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##### Table of Contents



NGAS Resources, Inc.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 September 30,
    
    
    December 31,2007
    
    
    2006(Unaudited)ASSETSCurrent assets:Cash
    
    $
    5,410,280
    
    
    $
    14,431,977Accounts receivable
    
    
    6,949,112
    
    
    
    9,108,574Prepaid expenses and other current assets
    
    
    800,797
    
    
    
    1,108,734Loans to related parties
    
    
    7,559
    
    
    
    7,147Total current assets
    
    
    13,167,748
    
    
    
    24,656,432Bonds and deposits
    
    
    465,195
    
    
    
    533,695Oil and gas properties
    
    
    175,795,404
    
    
    
    144,217,532Property and equipment
    
    
    3,657,671
    
    
    
    3,342,571Loans to related parties
    
    
    251,419
    
    
    
    257,430Deferred financing costs
    
    
    1,846,144
    
    
    
    2,264,022Other non-current assets
    
    
    3,386,008
    
    
    
    2,634,271Goodwill
    
    
    313,177
    
    
    
    313,177Total assets
    
    $
    198,882,766
    
    
    $
    178,219,130LIABILITIESCurrent liabilities:Accounts payable
    
    
    7,467,095
    
    
    
    9,286,849Accrued liabilities
    
    
    3,460,106
    
    
    
    3,998,978Customers drilling deposits
    
    
    487,805
    
    
    
    12,173,905Long term debt, current portion
    
    
    379,824
    
    
    
    24,000Total current liabilities
    
    
    11,794,830
    
    
    
    25,483,732Deferred income taxes
    
    
    8,609,206
    
    
    
    8,035,779Long term debt
    
    
    100,913,559
    
    
    
    66,922,744Deferred compensation
    
    
    1,857,182
    
    
    
    1,419,776Total liabilities
    
    
    123,174,777
    
    
    
    101,862,031SHAREHOLDERS EQUITYCapital stockAuthorized:5,000,000 Preferred shares100,000,000 Common sharesIssued:21,843,981 Common shares (2006  21,788,551)
    
    
    84,754,942
    
    
    
    84,531,83221,100 Common shares held in treasury, at cost
    
    
    (23,630
    )
    
    
    (23,630
    )Paid-in capital  options and warrants
    
    
    3,538,958
    
    
    
    3,073,287Contributed surplus
    
    
    1,131,435
    
    
    
    1,396,074To be issued:9,185 Common shares (2006  9,185)
    
    
    45,925
    
    
    
    45,92589,447,630
    
    
    
    89,023,488Deficit
    
    
    (13,739,641
    )
    
    
    (12,666,389
    )Total shareholders equity
    
    
    75,707,989
    
    
    
    76,357,099Total liabilities and shareholders equity
    
    $
    198,882,766
    
    
    $
    178,219,130
 See accompanying notes.
 1




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##### Table of Contents



NGAS Resources, Inc.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
 Three Months Ended
    
    
    Nine months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006REVENUEContract drilling
    
    $
    6,730,929
    
    
    $
    7,726,332
    
    
    $
    23,435,852
    
    
    $
    39,167,106Oil and gas production
    
    
    6,690,916
    
    
    
    5,560,470
    
    
    
    20,174,095
    
    
    
    17,700,437Gas transmission and compression
    
    
    1,793,970
    
    
    
    1,564,662
    
    
    
    5,628,950
    
    
    
    3,642,818Total revenue
    
    
    15,215,815
    
    
    
    14,851,464
    
    
    
    49,238,897
    
    
    
    60,510,361DIRECT EXPENSESContract drilling
    
    
    5,291,342
    
    
    
    6,180,299
    
    
    
    18,391,079
    
    
    
    30,723,788Oil and gas production
    
    
    1,873,413
    
    
    
    1,517,471
    
    
    
    5,355,613
    
    
    
    4,500,879Gas transmission and compression
    
    
    783,970
    
    
    
    532,650
    
    
    
    2,663,406
    
    
    
    1,706,948Impairment of oil and gas assets
    
    
    
    
    
    
    
    
    
    
    964,000
    
    
    
    Total direct expenses
    
    
    7,948,725
    
    
    
    8,230,420
    
    
    
    27,374,098
    
    
    
    36,931,615OTHER EXPENSES (INCOME)Selling, general and administrative
    
    
    2,572,348
    
    
    
    2,635,522
    
    
    
    9,636,594
    
    
    
    10,274,430Options, warrants and deferred compensation
    
    
    261,327
    
    
    
    363,167
    
    
    
    931,627
    
    
    
    1,211,701Depreciation, depletion and amortization
    
    
    2,493,219
    
    
    
    1,935,318
    
    
    
    7,160,865
    
    
    
    5,437,808Bad debt expense
    
    
    215,000
    
    
    
    
    
    
    
    215,000
    
    
    
    Interest expense
    
    
    1,834,852
    
    
    
    1,299,635
    
    
    
    4,593,824
    
    
    
    2,989,088Interest income
    
    
    (81,063
    )
    
    
    (68,881
    )
    
    
    (214,806
    )
    
    
    (288,765
    )Other, net
    
    
    (96,385
    )
    
