##### 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, 2006
 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
    
    Not Applicable(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 120 Prosperous Place, Suite 201Lexington, Kentucky
    
    40509-1844(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (859) 263-3948
  þ o
  o þ o
 o þ
  Title of Class
    
    Outstanding at November 3, 2006Common Stock
    
    21,635,215




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##### 



NGAS Resources, Inc.
 INDEX
 PagePart I. Financial InformationItem 1. Financial Statements:Condensed Consolidated Balance Sheets  September 30, 2006 (unaudited) and December 31, 2005
    
    
    1Condensed Consolidated Statement of Operations  Three months and nine months ended September 30, 2006 and 2005
    
    
    2Condensed Consolidated Statement of Cash Flows  Three months and nine month ended September 30, 2006 and 2005
    
    
    3Notes to Condensed Consolidated Financial Statements
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    22Item 4. Controls and Procedures
    
    
    22PART II. OTHER INFORMATIONItem 6. Exhibits
    
    
    23EX-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
 (Unaudited)
 September 30,
    
    
    December 31,2006
    
    
    2005ASSETSCurrent assets:Cash
    
    $
    5,657,412
    
    
    $
    23,944,252Accounts receivable
    
    
    14,475,482
    
    
    
    6,883,700Prepaid expenses and other current assets
    
    
    1,189,185
    
    
    
    3,161,847Loans to related parties
    
    
    7,147
    
    
    
    26,235Total current assets
    
    
    21,329,226
    
    
    
    34,016,034Bonds and deposits
    
    
    533,695
    
    
    
    432,695Oil and gas properties
    
    
    144,096,561
    
    
    
    105,785,340Property and equipment
    
    
    3,177,635
    
    
    
    2,934,169Loans to related parties
    
    
    259,251
    
    
    
    264,377Deferred financing costs
    
    
    2,403,315
    
    
    
    2,377,791Other non-current assets
    
    
    1,369,674
    
    
    
    650,000Goodwill
    
    
    313,177
    
    
    
    313,177Total assets
    
    $
    173,482,534
    
    
    $
    146,773,583LIABILITIESCurrent liabilities:Accounts payable
    
    $
    7,147,859
    
    
    $
    5,439,437Accrued liabilities
    
    
    5,920,257
    
    
    
    5,788,554Customers drilling deposits
    
    
    3,095,574
    
    
    
    23,627,975Long term debt, current portion
    
    
    24,000
    
    
    
    24,000Total current liabilities
    
    
    16,187,690
    
    
    
    34,879,966Future income taxes
    
    
    6,383,735
    
    
    
    3,881,755Long term debt
    
    
    74,840,531
    
    
    
    34,947,905Deferred compensation
    
    
    1,273,974
    
    
    
    836,568Total liabilities
    
    
    98,685,930
    
    
    
    74,546,194SHAREHOLDERS EQUITYCommon stock, no par value, 100,000,000 shares
authorized, 21,635,215 shares issued
(2005 - 21,357,628)
    
    
    83,592,086
    
    
    
    82,371,18921,100 shares held in treasury, at cost
    
    
    (23,630
    )
    
    
    (23,630
    )Paid-in capital  options and warrants
    
    
    2,872,114
    
    
    
    2,743,806Contributed surplus
    
    
    1,484,287
    
    
    
    1,748,9269,185 shares to be issued
    
    
    45,925
    
    
    
    45,92587,970,782
    
    
    
    86,886,216Accumulated deficit
    
    
    (13,174,178
    )
    
    
    (14,658,827
    )Total shareholders equity
    
    
    74,796,604
    
    
    
    72,227,389Total liabilities and shareholders equity
    
    $
    173,482,534
    
    
    $
    146,773,583
 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 30,2006
    
    
    2005
    
    
    2006
    
    
    2005REVENUEContract drilling
    
    $
    7,726,332
    
    
    $
    10,581,000
    
    
    $
    39,167,106
    
    
    $
    34,897,000Oil and gas production
    
    
    5,560,470
    
    
    
    4,199,754
    
    
    
    17,700,437
    
    
    
    10,583,245Gas transmission and compression
    
    
    1,564,662
    
    
    
    302,694
    
    
    
    3,642,818
    
    
    
    1,049,168Total revenue
    
    
    14,851,464
    
    
    
    15,083,448
    
    
    
    60,510,361
    
    
    
    46,529,413DIRECT EXPENSESContract drilling
    
    
    6,180,299
    
    
    
    8,361,324
    
    
    
    30,723,788
    
    
    
    27,349,389Oil and gas production
    
    
    1,517,471
    
    
    
    1,192,036
    
    
    
    4,500,879
    
    
    
    2,841,551Gas transmission and compression
    
    
    532,650
    
    
    
    252,743
    
    
    
    1,706,948
    
    
    
    880,611Total direct expenses
    
    
    8,230,420
    
    
    
    9,806,103
    
    
    
