##### 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, 2005
 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 þ
  Title of Class
    
    Outstanding at November 7, 2005Common Stock
    
    19,959,920




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NGAS Resources, Inc.
 INDEX
 PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements:Report of Independent Registered Public Accounting Firm
    
    
    1Condensed Consolidated Balance Sheets  September 30, 2005 (unaudited) and December 31, 2004
    
    
    2Condensed Consolidated Statement of Operations and Deficit  Three months and nine months ended
September 30, 2005 and 2004 (unaudited)
    
    
    3Condensed Consolidated Statement of Cash Flows  Three months and nine months ended
September 30, 2005 and 2004 (unaudited)
    
    
    4Notes to Condensed Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    25Item 4. Controls and Procedures
    
    
    25PART II. OTHER INFORMATIONItem 6. Exhibits
    
    
    26EX-11.1 COMPUTATION OF EARNINGS PER SHAREEX-31.1 302 CEO CERTIFICATIONEX-31.2 302 CFO CERTIFICATIONEX-32.1 906 CEO CERTIFICATIONEX-32.2 906 CFO CERTIFICATION




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 NGAS RESOURCES, INC.
 NGAS RESOURCES, INC.
    KRAFT, BERGER, GRILL, SCHWARTZ, COHEN & MARCH LLP
Chartered Accountants
 
 1




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##### Table of Contents



NGAS Resources, Inc.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (U.S. funds)
 September 30,
    
    
    December 31,2005
    
    
    2004(Unaudited)ASSETSCurrent assets:Cash
    
    $
    17,499,769
    
    
    $
    11,849,372Accounts receivable
    
    
    6,268,600
    
    
    
    2,281,715Prepaid expenses and other current assets
    
    
    3,542,571
    
    
    
    2,152,174Loans to related parties (Note 4)
    
    
    79,849
    
    
    
    142,718Total current assets
    
    
    27,390,789
    
    
    
    16,425,979Bonds and deposits
    
    
    387,695
    
    
    
    124,650Oil and gas properties (Note 2)
    
    
    87,248,623
    
    
    
    68,156,790Property and equipment (Note 3)
    
    
    2,901,594
    
    
    
    2,668,908Loans to related parties (Note 4)
    
    
    240,157
    
    
    
    357,175Investments (Note 5)
    
    
    
    
    
    
    55,454Deferred financing costs (Note 6)
    
    
    466,204
    
    
    
    1,024,810Goodwill (Note 7)
    
    
    313,177
    
    
    
    313,177Total assets
    
    $
    118,948,239
    
    
    $
    89,126,943LIABILITIESCurrent liabilities:Accounts payable
    
    
    5,704,793
    
    
    
    3,381,726Accrued liabilities
    
    
    5,657,919
    
    
    
    3,537,576Customers drilling deposits (Note 8)
    
    
    23,846,725
    
    
    
    12,652,001Long term debt, current portion (Note 9 and Note 16)
    
    
    15,027,692
    
    
    
    121,247Total current liabilities
    
    
    50,237,129
    
    
    
    19,692,550Future income taxes
    
    
    2,924,815
    
    
    
    2,053,432Long term debt (Note 9)
    
    
    7,883,545
    
    
    
    25,870,498Deferred compensation
    
    
    711,788
    
    
    
    368,935Total liabilities
    
    
    61,757,277
    
    
    
    47,985,415SHAREHOLDERS EQUITYCapital stock (Note 10)Authorized:5,000,000 Preferred shares, non-cumulative, convertible100,000,000 Common sharesIssued:18,894,646
Common shares (December 31, 2004  15,605,208)
    
    
    70,296,064
    
    
    
    54,929,88721,100 Common shares held in treasury, at cost
    
    
    (23,630
    )
    
    
    (23,630
    )Paid-in
capital  options and warrants
    
    
    2,095,575
    
    
    
    1,796,504To be issued:9,185 Common
shares (December 31, 2004  10,070)
    
    
    45,925
    
    
    
    50,35072,412,934
    
    
    
    56,753,111Deficit
    
    
    (15,222,972
    )
    
    
    (15,611,583
    )Total shareholders equity
    
    
    57,190,962
    
    
    
    41,141,528Total liabilities and shareholders equity
    
    $
    118,948,239
    
    
    $
    89,126,943
  2




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##### Table of Contents



NGAS Resources, Inc.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT
 (U.S. funds) (Unaudited)
 Three Months Ended
    
    
    Nine months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004REVENUEContract drilling
    
    $
    10,581,000
    
    
    $
    6,561,100
    
    
    $
    34,897,000
    
    
    $
    27,927,475Oil and gas production
    
    
    4,199,754
    
    
    