    
    (159,553
    )
    
    
    41,520
    
    
    
    (32,165
    )Total other expenses
    
    
    7,199,298
    
    
    
    6,005,208
    
    
    
    22,364,624
    
    
    
    19,592,097INCOME (LOSS) BEFORE INCOME TAXES
    
    
    67,792
    
    
    
    615,836
    
    
    
    (499,825
    )
    
    
    3,986,649DEFERRED INCOME TAX EXPENSE
    
    
    126,356
    
    
    
    479,877
    
    
    
    573,427
    
    
    
    2,502,000NET INCOME (LOSS)
    
    $
    (58,564
    )
    
    $
    135,959
    
    
    $
    (1,073,252
    )
    
    $
    1,484,649NET INCOME (LOSS) PER SHAREBasic
    
    $
    0.00
    
    
    $
    0.01
    
    
    $
    (0.05
    )
    
    $
    0.07Diluted
    
    $
    0.00
    
    
    $
    0.01
    
    
    $
    (0.05
    )
    
    $
    0.06WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING:Basic
    
    
    21,804,959
    
    
    
    21,552,294
    
    
    
    21,798,275
    
    
    
    21,462,856Diluted
    
    
    21,804,959
    
    
    
    22,858,854
    
    
    
    21,798,275
    
    
    
    22,981,498
 See accompanying notes.
 2




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##### Table of Contents



NGAS Resources, Inc.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 Three Months Ended
    
    
    Nine months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006OPERATING ACTIVITIESNet income (loss)
    
    $
    (58,564
    )
    
    $
    135,959
    
    
    $
    (1,073,252
    )
    
    $
    1,484,649Adjustments to reconcile net income to net cash
provided by (used in) operating activities:Incentive bonus paid in common shares
    
    
    
    
    
    
    33,200
    
    
    
    3,010
    
    
    
    324,232Compensation from options and warrants
    
    
    261,327
    
    
    
    363,167
    
    
    
    931,627
    
    
    
    1,211,701Depreciation, depletion and amortization
    
    
    2,493,219
    
    
    
    1,935,318
    
    
    
    7,160,865
    
    
    
    5,437,808Impairment of oil and gas assets
    
    
    
    
    
    
    
    
    
    
    964,000
    
    
    
    Bad debt expense
    
    
    215,000
    
    
    
    
    
    
    
    215,000
    
    
    
    Loss (gain) on sale of assets
    
    
    (28,834
    )
    
    
    (497,800
    )
    
    
    49,307
    
    
    
    (474,827
    )Deferred income taxes
    
    
    126,356
    
    
    
    479,857
    
    
    
    573,427
    
    
    
    2,501,980Changes in assets and liabilitiesAccounts receivable
    
    
    800,805
    
    
    
    (4,496,175
    )
    
    
    1,944,462
    
    
    
    (7,591,782
    )Prepaid expenses and other current assets
    
    
    65,317
    
    
    
    (289,507
    )
    
    
    307,937
    
    
    
    1,972,662Other non-current assets
    
    
    116,221
    
    
    
    42,146
    
    
    
    (751,737
    )
    
    
    (719,674
    )Accounts payable
    
    
    808,096
    
    
    
    (944,211
    )
    
    
    (1,819,754
    )
    
    
    1,708,422Accrued liabilities
    
    
    (59,711
    )
    
    
    (719,353
    )
    
    
    (538,872
    )
    
    
    131,703Customers drilling deposits
    
    
    (4,380,328
    )
    
    
    198,148
    
    
    
    (11,686,100
    )
    
    
    (20,532,401
    )Net cash provided by (used in)
operating activities
    
    
    358,904
    
    
    
    (3,759,251
    )
    
    
    (3,720,080
    )
    
    
    (14,545,527
    )INVESTING ACTIVITIESProceeds from sale of assets
    
    
    355,000
    
    
    
    505,800
    
    
    
    389,700
    
    
    
    510,243Purchase of property and equipment
    
    
    (340,590
    )
    
    
    (204,703
    )
    
    
    (1,327,094
    )
    
    
    (694,395
    )Change in bonds and deposits
    
    
    105,500
    
    
    
    (90,000
    )
    
    
    68,500
    
    
    
    (101,000
    )Additions to oil and gas properties
    
    
    (13,187,693
    )
    
    
    (7,884,577
    )
    
    
    (38,711,872
    )
    
    
    (42,929,221
    )Net cash used in investing activities
    
    
    (13,067,783
    )
    
    
    (7,673,480
    )
    
    
    (39,580,766
    )
    
    
    (43,214,373
    )FINANCING ACTIVITIESDecrease in loans to related parties
    
    
    1,889
    
    
    
    1,798
    
    
    
    5,599
    
    
    
    24,214Proceeds from issuance of common shares
    
    
    151,250
    
    
    
    609,039
    
    
    
    191,550
    
    
    
    896,665Payments of deferred financing costs
    
    
    
    
    
    
    (354,819
    )
    
    
    
    
    
    
    (429,819
    )Proceeds from issuance of long term debt
    
    
    15,100,000
    
    
    
    10,000,000
    
    
    
    34,100,000
    
    
    