    36,931,615
    
    
    
    31,071,551OTHER EXPENSES (INCOME)Selling, general and administrative
    
    
    2,635,522
    
    
    
    3,000,577
    
    
    
    10,274,430
    
    
    
    9,019,312Options, warrants and deferred compensation
    
    
    363,167
    
    
    
    362,290
    
    
    
    1,211,701
    
    
    
    853,988Depreciation, depletion and amortization
    
    
    1,935,318
    
    
    
    991,278
    
    
    
    5,437,808
    
    
    
    3,039,366Interest expense
    
    
    1,299,635
    
    
    
    360,605
    
    
    
    2,989,088
    
    
    
    1,424,359Interest income
    
    
    (68,881
    )
    
    
    (79,546
    )
    
    
    (288,765
    )
    
    
    (165,672
    )Other, net
    
    
    (159,553
    )
    
    
    69,626
    
    
    
    (32,165
    )
    
    
    (95,290
    )Total other expenses
    
    
    6,005,208
    
    
    
    4,704,830
    
    
    
    19,592,097
    
    
    
    14,076,063INCOME BEFORE INCOME TAXES
    
    
    615,836
    
    
    
    572,515
    
    
    
    3,986,649
    
    
    
    1,381,799FUTURE INCOME TAX EXPENSE
    
    
    479,877
    
    
    
    385,318
    
    
    
    2,502,000
    
    
    
    993,188NET INCOME
    
    $
    135,959
    
    
    $
    187,197
    
    
    $
    1,484,649
    
    
    $
    388,611NET INCOME PER SHAREBasic
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.07
    
    
    $
    0.02Diluted
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.06
    
    
    $
    0.02WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING:Basic
    
    
    21,552,294
    
    
    
    17,583,061
    
    
    
    21,462,856
    
    
    
    16,432,965Diluted
    
    
    22,858,854
    
    
    
    19,597,136
    
    
    
    22,981,498
    
    
    
    17,722,030
 See accompanying notes.
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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 30,2006
    
    
    2005
    
    
    2006
    
    
    2005OPERATING ACTIVITIESNet income
    
    $
    135,959
    
    
    $
    187,197
    
    
    $
    1,484,649
    
    
    $
    388,611Adjustments to reconcile net income to net cash
provided by (used in) operating activities:Incentive bonus paid in common shares
    
    
    33,200
    
    
    
    683,830
    
    
    
    324,232
    
    
    
    900,856Compensation from options and warrants
    
    
    363,167
    
    
    
    362,290
    
    
    
    1,211,701
    
    
    
    853,988Contract settlement paid in common shares
    
    
    
    
    
    
    90,300
    
    
    
    
    
    
    
    85,875Depreciation, depletion and amortization
    
    
    1,935,318
    
    
    
    991,278
    
    
    
    5,437,808
    
    
    
    3,039,366Write-down of investment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    55,454Gain on sale of assets
    
    
    (497,800
    )
    
    
    (11,962
    )
    
    
    (474,827
    )
    
    
    (24,530
    )Future income taxes
    
    
    479,857
    
    
    
    263,513
    
    
    
    2,501,980
    
    
    
    871,383Changes in assets and liabilitiesAccounts receivable
    
    
    (4,496,175
    )
    
    
    (1,791,503
    )
    
    
    (7,591,782
    )
    
    
    (3,986,885
    )Prepaid expenses and other current assets
    
    
    (289,507
    )
    
    
    (455,484
    )
    
    
    1,972,662
    
    
    
    (1,390,397
    )Other non-current assets
    
    
    42,146
    
    
    
    
    
    
    
    (719,674
    )
    
    
    Accounts payable
    
    
    (944,211
    )
    
    
    1,341,585
    
    
    
    1,708,422
    
    
    
    2,323,067Accrued liabilities
    
    
    (719,353
    )
    
    
    (108,778
    )
    
    
    131,703
    
    
    
    2,120,343Customers drilling deposits
    
    
    198,148
    
    
    
    3,912,000
    
    
    
    (20,532,401
    )
    
    
    11,194,724Net cash provided by (used in) operating activities
    
    
    (3,759,251
    )
    
    
    5,464,266
    
    
    
    (14,545,527
    )
    
    
    16,431,855INVESTING ACTIVITIESProceeds from sale of assets
    
    
    505,800
    
    
    
    84,519
    
    
    
    510,243
    
    
    
    358,119Purchase of property and equipment
    
    
    (204,703
    )
    
    
    (168,829
    )
    
    
    (694,395
    )
    
    
    (897,932
    )Increase in bonds and deposits
    
    
    (90,000
    )
    
    
    (16,000
    )
    
    
    (101,000
    )
    
    
    (263,045
    )Additions to oil and gas properties
    
    
    (7,884,577
    )
    
    
    (7,682,544
    )
    
    
    (42,929,221
    )
    
    
    (21,586,498
    )Net cash used in investing activities
    
    
    (7,673,480
    )
    