    1,452,338
    
    
    
    10,583,245
    
    
    
    3,230,351Gas transmission and compression
    
    
    302,694
    
    
    
    344,633
    
    
    
    1,049,168
    
    
    
    1,093,296Total revenue
    
    
    15,083,448
    
    
    
    8,358,071
    
    
    
    46,529,413
    
    
    
    32,251,122DIRECT EXPENSESContract drilling
    
    
    8,361,324
    
    
    
    5,157,915
    
    
    
    27,349,389
    
    
    
    20,499,504Oil and gas production
    
    
    1,192,036
    
    
    
    517,113
    
    
    
    2,841,551
    
    
    
    1,187,200Gas transmission and compression
    
    
    252,743
    
    
    
    172,532
    
    
    
    880,611
    
    
    
    686,724Total direct expenses
    
    
    9,806,103
    
    
    
    5,847,560
    
    
    
    31,071,551
    
    
    
    22,373,428OTHER EXPENSES (INCOME)Selling, general and administrative
    
    
    3,000,577
    
    
    
    1,901,190
    
    
    
    9,019,312
    
    
    
    6,831,254Options, warrants and deferred compensation
    
    
    362,290
    
    
    
    194,404
    
    
    
    853,988
    
    
    
    427,450Depreciation, depletion and amortization
    
    
    991,278
    
    
    
    324,946
    
    
    
    3,039,366
    
    
    
    833,550Interest expense
    
    
    360,605
    
    
    
    87,550
    
    
    
    1,424,359
    
    
    
    284,253Interest and dividend income
    
    
    (79,546
    )
    
    
    (80,076
    )
    
    
    (165,672
    )
    
    
    (248,282
    )Other, net
    
    
    69,626
    
    
    
    35,954
    
    
    
    (95,290
    )
    
    
    (76,275
    )Total other expenses
    
    
    4,704,830
    
    
    
    2,463,968
    
    
    
    14,076,063
    
    
    
    8,051,950INCOME BEFORE INCOME TAXES
    
    
    572,515
    
    
    
    46,543
    
    
    
    1,381,799
    
    
    
    1,825,744INCOME TAX EXPENSECurrent
    
    
    121,805
    
    
    
    9,351
    
    
    
    121,805
    
    
    
    416,157Future
    
    
    263,513
    
    
    
    20,124
    
    
    
    871,383
    
    
    
    416,895385,318
    
    
    
    29,475
    
    
    
    993,188
    
    
    
    833,052NET INCOME
    
    
    187,197
    
    
    
    17,068
    
    
    
    388,611
    
    
    
    992,692DEFICIT, beginning of period
    
    
    (15,410,169
    )
    
    
    (16,247,660
    )
    
    
    (15,611,583
    )
    
    
    (17,223,284
    )DEFICIT, end of period
    
    $
    (15,222,972
    )
    
    $
    (16,230,592
    )
    
    $
    (15,222,972
    )
    
    $
    (16,230,592
    )NET INCOME PER SHAREBasic
    
    $
    0.01
    
    
    $
    0.00
    
    
    $
    0.02
    
    
    $
    0.07Diluted
    
    $
    0.01
    
    
    $
    0.00
    
    
    $
    0.02
    
    
    $
    0.07WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING:Basic
    
    
    17,583,061
    
    
    
    14,725,187
    
    
    
    16,432,965
    
    
    
    13,555,811Diluted
    
    
    19,597,136
    
    
    
    15,877,802
    
    
    
    17,722,030
    
    
    
    16,107,154
  3




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##### Table of Contents



NGAS Resources, Inc.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (U.S. funds) (Unaudited)
 Three Months Ended
    
    
    Nine months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004OPERATING ACTIVITIESNet income
    
    $
    187,197
    
    
    $
    17,068
    
    
    $
    388,611
    
    
    $
    992,692Adjustments to reconcile net income to net cash
provided by (used in) operating activities:Incentive bonus paid in common shares
    
    
    683,830
    
    
    
    159,705
    
    
    
    900,856
    
    
    
    159,705Options, warrants and deferred compensation
    
    
    362,290
    
    
    
    194,404
    
    
    
    853,988
    
    
    
    427,450Contract settlement paid in common shares
    
    
    90,300
    
    
    
    
    
    
    
    85,875
    
    
    
    Depreciation, depletion and amortization
    
    
    991,278
    
    
    
    324,946
    
    
    
    3,039,366
    
    
    
    833,550Write-down of investment
    
    
    
    
    
    
    63,627
    
    
    
    55,454
    
    
    