    39,000,000Payments of long term debt
    
    
    (6,000
    )
    
    
    (6,000
    )
    
    
    (18,000
    )
    
    
    (18,000
    )Net cash provided by financing activities
    
    
    15,247,139
    
    
    
    10,250,018
    
    
    
    34,279,149
    
    
    
    39,473,060Change in cash
    
    
    2,538,260
    
    
    
    (1,182,713
    )
    
    
    (9,021,697
    )
    
    
    (18,286,840
    )Cash, beginning of period
    
    
    2,872,020
    
    
    
    6,840,125
    
    
    
    14,431,977
    
    
    
    23,944,252Cash, end of period
    
    $
    5,410,280
    
    
    $
    5,657,412
    
    
    $
    5,410,280
    
    
    $
    5,657,412SUPPLEMENTAL DISCLOSUREInterest paid
    
    $
    1,754,715
    
    
    $
    1,108,638
    
    
    $
    4,512,167
    
    
    $
    2,901,841Income taxes paid
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 See accompanying notes.
 3




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##### Table of Contents



NGAS Resources, Inc.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 Note 1. Summary of Significant Accounting Policies
 General NGAS U.S. GAAP
 Basis of Presentation DPI Company we our us
 Estimates .
 Note 2. Oil and Gas Properties
 Capitalized Costs and DD&A DD&A
 September 30,
    
    
    December 31,2007
    
    
    2006Proved oil and gas properties
    
    $
    140,614,887
    
    
    $
    110,169,303Unproved oil and gas properties
    
    
    3,655,147
    
    
    
    3,000,465Gathering facilities and well equipment
    
    
    53,017,463
    
    
    
    46,369,858197,287,497
    
    
    
    159,539,626Accumulated DD&A
    
    
    (21,492,093
    )
    
    
    (15,322,094
    )Net oil and gas properties and equipment
    
    $
    175,795,404
    
    
    $
    144,217,532
 4




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##### Table of Contents



Suspended Well Costs Accounting for Suspended Well
Costs
 Note 3. Property and Equipment
  September 30,
    
    
    December 31,2007
    
    
    2006Land
    
    $
    12,908
    
    
    $
    12,908Building improvements
    
    
    58,051
    
    
    
    48,350Machinery and equipment
    
    
    3,065,599
    
    
    
    2,680,174Office furniture and fixtures
    
    
    163,726
    
    
    
    129,031Computer and office equipment
    
    
    564,573
    
    
    
    569,877Vehicles
    
    
    1,767,035
    
    
    
    1,607,5545,631,892
    
    
    
    5,047,894Accumulated depreciation
    
    
    (1,974,221
    )
    
    
    (1,705,323
    )Net other property and equipment
    
    $
    3,657,671
    
    
    $
    3,342,571
 Note 4. Deferred Financing Costs
  Note 5. Goodwill
 Goodwill and Other Intangible Assets
 Note 6. Customer Drilling Deposits
  5




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##### Table of Contents



Note 7. Long Term Debt
 Convertible Notes
 Credit Facility
 Equipment Loan
 Acquisition Debt
 Total Long Term Debt and Maturities
 Principal Amount OutstandingSeptember 30,
    
    
    December 31,2007
    
    
    2006Total long term debt (including current portion)(1)
    
    $
    101,293,383
    
    
    $
    66,946,744Less current portion
    
    
    379,824
    
    
    
    24,000Total long term debt(1)
    
    $
    100,913,559
    
    
    $
    66,922,744Maturities of DebtRemainder of 2007
    
    $
    92,3142008
    
    
    386,9882009
    
    
    417,1162010
    
    
    36,318,3102011 and thereafter
    
    
    64,078,655
 
 (1)
    
    Reflects allocations of $1,131,435 at September 30, 2007 and $1,396,074 at December 31, 2006
from our 6% convertible notes in the principal amount of $37,000,000 based on equity
components of their conversion features. 6




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##### Table of Contents



Note 8. Capital Stock
 Authorized Shares
 Number ofShares
    
    
    AmountCommon Shares IssuedBalance, December 31, 2005
    
    
    21,357,628
    
    
    $
    82,371,189Issued to employees as incentive bonus
    
    
    65,945
    
    
    
    468,612Issued upon exercise of stock options and warrants
    
    
    336,106
    
    
    
    1,472,026Issued for contract settlement
    
    
    28,872
    
    
    
    220,005Balance, December 31, 2006
    
    
    21,788,551
    
    
    
    84,531,832Issued to employees as incentive bonus
    
    
    430
    
    
    
    3,010Issued upon exercise of stock options and warrants
    
    
    55,000
    
    
    
    220,100Balance, September 30, 2007
    
    
    21,843,981
    
    
    $
    84,754,942Paid In Capital  Options and WarrantsBalance, December 31, 2005
    
    
    
    
    
    $
    2,743,806Recognized
    
    
    
    
    
    
    975,468Expired
    
    
    
    
    
    
    (565,946
    )Accreted(1)
    
    
    
    
    
    
    (80,041
    )Balance, December 31, 2006
    
    
    
    
    
    
    3,073,287Recognized
    
    
    
    
    
    
    494,221Exercised
    
    
    