    
    (7,782,854
    )
    
    
    (43,214,373
    )
    
    
    (22,389,356
    )FINANCING ACTIVITIESDecrease in loans to related parties
    
    
    1,798
    
    
    
    56,084
    
    
    
    24,214
    
    
    
    179,887Proceeds from issuance of common shares
    
    
    609,039
    
    
    
    4,327,729
    
    
    
    896,665
    
    
    
    5,822,365Payments of deferred financing costs
    
    
    (354,819
    )
    
    
    
    
    
    
    (429,819
    )
    
    
    (451,496
    )Proceeds from issuance of long term debt
    
    
    10,000,000
    
    
    
    
    
    
    
    39,000,000
    
    
    
    6,168,696Payments of long term debt
    
    
    (6,000
    )
    
    
    (11,887
    )
    
    
    (18,000
    )
    
    
    (111,554
    )Net cash provided by financing activities
    
    
    10,250,018
    
    
    
    4,371,926
    
    
    
    39,473,060
    
    
    
    11,607,898Change in cash
    
    
    (1,182,713
    )
    
    
    2,053,338
    
    
    
    (18,286,840
    )
    
    
    5,650,397Cash, beginning of period
    
    
    6,840,125
    
    
    
    15,446,431
    
    
    
    23,944,252
    
    
    
    11,849,372Cash, end of period
    
    $
    5,657,412
    
    
    $
    17,499,769
    
    
    $
    5,657,412
    
    
    $
    17,499,769SUPPLEMENTAL DISCLOSUREInterest paid
    
    $
    1,108,638
    
    
    $
    360,605
    
    
    $
    2,901,841
    
    
    $
    1,467,666Income taxes paid
    
    
    
    
    
    
    40,000
    
    
    
    
    
    
    
    170,000SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING AND FINANCING ACTIVITIESCommon shares issued upon conversion of notes
    
    
    
    
    
    
    7,720,127
    
    
    
    
    
    
    
    8,340,591
 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
 Basis of Presentation
 Change in Accounting Principles .
 Estimates
 Reclassifications and Adjustments
 Note 2. Oil and Gas Properties
  September 30, 2006
    
    
    December 31,Accumulated
    
    
    
    
    
    
    2005Cost
    
    
    DD&A
    
    
    Net
    
    
    NetProved oil and gas properties
    
    $
    109,590,282
    
    
    $
    (10,723,521
    )
    
    $
    98,866,761
    
    
    $
    83,567,982Unproved oil and gas properties
    
    
    3,095,306
    
    
    
    
    
    
    
    3,095,306
    
    
    
    2,434,814Gathering lines and well equipment
    
    
    44,233,336
    
    
    
    (2,098,842
    )
    
    
    42,134,494
    
    
    
    19,782,544Total oil and gas properties
    
    $
    156,918,924
    
    
    $
    (12,822,363
    )
    
    $
    144,096,561
    
    
    $
    105,785,340
 4




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##### Table of Contents



Note 3. Property and Equipment
  September 30, 2006
    
    
    December 31,Accumulated
    
    
    
    
    
    
    2005Cost
    
    
    Depreciation
    
    
    Net
    
    
    NetLand
    
    $
    12,908
    
    
    $
    
    
    
    $
    12,908
    
    
    $
    12,908Building improvements
    
    
    48,350
    
    
    
    (8,982
    )
    
    
    39,368
    
    
    
    29,777Machinery and equipment
    
    
    2,522,036
    
    
    
    (707,700
    )
    
    
    1,814,336
    
    
    
    1,833,591Office furniture and fixtures
    
    
    122,459
    
    
    
    (45,840
    )
    
    
    76,619
    
    
    
    50,830Computer and office equipment
    
    
    535,897
    
    
    
    (284,612
    )
    
    
    251,285
    
    
    
    271,420Vehicles
    
    
    1,498,113
    
    
    
    (514,994
    )
    
    
    983,119
    
    
    
    735,643Total property and equipment
    
    $
    4,739,763
    
    
    $
    (1,562,128
    )
    
    $
    3,177,635
    
    
    $
    2,934,169
 Note 4. Deferred Financing Costs
  Note 5. Goodwill
  Note 6. Customer Drilling Deposits
  Note 7. Long Term Debt
 Convertible Notes
 5




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##### Table of Contents



Credit Facility
 Acquisition Debt
 Total Long Term Debt and Maturities
 Principal Amount OutstandingSeptember 30,
    
    
    December 31,2006
    
    
    2005Total long term debt (including current portion)(1)
    
    $
    74,864,531
    
    
    $
    34,971,905Less current portion
    
    
    24,000
    
    
    
    24,000Total long term debt(1)
    
    $
    74,840,531
    
    
    $
    34,947,905Maturities of DebtRemainder of 2006
    
    $
    6,0002007
    
    
    24,0002008
    
    
    24,0002009
    
    
    24,0002010 and thereafter
    
    
    74,786,531
 
 (1)
    