    63,627Notes issued in kind for interest on long term debt
    
    
    
    
    
    
    18,677
    
    
    
    
    
    
    
    74,036Gain on sale of assets
    
    
    (11,962
    )
    
    
    
    
    
    
    (24,530
    )
    
    
    (4,948
    )Future income taxes
    
    
    263,513
    
    
    
    20,124
    
    
    
    871,383
    
    
    
    416,895Changes in assets and liabilitiesAccounts receivable
    
    
    (1,791,503
    )
    
    
    (678,183
    )
    
    
    (3,986,885
    )
    
    
    (1,110,452
    )Prepaid expenses and other current assets
    
    
    (455,484
    )
    
    
    (16,831
    )
    
    
    (1,390,397
    )
    
    
    (239,507
    )Accounts payable
    
    
    1,341,585
    
    
    
    (119,922
    )
    
    
    2,323,067
    
    
    
    1,060,447Accrued liabilities
    
    
    (108,778
    )
    
    
    (505,110
    )
    
    
    2,120,343
    
    
    
    (459,828
    )Income taxes payable
    
    
    
    
    
    
    (185,649
    )
    
    
    
    
    
    
    (141,343
    )Customers drilling deposits
    
    
    3,912,000
    
    
    
    (1,081,500
    )
    
    
    11,194,724
    
    
    
    (5,091,500
    )Net cash provided by (used in) operating activities
    
    
    5,464,266
    
    
    
    (1,788,644
    )
    
    
    16,431,855
    
    
    
    (3,019,176
    )INVESTING ACTIVITIESProceeds from sale of assets
    
    
    84,519
    
    
    
    
    
    
    
    358,119
    
    
    $
    190,600Purchase of property and equipment
    
    
    (168,829
    )
    
    
    (135,275
    )
    
    
    (897,932
    )
    
    
    (357,505
    )Increase in bonds and deposits
    
    
    (16,000
    )
    
    
    
    
    
    
    (263,045
    )
    
    
    (25,400
    )Additions to oil and gas properties, net
    
    
    (7,682,544
    )
    
    
    (11,106,289
    )
    
    
    (21,586,498
    )
    
    
    (19,825,305
    )Net cash used in investing activities
    
    
    (7,782,854
    )
    
    
    (11,241,564
    )
    
    
    (22,389,356
    )
    
    
    (20,017,610
    )FINANCING ACTIVITIESDecrease in loans to related parties
    
    
    56,084
    
    
    
    46,494
    
    
    
    179,887
    
    
    
    123,148Proceeds from issuance of common shares
    
    
    4,327,729
    
    
    
    1,127,685
    
    
    
    5,822,365
    
    
    
    11,022,734Payments of deferred financing costs
    
    
    
    
    
    
    
    
    
    
    (451,496
    )
    
    
    Proceeds from issuance of long term debt
    
    
    
    
    
    
    
    
    
    
    6,168,696
    
    
    
    Payments of long term debt
    
    
    (11,887
    )
    
    
    (19,294
    )
    
    
    (111,554
    )
    
    
    (65,331
    )Net cash provided by financing activities
    
    
    4,371,926
    
    
    
    1,154,885
    
    
    
    11,607,898
    
    
    
    11,080,551Change in cash
    
    
    2,053,338
    
    
    
    (11,875,323
    )
    
    
    5,650,397
    
    
    
    (11,956,235
    )Cash, beginning of period
    
    
    15,446,431
    
    
    
    22,514,081
    
    
    
    11,849,372
    
    
    
    22,594,993Cash, end of period
    
    $
    17,499,769
    
    
    $
    10,638,758
    
    
    $
    17,499,769
    
    
    $
    10,638,758SUPPLEMENTAL DISCLOSUREInterest paid
    
    $
    360,605
    
    
    $
    39,379
    
    
    $
    1,467,666
    
    
    $
    180,723Income taxes paid
    
    
    40,000
    
    
    
    195,000
    
    
    
    170,000
    
    
    
    299,853SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING AND FINANCING ACTIVITIESCommon shares issued for accounts payable
    
    
    
    
    
    
    39,379
    
    
    
    
    
    
    
    180,723Common shares issued upon conversion of notes
    
    
    7,720,127
    
    
    
    
    
    
    
    8,340,591
    
    
    
    1,613,890
  4




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##### Table of Contents



NGAS Resources, Inc.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 September 30,
2005 (Unaudited)
 Note 1. Summary of Significant Accounting Policies
 General
 Basis of Consolidation
 Estimates
 Change in Accounting Policy
 Reclassifications and Adjustments
 5