    
    
    
    (28,550
    )Balance, September 30, 2007
    
    
    
    
    
    $
    3,538,958Contributed SurplusBalance, December 31, 2005
    
    
    
    
    
    $
    1,748,926Accreted(1)
    
    
    
    
    
    
    (352,852
    )Balance, December 31, 2006
    
    
    
    
    
    
    1,396,074Accreted(1)
    
    
    
    
    
    
    (264,639
    )Balance, September 30, 2007
    
    
    
    
    
    
    1,131,435Common Shares to be IssuedBalance, September 30, 2007 and December 31, 2006
    
    
    9,185
    
    
    $
    45,925
 
 (1)
    
    Reflects accretion of the equity components allocated to our 6% convertible notes and related
warrants issued in 2005. Stock Options and Awards
 7




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##### Table of Contents



Options
    
    
    Options
    
    
    Weighted AverageOutstanding
    
    
    Exercisable
    
    
    Exercise PriceBalance, December 31, 2005
    
    
    2,985,000
    
    
    
    571,250
    
    
    $
    4.67Vested
    
    
    
    
    
    
    509,583
    
    
    
    4.26Exercised
    
    
    (135,000
    )
    
    
    (135,000
    )
    
    
    4.05Forfeited
    
    
    (35,000
    )
    
    
    
    
    
    
    6.02Balance, December 31, 2006
    
    
    2,815,000
    
    
    
    945,833
    
    
    
    4.68Vested
    
    
    
    
    
    
    920,833
    
    
    
    6.03Exercised
    
    
    (45,000
    )
    
    
    (45,000
    )
    
    
    3.36Balance, September 30, 2007
    
    
    2,770,000
    
    
    
    1,821,666
    
    
    
    4.70
  Options Outstanding
    
    Options ExercisableWeighted
    
    Weighted
    
    
    
    
    
    WeightedExercise
    
    
    
    
    
    Average
    
    Average
    
    
    
    
    
    AveragePrice
    
    
    
    
    
    Remaining
    
    Exercise
    
    
    
    
    
    Exerciseor Range
    
    Number
    
    Life (years)
    
    Price
    
    Number
    
    Price$1.02
    
    
    135,000
    
    
    
    0.26
    
    
    $
    1.02
    
    
    
    135,000
    
    
    $
    1.024.03 4.09
    
    
    1,810,000
    
    
    
    2.01
    
    
    
    4.05
    
    
    
    1,010,000
    
    
    
    4.066.02 7.04
    
    
    825,000
    
    
    
    2.80
    
    
    
    6.74
    
    
    
    676,666
    
    
    
    6.022,770,000
    
    
    
    
    
    
    
    
    
    
    
    1,821,666
 Share-Based Payment
 Common Stock Purchase Warrants
 Note 9. Income (Loss) Per Share
 EPS
 8




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,Diluted EPS
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Numerator:Net income (loss) as reported for basic EPS
    
    $
    (58,564
    )
    
    $
    135,959
    
    
    $
    (1,073,252
    )
    
    $
    1,484,649Adjustments for diluted EPS
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss) for diluted EPS
    
    $
    (58,564
    )
    
    $
    135,959
    
    
    $
    (1,073,252
    )
    
    $
    1,484,649Denominator:Weighted average shares for basic EPS
    
    
    21,804,959
    
    
    
    21,552,294
    
    
    
    21,798,275
    
    
    
    21,462,856Effect of dilutive securities:Stock options
    
    
    
    
    
    
    1,239,174
    
    
    
    
    
    
    
    1,361,171Warrants
    
    
    
    
    
    
    67,386
    
    
    
    
    
    
    
    157,471Adjusted weighted average shares and
assumed conversions for diluted EPS
    
    
    21,804,959
    
    
    
    22,858,854
    
    
    
    21,798,275
    
    
    
    22,981,498Basic EPS
    
    $
    0.00
    
    
    $
    0.01
    
    
    $
    (0.05
    )
    
    $
    0.07Diluted EPS
    
    $
    0.00
    
    
    $
    0.01
    
    
    $
    (0.05
    )
    
    $
    0.06
 Note 10. Segment Information
 Disclosure about
Segments of an Enterprise and Related Information
 Note 11. Commitments
  Commercial CommitmentsOperating
    
    
    OtherYear
    
    Leases
    
    
    Commitments
    
    
    TotalRemainder of 2007
    
    $
    548,216
    
    
    $
    240,000
    (1)
    
    $
    788,2162008
    
    
    1,920,596
    
    
    
    100,000
    (2)
    
    
    2,020,5962009
    
    
    1,776,054
    
    
    
    2,045,000
    (2)
    
    
    3,821,0542010
    
    
    1,706,974
    
    
    
    
    
    
    
    1,706,9742011 and thereafter
    
    
    1,847,021
    
    
    
    
    
    
    
    1,847,021Total
    
    $
    7,798,861
    
    
    $
    2,385,000
    
    
    $
    10,183,861
 
 (1)
    
    Reflects obligations under a guaranty secured by a certificate of deposit provided for bank
debt of Galax Energy Concepts, LLC, a limited liability company in which DPI previously held a
minority interest.(2)
    