    Reflects allocations of $1,484,287 at September 30, 2006 and $2,394,913 at December 31,
2005 from our 6% convertible notes in the principal amount of $37,000,000 based on equity
components of their conversion features and related warrants. 6




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##### Table of Contents



Note 8. Capital Stock
 Preferred Shares
 Common Shares
 Number ofShares
    
    
    AmountCommon Shares IssuedBalance, December 31, 2004
    
    
    15,605,208
    
    
    $
    54,929,887Issued to employees as incentive bonus
    
    
    154,415
    
    
    
    900,856Issued upon exercise of stock options and warrants
    
    
    2,143,527
    
    
    
    10,983,938Issued upon conversion of convertible notes
    
    
    3,439,478
    
    
    
    15,466,208Issued for contract settlement
    
    
    15,000
    
    
    
    90,300Balance, December 31, 2005
    
    
    21,357,628
    
    
    
    82,371,189Issued to employees as incentive bonus
    
    
    43,315
    
    
    
    324,232Issued upon exercise of stock options and warrants
    
    
    234,272
    
    
    
    896,665Balance, September 30, 2006
    
    
    21,635,215
    
    
    $
    83,592,086Paid In Capital  Options and WarrantsBalance, December 31, 2004
    
    
    
    
    
    $
    1,796,504Recognized
    
    
    
    
    
    
    1,452,410Exercised
    
    
    
    
    
    
    (505,108
    )Balance, December 31, 2005
    
    
    
    
    
    
    2,743,806Recognized
    
    
    
    
    
    
    774,295Expired
    
    
    
    
    
    
    (565,946
    )Accreted(1)
    
    
    
    
    
    
    (80,041
    )Balance, September 30, 2006
    
    
    
    
    
    $
    2,872,114Contributed SurplusBalance, December 31, 2004
    
    
    
    
    
    $
    Allocated
    
    
    
    
    
    
    1,748,926Balance, December 31, 2005
    
    
    
    
    
    
    1,748,926Accreted(1)
    
    
    
    
    
    
    (264,639
    )Balance, September 30, 2006
    
    
    
    
    
    $
    1,484,287Common Shares to be IssuedBalance, December 31, 2004
    
    
    10,070
    
    
    $
    50,350Contract settlement paid in cash in lieu of common shares
    
    
    (885
    )
    
    
    (4,425
    )Balance, September 30, 2006 and December 31, 2005
    
    
    9,185
    
    
    $
    45,925
 
 (1)
    
    Reflects accretion of the equity components allocated to our 6% convertible notes and
related warrants in 2005. Stock Options and Awards
 7




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##### Table of Contents



Weighted AverageIssued
    
    
    Exercisable
    
    
    Exercise PriceBalance, December 31, 2004
    
    
    2,385,000
    
    
    
    370,000
    
    
    $
    3.58Issued(1)
    
    
    860,000
    
    
    
    
    
    
    
    6.71Exercised
    
    
    (260,000
    )
    
    
    
    
    
    
    1.43Balance, December 31, 2005
    
    
    2,985,000
    
    
    
    571,250
    
    
    
    4.67Vested
    
    
    
    
    
    
    509,583
    
    
    
    4.26Exercised
    
    
    (135,000
    )
    
    
    (135,000
    )
    
    
    4.05Forfeited
    
    
    (35,000
    )
    
    
    
    
    
    
    6.02Balance, September 30, 2006
    
    
    2,815,000
    
    
    
    945,833
    
    
    
    4.68
 
 (1)
    
    Vesting in increments from February 25, 2007 through February 25, 2009.  Options Issued and Outstanding
    
    
    Options ExercisableWeighted
    
    
    Weighted
    
    
    
    
    
    
    WeightedExercise
    
    
    
    
    
    
    Average
    
    
    Average
    
    
    
    
    
    
    AveragePrice
    
    
    
    
    
    
    Remaining
    
    
    Exercise
    
    
    
    
    
    
    Exerciseor Range
    
    
    Number
    
    
    Life (years)
    
    
    Price
    
    
    Number
    
    
    Price$
    
    
    1.02
    
    
    
    145,000
    
    
    
    1.26
    
    
    $
    1.02
    
    
    
    145,000
    
    
    $
    1.024.03
    
    
    4.09
    
    
    
    1,845,000
    
    
    
    3.00
    
    
    
    4.05
    
    
    
    752,500
    
    
    
    4.076.02
    
    
    7.04
    
    
    
    825,000
    
    
    
    3.80
    
    
    
    6.74
    
    
    
    48,333
    
    
    
    6.022,815,000
    
    
    
    
    
    
    
    
    
    
    
    945,833
  Common Stock Purchase Warrants
 Weighted AverageIssued
    
    
    Exercisable
    
    
    Exercise PriceBalance, December 31 2004
    
    
    2,422,055
    
    
    