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##### Table of Contents



Three Months
    
    
    Nine monthsEnded
    
    
    EndedSeptember 30,
    
    
    September 30,2004
    
    
    2004Gross profit, as reported
    
    $
    2,510,511
    
    
    $
    9,877,694Less DD&A, as a component of direct expenses
    
    
    (324,946
    )
    
    
    (833,550
    )Gross profit, as restated
    
    $
    2,185,565
    
    
    $
    9,044,144
 Note 2. Oil and Gas Properties
  September 30, 2005
    
    
    December 31,Accumulated
    
    
    
    
    
    2004Cost
    
    
    DD&A
    
    
    Net
    
    
    NetProved oil and gas properties
    
    $
    75,054,652
    
    
    $
    (5,940,328
    )
    
    $
    69,114,324
    
    
    $
    59,387,998Unproved oil and gas properties
    
    
    2,085,540
    
    
    
    
    
    
    
    2,085,540
    
    
    
    1,838,038Gathering lines and well equipment
    
    
    16,782,423
    
    
    
    (733,664
    )
    
    
    16,048,759
    
    
    
    6,930,754Total oil and gas properties
    
    $
    93,922,615
    
    
    $
    (6,673,992
    )
    
    $
    87,248,623
    
    
    $
    68,156,790
 Note 3. Property and Equipment
  September 30, 2005

   
    
    
    December 31,Accumulated
    
    
    
    
    
    2004Cost
    
    
    Depreciation
    
    
    Net
    
    
    NetLand
    
    $
    12,908
    
    
    $
    
    
    
    $
    12,908
    
    
    $
    12,908Building improvements
    
    
    36,134
    
    
    
    (5,754
    )
    
    
    30,380
    
    
    
    16,234Machinery and equipment
    
    
    2,306,881
    
    
    
    (499,782
    )
    
    
    1,807,099
    
    
    
    1,706,238Office furniture and fixtures
    
    
    83,570
    
    
    
    (31,896
    )
    
    
    51,674
    
    
    
    59,308Computer and office equipment
    
    
    456,670
    
    
    
    (194,405
    )
    
    
    262,265
    
    
    
    257,977Vehicles
    
    
    1,081,369
    
    
    
    (344,101
    )
    
    
    737,268
    
    
    
    616,243Total property and equipment
    
    $
    3,977,532
    
    
    $
    (1,075,938
    )
    
    $
    2,901,594
    
    
    $
    2,668,908
 Note 4. Loans to Related Parties
  6




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##### Table of Contents



Note 5. Investments
  Note 6. Deferred Financing Costs
  Note 7. Goodwill
  Note 8. Customer Drilling Deposits
  Note 9. Long Term Debt
 Credit Facility
 Convertible Notes
 7




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##### Table of Contents



Shares Issuable atPrincipal Amount Outstanding at
    
    
    
    
    
    
    September 30, 2005September 30,
    
    
    December 31,
    
    
    Conversion
    
    
    uponTitle of Notes
    
    2005
    
    
    2004
    
    
    Price
    
    
    Conversion10% Convertible Notes
due May 1, 2007
    
    $
    
    
    
    $
    560,500
    
    
    $
    1.50
    
    
    
    8% Convertible Notes
due April 10, 2008
    
    
    705,925
    
    
    
    745,925
    
    
    
    1.90
    
    
    
    371,5398% Convertible Notes
due May 1, 2008
    
    
    166,250
    
    
    
    188,750
    
    
    
    2.25
    
    
    
    73,8887% Convertible Notes
due September 5, 2008
    
    
    1,077,202
    
    
    
    1,077,202
    
    
    
    4.50
    
    
    
    239,3787% Convertible Notes
due October 4, 2009
    
    
    
    
    
    
    6,100,000
    
    
    
    6.00
    
    
    
    7% Convertible Notes
due March 31, 2010
    
    
    5,585,350
    
    
    
    1,831,304
    
    
    
    6.00
    
    
    
    930,891Total
    
    $
    7,534,727
    
    
    $
    10,503,681
    
    
    
    
    
    
    
    1,615,696
 Acquisition Debt
 Miscellaneous Debt
 Principal Amount Outstanding atSeptember 30,
    
    
    December 31,Terms of Debt
    
    2005
    
    
    2004Notes issued to finance equipment and vehicles,
payable monthly in various amounts through 2005,
with interest ranging from 8.68% to 9.5% per annum,
collateralized by the acquired equipment and vehicles
    
    $
    
    
    
    $
    4,451Loan payable to unaffiliated company, bearing interest
at 10% per annum payable quarterly, collateralized
by assets of subsidiary guarantor
    
    
    