    Reflects commitments under a purchase contract for an airplane. Note 12. Recent Accounting Standards
 EITF 6-11 FASB EITF Accounting for Income
Tax Benefits of Dividends on Share-Based Payment Awards
 9




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##### Table of Contents



FSP No. FIN 481 FSP Definition of Settlement in FASB Interpretation No. 48
 EITF 6-10 Accounting for the Deferred Compensation and Post Retirement Benefit Aspects of
Collateral Assignment Split-Dollar Life Insurance Arrangements
 SFAS No. 159 The Fair Value Option
for Financial Assets and Financial Liabilities
 SAB No. 108 SAB Considering the Effects of Prior Year Misstatements
when Quantifying Misstatements in Current Year Financial Statements
 SFAS No. 158 Employers Accounting
for Defined Benefit Pension and Other Postretirement Plans
 SFAS No. 157 Fair Value
Measurements
 FSP AUG AIR1 Accounting for
Planned Major Maintenance Activities
 10




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##### Table of Contents



NGAS Resources, Inc.
 
 Item 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 General
  NGAS we our us Dth Mcf Bcf Mcfe Bcfe
 Strategy
  
    
    Organic Growth through Drilling. Development drilling is our mainstay for
production and reserve growth. As of September 30, 2007, we had interests in a total of
1,179 wells, concentrated in operated properties within the Appalachian basin. We believe
our long and successful operating history in Appalachia and proven ability to drill a large
number of wells year after year have positioned us as a leading player in this region. We
participated in 226 gross (65.4577 net) wells during 2006 and an additional 169 gross
(60.2608 net) wells in the first nine months of 2007. The increase in our net well
position this year reflects our strategy for accelerating organic growth by retaining
larger working interests in new wells drilled on our key operated properties and limiting
our reliance on new drilling programs to participation in non-operated initiatives. A
majority of the acreage in our major fields is undeveloped, providing us with a multi-year
inventory of drilling locations for future development.
    
    Investment in Midstream Assets. We own and operate a strategically located
open-access gas gathering system spanning 116 miles in southeastern Kentucky and
southwestern Virginia. We acquired these midstream assets in March 2006 through our NGAS
Gathering subsidiary for $18 million. We operated this system since October 2004 and
augmented it after the acquisition through two high-pressure lateral upgrades. Ownership
of these facilities compliments our field-wide Appalachian gathering systems, expanding our
total gathering position to 578 miles as of September 30, 2007. We currently move
production from our Leatherwood, Straight Creek and SME fields for delivery through the
NGAS Gathering system, which has daily gross throughput of over 18,500 Dth, including
third-party deliveries. In addition to generating gas transmission and compression
revenues from third-party throughput and cost savings for our own Appalachian production,
ownership of these assets gives us control over gas flow from our connected fields and
enhances our competitive position in the region.
 11




---



##### Table of Contents




    
    Addition of Gas Processing and Treatment Facilities. Early in the fourth
quarter of 2007, we completed arrangements with a joint venture partner, Seminole Gas
Company, for construction of a natural gas processing plant in southern Appalachia and a
separate treatment facility for production from our New Albany shale project in the
Illinois basin. The processing plant will be located in Rogersville, Tennessee, with a
connection to a pipeline network operated by East Tennessee Natural Gas, LLC. The plant
will extract natural gas liquids from local production serviced by the NGAS Gathering
system and flow dry pipeline quality natural gas into the interstate system at rates up to
25,000 Mcf per day, which can be increased to accommodate forecasted production growth and
relief of constrained regional supplies. This initiative will enhance our growth potential
in the region, while increasing supply options and reliability for pipeline shippers and
customers. Our arrangements with Seminole also include construction of a nitrogen
rejection facility to service our New Albany shale development project in northern
Christian County, Kentucky. Both initiatives are scheduled for completion near year-end
and will be co-owned and operated for us by Seminole.
    
    Extension of Infrastructure. We continually upgrade our field-wide gas
gathering and compression facilities for our Appalachian properties to keep pace with our
expanding production base. Because we control third-party access to these facilities, they
provide us with competitive advantages in acquiring and developing nearby acreage. Our
field-wide systems spanned 462 miles at September 30, 2007, including 103 miles of
production lines installed in 2006 and 48 miles in the first nine months this year. Recent
additions to our infrastructure include facilities that have enabled us to bring
unconnected wells in our Leatherwood field on line sequentially for compression into the
NGAS Gathering system and to enhance flow rates from new Leatherwood wells. We are also
extending our infrastructure in our Fonde field to provide deliverability from through a
14-mile, six-inch steel line to our midstream system. Production in Fonde has historically
been limited by pipeline capacity constraints. When completed, our new system will enable
us to begin connecting a backlog of wells drilled in Fonde and open nearly 50,000 acres for
future development in this field.
    