    2,422,055
    
    
    $
    4.96Issued in financing transactions
    
    
    945,809
    
    
    
    
    
    
    
    13.04Exercised
    
    
    (1,883,527
    )
    
    
    
    
    
    
    5.37Expired
    
    
    (169,954
    )
    
    
    
    
    
    
    2.91Balance, December 31, 2005
    
    
    1,314,383
    
    
    
    1,314,383
    
    
    
    10.46Exercised
    
    
    (99,272
    )
    
    
    
    
    
    
    3.52Expired
    
    
    (1,102,767
    )
    
    
    
    
    
    
    11.59Balance, September 30, 2006
    
    
    112,344
    
    
    
    112,344
    
    
    
    5.51
 8




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##### Table of Contents



Note 9. Income Per Share
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,Diluted EPS
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Numerator:Net income as reported for basic EPS
    
    $
    135,959
    
    
    $
    187,197
    
    
    $
    1,484,649
    
    
    $
    388,611Adjustments to income for diluted EPS
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income for diluted EPS
    
    $
    135,959
    
    
    $
    187,197
    
    
    $
    1,484,649
    
    
    $
    388,611Denominator:Weighted average shares for basic EPS
    
    
    21,552,294
    
    
    
    17,583,061
    
    
    
    21,462,856
    
    
    
    16,432,965Effect of dilutive securities:Stock options
    
    
    1,239,174
    
    
    
    1,281,751
    
    
    
    1,361,171
    
    
    
    899,062Warrants
    
    
    67,386
    
    
    
    732,324
    
    
    
    157,471
    
    
    
    390,003Adjusted weighted average shares and
assumed conversions for diluted EPS
    
    
    22,858,854
    
    
    
    19,597,136
    
    
    
    22,981,498
    
    
    
    17,722,030Basic EPS
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.07
    
    
    $
    0.02Diluted EPS
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.06
    
    
    $
    0.01
 Note 10. Segment Information
  Three Months Ended
    
    
    Nine months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenue, net:Oil and gas development
    
    $
    14,851,464
    
    
    $
    15,083,448
    
    
    $
    60,510,361
    
    
    $
    46,529,413Corporate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    14,851,464
    
    
    
    15,083,448
    
    
    
    60,510,361
    
    
    
    46,529,413DD&A:Oil and gas development
    
    
    1,779,606
    
    
    
    916,266
    
    
    
    4,976,430
    
    
    
    2,781,808Corporate
    
    
    155,712
    
    
    
    75,012
    
    
    
    461,378
    
    
    
    257,558Total
    
    
    1,935,318
    
    
    
    991,278
    
    
    
    5,437,808
    
    
    
    3,039,366Interest expense:Oil and gas development
    
    
    744,635
    
    
    
    160,889
    
    
    
    1,324,088
    
    
    
    686,180Corporate
    
    
    555,000
    
    
    
    199,716
    
    
    
    1,665,000
    
    
    
    738,179Total
    
    
    1,299,635
    
    
    
    360,605
    
    
    
    2,989,088
    
    
    
    1,424,359Net income (loss):Oil and gas development
    
    
    1,047,819
    
    
    
    637,485
    
    
    
    4,080,354
    
    
    
    1,793,411Corporate
    
    
    (911,860
    )
    
    
    (450,288
    )
    
    
    (2,595,705
    )
    
    
    (1,404,800
    )Total
    
    
    135,959
    
    
    
    187,197
    
    
    
    1,484,649
    
    
    
    388,611Capital expenditures:Oil and gas development
    
    
    8,038,104
    
    
    
    7,809,166
    
    
    
    43,450,017
    
    
    
    22,259,947Corporate
    
    
    51,176
    
    
    
    42,207
    
    
    
    173,599
    
    
    
    224,483Total
    
    $
    8,089,280
    
    
    $
    7,851,373
    
    
    $
    43,623,616
    
    
    $
    22,484,430
 9




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##### Table of Contents



September 30,
    
    
    December 31,2006
    
    
    2005Identifiable assets:Oil and gas development
    
    $
    170,144,340
    
    
    $
    126,590,249Corporate
    
    
    3,338,194
    
    
    
    20,183,334Total
    
    $
    173,482,534
    
    
    $
    146,773,583
 Note 11. Commitments
  Commercial CommitmentsOperating
    
    
    OtherYear
    
    Leases
    
    
    Commitments
    
    
    TotalRemainder of 2006
    
    $
    149,979
    
    
    $
    240,000
    (1)
    
    $
    389,9792007
    
    
    601,498
    
    
    
    
    
    
    
    601,4982008
    
    
    292,289
    
    
    
    100,000
    (2)
    
    
    392,2892009
    
    
    195,000
    
    
    
    2,045,000
    (2)
    
    
    2,240,0002010 and thereafter
    
    
    97,500
    
    
    
    
    
    
    