    
    
    
    64,779Note payable to unaffiliated individual, payable in
60 installments of $1,370, together with interest at 8%
per annum, through 2005
    
    
    
    
    
    
    4,964Loans payable to various banks, payable monthly in
various amounts, together with interest at rates ranging
from 4% to 9.75% per annum, through 2005,
collateralized by receivables and various vehicles
    
    
    3,692
    
    
    
    23,052Total
    
    $
    3,692
    
    
    $
    97,246
 Maturities of Long Term Debt
 8




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##### Table of Contents



Principal Amount Outstanding atSeptember 30,
    
    
    December 31,2005
    
    
    2004Total long term debt (including current portion)
    
    $
    22,911,237
    
    
    $
    25,991,745Less current portion(1)
    
    
    15,027,692
    
    
    
    121,247Total long term debt
    
    $
    7,883,545
    
    
    $
    25,870,498
 Maturities of DebtBalance of 2005
    
    $
    9,6922006
    
    
    15,024,000
    (1)2007
    
    
    24,0002008
    
    
    1,973,377
    (2)2009
    
    
    24,0002010 and thereafter
    
    
    5,856,168
    (2)
 
 (1)
    
    Primarily reflects borrowings under the Companys revolving credit facility, based on the
July 2006 maturity date in effect on September 30, 2005.(2)
    
    Primarily reflects long term debt under the Companys convertible notes outstanding at
September 30, 2005, some of which were converted after that
date. See Note 16  Subsequent
Event. Note 10. Capital Stock
 Preferred and Common Shares
 Number ofCommon Shares Issued
    
    Shares
    
    
    AmountBalance, December 31, 2003
    
    
    10,676,030
    
    
    $
    36,244,623Issued for cash
    
    
    2,557,665
    
    
    
    12,200,886Issued to employees as incentive bonus
    
    
    157,250
    
    
    
    674,905Issued upon exercise of stock options and warrants
    
    
    1,520,936
    
    
    
    3,507,493Issued upon conversion of convertible notes
    
    
    560,601
    
    
    
    1,688,590Issued for settlement of accounts payable
    
    
    46,352
    
    
    
    181,520Issued for contract settlement
    
    
    86,374
    
    
    
    431,870Balance, 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
    
    
    1,296,207
    
    
    
    6,034,431Issued upon conversion of convertible notes
    
    
    1,823,816
    
    
    
    8,340,591Issued for contract settlement
    
    
    15,000
    
    
    
    90,300Balance, September 30, 2005
    
    
    18,894,646
    
    
    $
    70,296,065
 Paid In Capital  Options and Warrants
    
    AmountBalance, December 31, 2003
    
    $
    1,140,321Issued
    
    
    676,433Exercised
    
    
    (20,250
    )Balance, December 31, 2004
    
    
    1,796,504Issued
    
    
    511,135Exercised
    
    
    (212,064
    )Balance, September 30, 2005
    
    $
    2,095,575
 9




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##### Table of Contents



Number ofCommon Shares to be Issued
    
    Shares
    
    
    AmountBalance, December 31, 2003
    
    
    1,403,335
    
    
    $
    5,917,958Issued in contract settlement(1)
    
    
    (86,374
    )
    
    
    (431,870
    )Contract settlement in cash in lieu of common shares
    
    
    (3,556
    )
    
    
    (17,780
    )Issued in financing transaction(2)
    
    
    (1,303,335
    )
    
    
    (5,417,958
    )Balance, December 31, 2004
    
    
    10,070
    
    
    
    50,350Contract settlement in cash in lieu of common shares
    
    
    (885
    )
    
    
    (4,425
    )Balance at September 30, 2005
    
    
    9,185
    
    
    $
    45,925
 
 (1)
    
    Reflects shares issuable in a contract settlement, of which 3,335 shares were settled in
cash during 2004 and 10,070 shares remained unissued at September 30, 2005 and
December 31, 2004.(2)
    
    Reflects shares subscribed at the end of 2003 in an institutional private placement, part of
the proceeds from which were received in January 2004, resulting in the classification of all
the shares subscribed in the financing as common shares to be issued at December 31, 2003. Stock Options and Awards
  Weighted AverageStock Options
    
    Issued
    
    
    Exercisable
    
    
    Exercise PriceBalance, December 31, 2003
    
    
    1,119,331
    
    
    
    1,119,331
    
    
    
    1.10Issued(1)
    
    
    2,015,000
    
    
    
    
    
    
    
    4.05Exercised
    
    
    (311,480
    )
    
    
    
    
    
    
    1.00Expired
    
    
    (437,851
    )
    
    
    