    Development of Additional Drilling Prospects. We follow a disciplined capital
allocation process in selecting opportunities to build our substantial inventory of
drilling prospects that meet our criteria for predictable, long-lived reserves. Our goal
is to consolidate our position in the Appalachian basin, while diversifying our prospect
inventory outside the basin with similar unconventional plays. In implementing this
strategy, we have entered the second phase of an exploratory project to test the New Albany
shale on acquired acreage in the central Kentucky portion of the Illinois basin. See
Drilling Operations. In addition, as a potential foundation for further extending our
operating reach, we recently acquired exclusive development rights and a 50% interest in
currently constrained gathering infrastructure for a project spanning up to 100,000 acres
across six counties in eastern Kentucky, where we are conducting a geological evaluation of
data from existing wells. We have also implemented initiatives to leverage our core
expertise with evolving technologies in horizontal and directional drilling, which may
provide advantages in extracting tight gas from unconventional formations. The initial
projects are being conducted in the Arkoma basin for coalbed methane (CBM) recovery and in
West Virginia and Buchanan County, Virginia on acreage controlled by a joint venture
partner. We plan to continue capitalizing on opportunities to assemble or participate in
developing large tracts with significant reserve potential.
    
    Purchase of Producing Properties. The purchase of third-party production
offers a means in addition to drilling for capitalizing on our operating experience and
accelerating our growth. Our acquisition criteria for producing properties include reserve
life, profit enhancement potential, existing infrastructure, geographic concentration and
working interest levels permitting operation of acquired properties. Based on our current
evaluations, we believe our mature drilling programs present attractive acquisition
candidates, providing opportunities to increase our interest in producing properties
meeting all these criteria. We plan to implement a strategy to begin purchasing the assets
of targeted programs based on independent reserve valuations that will give effect to our
working interests and reversionary interests in these programs. The consolidation of these
assets is expected to increase our reserves and cash flows, while also generating
administrative efficiencies and simplifying our capital structure.
 Regional Advantages
 Geographic
 12




---



##### Table of Contents



Geological
 Drilling Operations
 Drilling Results
 Development Wells
    
    
    
    
    
    
    
    
    
    Exploratory WellsProductive
    
    Dry
    
    Productive
    
    DryGross
    
    Net
    
    Gross
    
    Gross
    
    Net
    
    GrossYear ended December 31, 2006
    
    
    193
    
    
    
    56.3007
    
    
    
    
    
    
    
    4
    
    
    
    3.1250
    
    
    
    29Nine months ended
September 30, 2007
    
    
    163
    
    
    
    54.2608
    
    
    
    
    
    
    
    6
    
    
    
    6.0000
    
    
    
    
  Production Volumes and Sales Prices
 13




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##### Table of Contents



Nine Months Ended
    
    
    Year EndedSeptember 30,
    
    
    December 31,Production volumes:
    
    2007
    
    
    2006
    
    
    2006Natural gas (Mcf)
    
    
    2,109,831
    
    
    
    1,914,458
    
    
    
    2,622,474Oil (Bbl)
    
    
    44,398
    
    
    
    28,564
    
    
    
    40,938Equivalents (Mcfe)
    
    
    2,376,219
    
    
    
    2,085,840
    
    
    
    2,868,102Average sales prices:Natural gas (per Mcf)
    
    $
    8.25
    
    
    $
    8.27
    
    
    $
    8.23Oil (per Bbl)
    
    
    58.99
    
    
    
    60.24
    
    
    
    59.60
 Participation Rights
 Results of Operations  Three Months Ended September 30, 2007 and 2006
 Revenues
 Three Months Ended September 30,% of
    
    
    
    
    
    
    %Revenue:
    
    2007
    
    
    Revenue
    
    
    2006
    
    
    ChangeContract drilling
    
    $
    6,730,929
    
    
    
    44
    %
    
    $
    7,726,332
    
    
    
    (13
    )%Oil and gas production
    
    
    6,690,916
    
    
    
    44
    
    
    
    5,560,470
    
    
    
    20Gas transmission and compression
    
    
    1,793,970
    
    
    
    12
    
    
    
    1,564,662
    
    
    
    15Total
    
    $
    15,215,815
    
    
    
    100
    %
    
    $
    14,851,464
    
    
    
    2
    %
    14




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##### Table of Contents



Expenses
 Three Months Ended September 30,2007
    
    
    Margin
    
    
    2006
    
    
    MarginDirect Expenses:Contract drilling
    
    $
    5,291,342
    
    
    
    21
    %
    
    $
    6,180,299
    
    
    
    20
    %Oil and gas production
    
    
    1,873,413
    
    
    
    72
    
    
    
    1,517,471
    
    
    
    73Gas transmission and compression
    
    
    783,970
    
    
    
    56
    
    
    
    532,650
    
    
    
    66Total direct expenses
    
    
    7,948,725
    
    
    
    48
    
    
    
    8,230,420
    
    
    
    45
 % Revenue
    
    
    
    
    
    
    % RevenueOther Expenses:Selling, general and administrative
    
    
    2,572,348
    
    
    
    17
    %
    
    
    2,635,522
    
    
    
    18
    %Options, warrants and deferred compensation
    
    
    261,327
    
    
    
    2
    
    
    
    363,167
    
    
    
    2Depreciation, depletion and amortization
    
    
    2,493,219
    
    
    
    16
    
    
    
    1,935,318
    
    
    
    13Bad debt expense
    
    
    215,000
    
    
    
    1
    
    
    