    97,500Total
    
    $
    1,336,266
    
    
    $
    2,385,000
    
    
    $
    3,721,266
 
 (1)
    
    Reflects obligations under a guaranty for a limited liability company in which we
previously held a minority interest.(2)
    
    Reflects commitments under a purchase contract for an airplane. Note 12. Recent Accounting Standards
 FSP No. 123(R)-4
 FIN No. 48
 SAB No. 108
 SFAS No. 157 10
    Table of Contents    SFAS No. 158
 FSP AUG AIR1
 11




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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
   Strategy
  
    
    Acceleration of Drilling Operations. Development drilling is our
mainstay for production and reserve growth. During the first nine months of 2006, we
drilled 180 gross (48.6319 net) wells, primarily through our drilling programs. See
Drilling Operations. We believe that our long and successful operating history and
proven ability to drill a large number of wells year after year have positioned us as a
leading player in the Appalachian basin. Over the next few years, we plan to continue our
focus on developing our Leatherwood field, where we drilled 86 wells in the first nine
months of 2006 and have identified over 550 additional drilling locations. We are also
pursuing opportunities to capitalize on our teams experience and diversify our asset base
through targeted expansion in other unconventional natural gas basins.
    
    Drilling Program Financings. Our ability to attract outside capital
through our drilling programs has enabled us to capitalize on natural gas development
opportunities and long range pricing expectations for this commodity. Beginning this year,
we changed the structure of our new drilling programs from turnkey to cost-plus pricing,
with a view to reducing our exposure to price volatility for drilling services, equipment
and steel casing requirements. We launched our first cost-plus drilling program in March
2006 to participate with our joint venture partner in up to 60 natural gas wells on its
acreage in Jackson and Roane Counties, West Virginia. Our second program this year is
participating in six horizontal CBM wells in our Arkoma basin project. Our third 2006
drilling program will invest in a portfolio of 85 wells in four of our major Appalachian
fields, where we are retaining a 75% program interest in Leatherwood development, 60% for
our drilling initiatives in Amvest and Martins Fork, 25% in Straight Creek and 20% in our
Fonde field.
 12




---



##### Table of Contents




    
    Acquisition 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. During the
fourth quarter of 2005, we acquired a significant position in approximately 14,000 acres of
CBM properties in the Arkoma basin within Leflore County, Oklahoma and Sebastian County,
Arkansas. We also initiated an exploratory play during 2005 in the Illinois basin on
acquired tracts spanning approximately 15,500 acres within Breckinridge, Grayson, Hardin,
Meade and Ohio Counties in western Kentucky. We plan to continue capitalizing on
opportunities to assemble or acquire large tracts with significant unproved gas development
potential. Our goal is to consolidate our position in the Appalachian basin, while also
diversifying our inventory of drilling prospects in other basins that offer attractive
natural gas and CBM plays.
    
    Repeatable Drilling. As of September 30, 2006, we had interests in a
total of 995 wells and had identified over 1,100 additional drilling locations. Most of
our wells are drilled to relatively shallow total depths up to 5,000 feet, generally
encountering several predictable natural gas pay zones. We focus on repeatable prospects
to reduce drilling risks, as reflected in our success rate. Historically, over 99% of our
Appalachian wells have been completed as producers. The primary pay zone for most of our
Appalachian wells is the Devonian shale formation. This is considered an unconventional
target due to its low permeability. To be productive, natural fracturing must be present
and generally must be enhanced by effective acidizing or other fracturing treatment. While
this typically results in modest initial volumes and pressures, it also accounts for the
low annual decline rates demonstrated by our wells in the region, many of which are
expected to produce for 25 years or more. We recently implemented initiatives to leverage
our core expertise with evolving technologies in horizontal drilling, which may provide
advantages in extracting this type of tight gas. The initial programs are being conducted
in the Arkoma basin for accelerated CBM recovery and on recently acquired acreage in the
Illinois basin to test the New Albany shale formation, which has similar geologic
characteristics to the Devonian shale in the Appalachian basin.
    
    Extension of Gas Gathering Systems. We construct and operate gas
gathering facilities to connect our wells to interstate pipelines with access to major east
coast natural gas markets. In addition to generating gas transmission and compression
revenues, our 100% ownership of these systems gives us control over third-party access,
providing competitive advantages in acquiring and developing nearby acreage. As of
September 30, 2006, our gas gathering facilities spanned 400 miles, including 140 miles
installed during 2005 and 89 miles in the first nine months of 2006, in addition to 116
miles of the NGAS Gathering open-access system acquired in March 2006. See Recent
Initiatives below. The recent extensions to our gathering systems include a 23-mile,
eight-inch steel line for connecting our wells in the Leatherwood field and a 16-mile,
six-inch line that connects them to the NGAS Gathering system. As of the date of this
report, we have a total of 185 wells producing to sales in Leatherwood and an additional 19
wells awaiting connection. With this infrastructure now in place, we expect to bring
current and future Leatherwood wells on line soon after completion.
    