    
    
    
    1.23Balance, December 31, 2004
    
    
    2,385,000
    
    
    
    370,000
    
    
    
    3.58Issued(2)
    
    
    860,000
    
    
    
    
    
    
    
    6.71Exercised
    
    
    (260,000
    )
    
    
    
    
    
    
    1.43Balance, September 30, 2005
    
    
    2,985,000
    
    
    
    596,250
    
    
    $
    4.67
 
 (1)
    
    Granted to employees and directors under stock option plans at exercise prices ranging from
$4.03 to $4.09 per share and vesting in increments from February 25, 2005 through February 25,
2009.(2)
    
    Granted to employees and directors under stock option plans at exercise prices ranging from
$6.02 to $7.04 per share and vesting in increments from July 1, 2006 through February 25,
2009.  10




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##### Table of Contents



Common Stock Purchase Warrants
 Weighted AverageCommon Stock Purchase Warrants
    
    Issued
    
    
    Exercisable
    
    
    Exercise PriceBalance, December 31, 2003
    
    
    3,333,523
    
    
    
    3,333,523
    
    
    $
    3.43Issued in financing transactions
    
    
    967,050
    
    
    
    
    
    
    
    6.09Issued for consulting services
    
    
    20,000
    
    
    
    
    
    
    
    4.03Exercised
    
    
    (1,209,456
    )
    
    
    
    
    
    
    2.63Expired
    
    
    (689,062
    )
    
    
    
    
    
    
    3.06Balance, December 31 2004
    
    
    2,422,055
    
    
    
    2,422,055
    
    
    
    4.96Exercised
    
    
    (1,036,207
    )
    
    
    
    
    
    
    5.26Balance, September 30, 2005
    
    
    1,385,848
    
    
    
    1,385,848
    
    
    $
    4.74
 Note 11. Income Per Share
  Three Months Ended
    
    
    Nine months EndedSeptember 30,
    
    
    September 30,Diluted EPS
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004Numerator:Net income as reported for basic EPS
    
    $
    187,197
    
    
    $
    17,068
    
    
    $
    388,611
    
    
    $
    992,692Adjustments to income for diluted EPS
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    56,520Net income for diluted EPS
    
    $
    187,197
    
    
    $
    17,068
    
    
    $
    388,611
    
    
    $
    1,049,212Denominator:Weighted average shares for basic EPS
    
    
    17,583,061
    
    
    
    14,725,187
    
    
    
    16,432,965
    
    
    
    13,555,811Effect of dilutive securities:Stock options
    
    
    1,281,751
    
    
    
    642,795
    
    
    
    899,062
    
    
    
    952,136Warrants
    
    
    732,324
    
    
    
    509,820
    
    
    
    390,003
    
    
    
    806,119Convertible notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    793,088Adjusted weighted average shares and
assumed conversions for dilutive EPS
    
    
    19,597,136
    
    
    
    15,877,802
    
    
    
    17,722,030
    
    
    
    16,107,154Diluted EPS
    
    $
    0.01
    
    
    $
    0.00
    
    
    $
    0.02
    
    
    $
    0.07
 11




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##### Table of Contents



Note 12. Related Party Transactions
 General
 Drilling Programs
 Reporting Period
    
    Drilling Contract RevenueThree months ended September 30, 2005
    
    $
    10,581,000Three months ended September 30, 2004
    
    
    6,561,100Nine months ended September 30, 2005
    
    
    34,897,000Nine months ended September 30, 2004
    
    
    27,927,475
 Note 13. Segment Information
  Three Months Ended
    
    
    Nine months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Revenue, net:Oil and gas development
    
    $
    15,083,448
    
    
    $
    8,358,071
    
    
    $
    46,529,413
    
    
    $
    32,251,122Corporate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    15,083,448
    
    
    
    8,358,071
    
    
    
    46,529,413
    
    
    
    32,251,122DD&A:Oil and gas development
    
    
    916,266
    
    
    
    295,479
    
    
    
    2,781,808
    
    
    
    741,629Corporate
    
    
    75,012
    
    
    
    29,467
    
    
    
    257,558
    
    
    
    91,921Total
    
    
    991,278
    
    
    
    324,946
    
    
    
    3,039,366
    
    
    
    833,550Interest expense:Oil and gas development
    
    
    160,889
    
    
    
    34,674
    
    
    
    686,180
    
    
    
    102,477Corporate
    
    
    199,716
    
    
    
    52,876
    
    
    
    738,179
    
    
    
    181,776Total
    
    
    360,605
    
    
    
    87,550
    
    
    
    1,424,359
    
    
    