    
    
    
    
    N/AInterest expense, net of interest income
    
    
    1,753,789
    
    
    
    12
    
    
    
    1,230,754
    
    
    
    8Other, net
    
    
    (96,385
    )
    
    
    N/A
    
    
    
    (159,553
    )
    
    
    N/ATotal other expenses
    
    $
    7,199,298
    
    
    
    
    
    
    $
    6,005,208
    SG&A
 15




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##### Table of Contents



DD&A
    Net Income and EPS EPS
 Results of Operations  Nine Months Ended September 30, 2007 and 2006
 Revenues
 Nine Months Ended September 30,% of
    
    
    
    
    
    
    %Revenue:
    
    2007
    
    
    Revenue
    
    
    2006
    
    
    ChangeContract drilling
    
    $
    23,435,852
    
    
    
    48
    
    
    $
    39,167,106
    
    
    
    (40
    )%Oil and gas production
    
    
    20,174,095
    
    
    
    41
    
    
    
    17,700,437
    
    
    
    14Gas transmission and compression
    
    
    5,628,950
    
    
    
    11
    
    
    
    3,642,818
    
    
    
    55Total
    
    $
    49,238,897
    
    
    
    100
    %
    
    $
    60,510,361
    
    
    
    (19
    )%
   16




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##### Table of Contents



Expenses
 Nine Months Ended September 30,2007
    
    
    Margin
    
    
    2006
    
    
    MarginDirect Expenses:Contract drilling
    
    $
    18,391,079
    
    
    
    22
    %
    
    $
    30,723,788
    
    
    
    22
    %Oil and gas production
    
    
    5,355,613
    
    
    
    73
    
    
    
    4,500,879
    
    
    
    75Gas transmission and compression
    
    
    2,663,406
    
    
    
    53
    
    
    
    1,706,948
    
    
    
    53Impairment of oil and gas assets
    
    
    964,000
    
    
    
    N/A
    
    
    
    
    
    
    
    N/ATotal direct expenses
    
    
    27,374,098
    
    
    
    44
    
    
    
    36,931,615
    
    
    
    39
 % Revenue
    
    
    
    
    
    
    % RevenueOther Expenses:Selling, general and administrative
    
    
    9,636,594
    
    
    
    20
    %
    
    
    10,274,430
    
    
    
    17
    %Options, warrants and deferred compensation
    
    
    931,627
    
    
    
    2
    
    
    
    1,211,701
    
    
    
    2Depreciation, depletion and amortization
    
    
    7,160,865
    
    
    
    15
    
    
    
    5,437,808
    
    
    
    9Bad debt expense
    
    
    215,000
    
    
    
    
    
    
    
    
    
    
    
    N/AInterest expense, net of interest income
    
    
    4,379,018
    
    
    
    9
    
    
    
    2,700,323
    
    
    
    4Other, net
    
    
    41,520
    
    
    
    
    
    
    
    (32,165
    )
    
    
    N/ATotal other expenses
    
    $
    22,364,624
    
    
    
    
    
    
    $
    19,592,097
     17




---



##### Table of Contents



Net Income and EPS
  Liquidity and Capital Resources
 Liquidity
 Capital Resources
  18




---



##### Table of Contents



Contractual Obligations and Commercial Commitments
  19




---



##### Table of Contents



Operating Leases
    
    
    Other
    
    
    Long TermYear
    
    Equipment
    
    
    Premises
    
    
    Total
    
    
    Commitments
    
    
    DebtRemainder of 2007
    
    $
    485,191
    
    
    $
    63,025
    
    
    $
    548,216
    
    
    $
    240,000
    (1)
    
    $
    92,3142008
    
    
    1,899,588
    
    
    
    21,008
    
    
    
    1,920,596
    
    
    
    100,000
    (2)
    
    
    386,9882009
    
    
    1,776,054
    
    
    
    
    
    
    
    1,776,054
    
    
    
    2,045,000
    (2)
    
    
    417,1162010
    
    
    1,706,974
    
    
    
    
    
    
    
    1,706,974
    
    
    
    
    
    
    
    36,318,310
    (3)2011 and thereafter
    
    
    1,847,021
    
    
    
    
    
    
    
    1,847,021
    
    
    
    
    
    
    
    64,078,655Total
    
    $
    7,714,828
    
    
    $
    84,033
    
    
    $
    7,798,861
    
    
    $
    2,385,000
    
    
    $
    101,293,383
 
 (1)
    
    Reflects obligations under a guaranty secured by a certificate of deposit provided for bank
debt of Galax Energy Concepts, LLC, a limited liability company in which DPI previously held a
minority interest.(2)
    
    Reflects commitments under a purchase contract for an airplane.(3)
    
    Excludes an allocation of $1,131,435 from our 6% convertible notes in the principal amount of
$37,000,000 based on equity components of their conversion features. Critical Accounting Policies and Estimates
 General
 Allowance for Doubtful Accounts .
 Impairment of Long-Lived Assets .
 Forward Looking Statements and Risk Factors
  