    Purchase of Producing Properties. The purchase of third party production
offers a means in addition to drilling for accelerating our growth, while continuing to
capitalize on our operating experience. 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. In
the fourth quarter of 2005, we acquired a 25% interest in producing properties within the
Arkoma basin, with an estimated 7.0 Bcf of proved CBM reserves, at an acquisition price of
$1.63 per Mcfe. We continuously evaluate opportunities to acquire producing properties
meeting our criteria for long-lived reserves in targeted geographic areas.
 Recent Initiatives
 Gathering System Acquisition
 13




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##### Table of Contents



Property Acquisition
 Williston Basin Leasing Initiative
 Purchase and Sale of Royalty Interests
 Regional Advantages
  Drilling Operations
 Drilling Program Structure
 Drilling Program Investments
 14




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##### Table of Contents



Drilling Program Benefits
 
    
    Expanding our drilling budget with outside capital from program investors enables
us to compete for attractive properties by increasing our drilling commitments and to
maintain a larger and more capable staff than we could otherwise support if we were
operating solely for our own account. It also leverages our buying power for drilling
services and materials, contributing to lower overall development costs.
    
    Accelerating the pace of development activities through our drilling programs
expands the production capacity we can make available to gas purchasers, contributing to
higher and more stable sales prices for our production.
    
    By conducting exploratory operations through specially tailored programs, we
expand our inventory of developmental locations with lower risk profiles for subsequent
programs, while adding to our proved reserves, both developed and undeveloped.
    
    Our drilling program strategy substantially increases the number of wells we
could drill solely for our own account, diversifying the risks of drilling operations.
 Participation Rights
 Drilling Results
 Development Wells
    
    Exploratory WellsProductive
    
    Dry
    
    Productive
    
    DryGross
    
    Net
    
    Gross
    
    Gross
    
    Net
    
    GrossNine months ended
September 30, 2006
    
    
    149
    
    
    
    40.5999
    
    
    
    
    
    
    
    31
    
    
    
    8.0320
    
    
    
    Year ended December 31, 2005
    
    
    151
    
    
    
    43.1590
    
    
    
    
    
    
    
    4
    
    
    
    1.1450
    
    
    
    
 15




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##### Table of Contents



Production Volumes and Sales Prices
 Nine Months Ended
    
    Year EndedSeptember 30,
    
    December 31,2006
    
    2005
    
    2005Production volumes:Oil (Bbl)
    
    
    28,564
    
    
    
    28,703
    
    
    
    39,959Natural gas (Mcf)
    
    
    1,914,458
    
    
    
    1,141,947
    
    
    
    1,583,922Equivalents (Mcfe)
    
    
    2,085,840
    
    
    
    1,314,166
    
    
    
    1,823,673Average sales price:Natural gas (per Mcf)
    
    $
    8.27
    
    
    $
    8.05
    
    
    $
    9.02Oil (per Bbl)
    
    
    60.24
    
    
    
    46.21
    
    
    
    48.36
 Results of Operations  Three Months Ended September 30, 2006 and 2005
 Revenues
 Three Months Ended September 30,% of
    
    
    
    
    
    
    %2006
    
    
    Revenue
    
    
    2005
    
    
    ChangeContract drilling
    
    $
    7,726,332
    
    
    
    52
    %
    
    $
    10,581,000
    
    
    
    (27
    )%Oil and gas production
    
    
    5,560,470
    
    
    
    37
    
    
    
    4,199,754
    
    
    
    32Gas transmission and compression
    
    
    1,564,662
    
    
    
    11
    
    
    
    302,694
    
    
    
    417Total
    
    $
    14,851,464
    
    
    
    100
    %
    
    $
    15,083,448
    
    
    
    (2
    )
    16




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##### Table of Contents



Expenses
 Three Months Ended September 30,2006
    
    Margin
    
    2005
    
    MarginContract drilling
    
    $
    6,180,299
    
    
    
    20
    %
    
    $
    8,361,324
    
    
    
    21
    %Oil and gas production
    
    
    1,517,471
    
    
    
    73
    
    
    
    1,192,036
    
    
    
    72Gas transmission and compression
    
    
    532,650
    
    
    
    66
    
    
    
    252,743
    
    
    
    17Total direct expenses
    
    
    8,230,420
    
    
    
    45
    
    
    
    9,806,103
    
    
    
    35% Revenue

    
    
    
    
    
    % RevenueSelling, general and administrative
    
    
    2,635,522
    
    
    
    18
    %
    
    
    3,000,577
    
    
    
    20
    %Options, warrants and deferred compensation
    
    
    363,167
    
    
    
    2
    
    
    
    362,290
    
    
    
    2Depreciation, depletion and amortization
    
    
    1,935,318
    
    
    
    13
    
    
    
    991,278
    
    
    
    7Interest expense, net of interest income
    
    
    1,230,754
    
    
    