    284,253Net income (loss):Oil and gas development
    
    
    637,485
    
    
    
    184,791
    
    
    
    1,793,411
    
    
    
    1,662,086Corporate
    
    
    (450,288
    )
    
    
    (167,723
    )
    
    
    (1,404,800
    )
    
    
    (669,394
    )Total
    
    
    187,197
    
    
    
    17,068
    
    
    
    388,611
    
    
    
    992,692Capital expenditures:Oil and gas development
    
    
    7,809,166
    
    
    
    11,196,473
    
    
    
    22,259,947
    
    
    
    20,063,642Corporate
    
    
    42,207
    
    
    
    45,091
    
    
    
    224,483
    
    
    
    119,168Total
    
    $
    7,851,373
    
    
    $
    11,241,564
    
    
    $
    22,484,430
    
    
    $
    20,182,810
 12




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##### Table of Contents



September 30,
    
    
    December 31,Identifiable assets:
    
    2005
    
    
    2004Oil and gas development
    
    $
    113,636,029
    
    
    $
    82,380,938Corporate
    
    
    5,312,210
    
    
    
    6,746,005Total
    
    $
    118,948,239
    
    
    $
    89,126,943
 Note 14. United States and Canadian Accounting Principles
 Differences Reflected in Condensed Consolidated Financial Statements
 Recent
Accounting Pronouncements  Canadian GAAP
 Financial Instruments
 Comprehensive Income
 Equity
 Recent
Accounting Pronouncements  U.S. GAAP
 SFAS No. 123R
 13




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##### Table of Contents



SFAS No. 19 and FAS No. 19-1
 SFAS No. 154
 EITF No. 04-10
 EITF No. 05-2
 FERC Pronouncement
 Note 15. Commitments
  14




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##### Table of Contents



Commercial CommitmentsOperating
    
    
    OtherYear
    
    Leases
    
    
    Commitments
    
    
    TotalBalance of 2005
    
    $
    138,841
    
    
    $
    240,000
    (1)
    
    $
    378,8412006
    
    
    547,048
    
    
    
    
    
    
    
    547,0482007
    
    
    547,732
    
    
    
    
    
    
    
    547,7322008
    
    
    287,809
    
    
    
    100,000
    (2)
    
    
    387,8092009
    
    
    195,000
    
    
    
    2,045,000
    (2)
    
    
    2,240,0002010 and thereafter
    
    
    97,500
    
    
    
    
    
    
    
    97,500Total
    
    $
    1,813,930
    
    
    $
    2,385,000
    
    
    $
    4,198,930
 
 (1)
    
    Reflects obligations under a guaranty secured by a certificate of deposit provided for bank
debt of Galax Energy Concepts, LLC, a North Carolina limited liability company in which DPI
previously held a minority interest.(2)
    
    Reflects commitments under a purchase contract for an airplane. Note 16. Subsequent Event
  15




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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. To help finance our drilling initiatives, we sponsor and
manage Drilling Programs for private investors, contributing between 25% to 66.67% of total
program capital and maintaining a proportionate working interest in program wells. Since
2000, we drilled 435 gross (130.5431 net) gas wells through our Drilling Programs. This
includes 118 gross (33.6953 net) wells in the first nine months of 2005 and 155 gross
(49.7149 net) wells during 2004. We sponsored Drilling Programs for 150 new wells in the
first nine months of 2005, including two exploratory wells, retaining initial working
interests in program wells ranging from 30.7% to 40.6%.
    
    Acquisition of Additional Drilling Prospects. We focus on expanding our
substantial inventory of drilling prospects that meet our criteria for building
predictable, long-lived reserves. Over the last several years, we acquired oil and gas
drilling rights covering approximately 100,000 acres on the southwestern edge of the Big
Sandy Gas Field in eastern Kentucky (the Leatherwood Field), as well as leases for 26,500
acres on the north side of the Pine Mountain Fault System near the Leatherwood Field (the
Straight Creek Field). Our property acquisitions in 2004 also expanded our inventory of
development prospects, primarily on acreage positions we acquired from Stone Mountain
Energy Company (SME) during October 2004 in the Martins Fork and Amvest Fields, which
span portions of Harlan County, Kentucky and Lee County, Virginia. We plan to continue
capitalizing on opportunities to acquire large tracts with significant unproved gas
development potential as well as established infrastructure, further expanding our
inventory of drilling prospects and our stake in Appalachian Basin gas reserves and
production.
 16




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##### Table of Contents




    
    Disciplined Approach to Drilling. As of September 30, 2005, we had interests
in a total of 726 wells, primarily in the Appalachian Basin. Most of our wells are drilled
to relatively shallow total depths up to 5,000 feet, usually encountering as many as five
distinct and predictable natural gas pay zones. This disciplined approach focused on
repeatable prospects helps reduce drilling risks, as reflected in our success rate.
Historically, over 99% of our wells have been completed as producers. We complete and
produce our wells from multiple pay zones whenever possible, eliminating the costs and
complexities of deferred completions with behind-pipe gas. While our wells typically
produce at modest initial volumes and pressures, they also demonstrate low annual decline
rates and are expected to produce for 25 years or more.
    