 Item 3. Quantitative and Qualitative Disclosures about Market Risk
  20




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##### Table of Contents



Item 4. Controls and Procedures
   
 PART II. OTHER INFORMATION
 
 Item 6. Exhibits
 ExhibitNumber
    
    Description of Exhibit3.1
    
    
    Notice of Articles, certified on June 3, 2004 by the Registrar of Corporations under the
British Columbia Business Corporations Act (incorporated by reference to Exhibit 3.1 to
Current Report on Form 8-K [File No. 0-12185], filed June 29, 2004).3.2
    
    
    Alteration to Notice of Articles, certified on June 25, 2004 by the Registrar of
Corporations under the British Columbia Business Corporations Act (incorporated by reference
to Exhibit 3.2 to Current Report on Form 8-K [File No. 0-12185], filed June 29, 2004).3.3
    
    
    Articles dated June 25, 2004, as amended and restated for corporate transition under the
British Columbia Business Corporations Act (incorporated by reference to Exhibit 3.3 to
Current Report on Form 8-K [File No. 0-12185], filed June 29, 2004).10.1
    
    
    1997 Stock Option Plan (incorporated by reference to Exhibit 10[a] to Annual Report on
Form 10-KSB [File No. 0-12185] for the year ended December 31, 2002).10.2
    
    
    2001 Stock Option Plan (incorporated by reference to Exhibit 10[b] to Annual Report on
Form 10-KSB [File No. 0-12185] for the year ended December 31, 2002).10.3
    
    
    2003 Incentive Stock and Stock Option Plan (incorporated by reference to Exhibit 10.3 to
Quarterly Report on Form 10-QSB [File No. 0-12185] for the quarter ended March 31, 2004).10.4
    
    
    Asset Purchase and Sale Agreement dated as of January 17, 2006 among Duke Energy Gas
Services, LLC, NGAS Gathering, LLC and Daugherty Resources, Inc. (incorporated by reference
to Exhibit 10.1 to current report on Form 8-K [File No. 0-12185] dated January 19, 2006).
 21




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibit10.5
    
    
    Securities Purchase Agreement dated as of December 13, 2005 among NGAS Resources, Inc. and
the investors named therein (incorporated by reference to Exhibit 10.1 to current report on
Form 8-K [File No. 0-12185] dated December 14, 2005).10.6
    
    
    Form of 6% convertible notes issued pursuant to the Securities Purchase Agreement dated as
of December 13, 2005 among NGAS Resources, Inc. and the investors named therein (incorporated
by reference to Exhibit 10.2 to current report on Form 8-K [File No. 0-12185] dated
December 14, 2005).10.7
    
    
    Credit Agreement dated as of September 8, 2006 among NGAS Resources, Inc., Daugherty
Petroleum, Inc. and KeyBank National Association, as agent for the lenders named therein
(incorporated by reference to Exhibit 10.1 to current report on Form 8-K [File No. 0-12185]
dated September 8, 2006).10.8
    
    
    Form of Change of Control Agreement dated as of February 25, 2004 (incorporated by
reference to Exhibit 10.9 to quarterly report on Form 10-QSB [File No. 0-12185] for the
quarter ended March 31, 2004).10.9
    
    
    Form of Indemnification Agreement dated as of February 25, 2004 (incorporated by reference
to Exhibit 10.10 to quarterly report on Form 10-QSB [File No. 0-12185] for the quarter ended
March 31, 2004).10.10
    
    
    Form of Long Term Incentive Agreement dated as of February 25, 2004 (incorporated by
reference to Exhibit 10.11 to quarterly report on Form 10-QSB [File No. 0-12185] for the
quarter ended March 31, 2004).10.11
    
    
    Form of general partnership agreement with sponsored drilling programs (incorporated by
reference to Exhibit 10.11 to amended annual report on Form 10-K/A [File No. 0-12185] for the
year ended December 31, 2006).10.12
    
    
    Form of limited partnership agreement with sponsored investment partnerships (incorporated
by reference to Exhibit 10.12 to amended annual report on Form 10-K/A [File No. 0-12185] for
the year ended December 31, 2006).10.13
    
    
    Form of assignment of drilling rights with sponsored drilling programs (incorporated by
reference to Exhibit 10.13 to amended annual report on Form 10-K/A [File No. 0-12185] for the
year ended December 31, 2006).10.14
    
    
    Form of drilling and operating agreement with sponsored drilling programs (incorporated by
reference to Exhibit 10.14 to amended annual report on Form 10-K/A [File No. 0-12185] for the
year ended December 31, 2006).11.1
    
    
    Computation of Earnings Per Share (included in Note 9 to the accompanying consolidated
financial statements)21.0
    
    
    Subsidiaries (incorporated by reference to Exhibit 21.1 to annual report on Form 10-K [File
No. 0-12185] for the year ended December 31, 2006).31.1
    
    
    Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a), as
adopted under Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a), as
adopted under Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    
    Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(b), as
adopted under Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(b), as
adopted under Section 906 of the Sarbanes-Oxley Act of 2002.
 
 22




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##### Table of Contents



SIGNATURES
  NGAS Resources, Inc.Date: November 6, 2007
    By:
    /s/  William S. DaughertyWilliam S. DaughertyChief Executive Officer
(Duly Authorized Officer)
(Principal Executive Officer) 23