    8
    
    
    
    281,059
    
    
    
    2Other, net
    
    
    (159,553
    )
    
    
    N/A
    
    
    
    69,626
    
    
    
    1Total other expenses
    
    $
    6,005,208
    
    
    
    
    
    
    $
    4,704,830
       17




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##### Table of Contents



Net Income and EPS
 Results of Operations  Nine Months Ended September 30, 2006 and 2005
 Revenues
 Nine Months Ended September 30,% of
    
    
    
    
    
    
    %2006
    
    
    Revenue
    
    
    2005
    
    
    ChangeContract drilling
    
    $
    39,167,106
    
    
    
    65
    %
    
    $
    34,897,000
    
    
    
    12
    %Oil and gas production
    
    
    17,700,437
    
    
    
    29
    
    
    
    10,583,245
    
    
    
    67Gas transmission and compression
    
    
    3,642,818
    
    
    
    6
    
    
    
    1,049,168
    
    
    
    247Total
    
    $
    60,510,361
    
    
    
    100
    %
    
    $
    46,529,413
    
    
    
    30
     18




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##### Table of Contents



Expenses
 Nine Months Ended September 30,2006
    
    Margin
    
    2005
    
    MarginContract drilling
    
    $
    30,723,788
    
    
    
    22
    %
    
    $
    27,349,389
    
    
    
    22
    %Oil and gas production
    
    
    4,500,879
    
    
    
    75
    
    
    
    2,841,551
    
    
    
    73Gas transmission and compression
    
    
    1,706,948
    
    
    
    53
    
    
    
    880,611
    
    
    
    16Total direct expenses
    
    
    36,931,615
    
    
    
    39
    
    
    
    31,071,551
    
    
    
    33% Revenue

    
    
    
    
    
    % RevenueSelling, general and administrative
    
    
    10,274,430
    
    
    
    17
    %
    
    
    9,019,312
    
    
    
    19
    %Options, warrants and deferred compensation
    
    
    1,211,701
    
    
    
    2
    
    
    
    853,988
    
    
    
    2Depreciation, depletion and amortization
    
    
    5,437,808
    
    
    
    9
    
    
    
    3,039,366
    
    
    
    7Interest expense, net of interest income
    
    
    2,700,323
    
    
    
    4
    
    
    
    1,258,687
    
    
    
    3Other, net
    
    
    (32,165
    )
    
    
    N/A
    
    
    
    (95,290
    )
    
    
    N/ATotal other expenses
    
    $
    19,592,097
    
    
    
    
    
    
    $
    14,076,063
      19




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##### Table of Contents



Net Income and EPS
  Liquidity and Capital Resources
 Liquidity
  Capital Resources
  20




---



##### Table of Contents



Contractual Obligations and Commercial Commitments
  21




---



##### Table of Contents



Operating Leases
    
    
    Other
    
    
    Long TermYear
    
    Equipment
    
    
    Premises
    
    
    Total
    
    
    Commitments
    
    
    DebtRemainder of 2006
    
    $
    95,206
    
    
    $
    54,773
    
    
    $
    149,979
    
    
    $
    240,000
    (1)
    
    $
    6,0002007
    
    
    380,826
    
    
    
    220,672
    
    
    
    601,498
    
    
    
    
    
    
    
    24,0002008
    
    
    273,900
    
    
    
    18,389
    
    
    
    292,289
    
    
    
    100,000
    (2)
    
    
    24,0002009
    
    
    195,000
    
    
    
    
    
    
    
    195,000
    
    
    
    2,045,000
    (2)
    
    
    24,0002010 and thereafter
    
    
    97,500
    
    
    
    
    
    
    
    97,500
    
    
    
    
    
    
    
    74,786,531Total
    
    $
    1,042,432
    
    
    $
    293,834
    
    
    $
    1,336,266
    
    
    $
    2,385,000
    
    
    $
    74,864,531
 
 (1)
    
    Reflects obligations under a guaranty for a limited liability company in which we
previously held a minority interest.(2)
    
    Reflects commitments under a purchase contract for an airplane. 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
  
 Item 4. Controls and Procedures
  22




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##### Table of Contents



PART II. OTHER INFORMATION
 
 Item 6. Exhibits
 ExhibitNumber
    
    Description of Exhibit3.1
    
    Notice of Articles, certified on September 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 September 29, 2004).3.2
    
    Alteration to Notice of Articles, certified on September 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 September 29, 2004).3.3
    
    Articles dated September 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 September 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).10.5
    
    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).
 23




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibit10.6
    
    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).11.1
    
    Computation of Earnings Per Share (included in Note 10 to the accompanying condensed
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, 2005).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.
 
 SIGNATURES
  NGAS Resources, Inc.Date: November 9, 2006
    
    By:
    
    /s/ William S. DaughertyWilliam S. DaughertyChief Executive Officer(Duly Authorized Officer)(Principal Executive Officer)
 24