    Extension of Gas Gathering Systems. We construct and operate gas gathering
facilities to connect our wells to interstate pipelines with access to major natural gas
markets. As of September 30, 2005, our gas gathering facilities aggregated approximately
280 miles. 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. During the first nine months of
2005, we extended our gathering systems by 109 miles, including a 23-mile, eight-inch steel
gathering line for connecting our wells in the Leatherwood Field. As of the date of this
report, we have installed compressors, dehydration units and lateral lines for 47 wells in
the Leatherwood Field, with an additional 54 Leatherwood wells awaiting connection. We
expect to bring most of those wells on line during the next several months as our
Leatherwood system is put in service.
    
    Operation of Third-Party Gathering System. Gas production from the properties
we acquired from SME in October 2004 is delivered through a 150-mile gathering system owned
by Duke Energy and previously operated by SME in southeastern Kentucky, southwestern
Virginia and northeastern Tennessee. The Stone Mountain system interconnects with Duke
Energys East Tennessee natural gas pipeline at Rogersville, Tennessee, connecting major
natural gas supply basins to growing markets in the eastern United States. Following the
SME acquisition, we expanded our arrangements with Duke Energy to operate and maintain the
Stone Mountain gas gathering system and to dedicate our SME production and part of our
Straight Creek production for delivery through the system. Gas production from our
Leatherwood Field can also move through the Stone Mountain system when our 23-mile
gathering facilities are completed for that area. We expect the expansion of our
throughput to major natural gas markets serviced by the Stone Mountain system to further
consolidate our competitive position in the region.
    
    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.
During the second half of 2004, we completed three separate acquisitions of oil and gas
interests covering a total of 89,737 acres in the Appalachian Basin, adding over 29.7 Bcf
of gas equivalents to our estimated proved reserves at an acquisition price averaging $1.17
per Mcfe. We continuously evaluate acquisition opportunities for our own account and may
begin sponsoring production programs with private investors to participate in these
initiatives.
 Regional Advantages
  17




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##### Table of Contents



Drilling Operations
 Drilling Program Structure
  Drilling Program Benefits
 
    
    Depending on the level of outside capital invested in our Drilling Programs, we
control a drilling budget up to four times greater than we could support on our own. This
helps us compete for attractive properties by increasing our drilling commitments. It also
expands our buying power for drilling services and materials, contributing to lower overall
development costs.
    
    Aggregating our capital with private investors in our Drilling Programs enables
us to maintain a larger and more capable staff than we could otherwise support if we were
operating solely for our own account.
    
    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 drilling operations on our undeveloped prospects through smaller,
specialized Drilling Programs and retaining up to 67% of the working interests, we expand
our inventory of developmental locations with lower risk profiles for larger, subsequent
Drilling 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 inherent in drilling
operations.
 Drilling Program Financings
 18




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##### Table of Contents



Drilling Results
 Development Wells
    
    Exploratory WellsProductive
    
    Dry
    
    Productive
    
    DryGross
    
    Net
    
    Gross
    
    Gross
    
    Net
    
    GrossNine months ended September 30, 2005
    
    
    116
    
    
    
    32.8833
    
    
    
    
    
    
    
    2
    
    
    
    0.8120
    
    
    
    Year ended December 31, 2004
    
    
    140
    
    
    
    39.7149
    
    
    
    
    
    
    
    15
    
    
    
    10.0000
    
    
    
    
 Results
of Operations  Three Months Ended September 30, 2005 and 2004
 Revenues
    19




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##### Table of Contents



Expenses
         Net Income and EPS
 20




---



##### Table of Contents



Results
of Operations  Nine months Ended September 30, 2005 and 2004
 Revenues
    Expenses
    21




---



##### Table of Contents



Net Income and EPS
  Liquidity and Capital Resources
 Liquidity
  22




---



##### Table of Contents



Capital Resources
       23




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##### Table of Contents



Forward Looking Statements
  Related Party Transactions
  Contractual Obligations and Commercial Commitments
  Operating
    
    
    Long Term
    
    
    OtherYear
    
    Leases
    
    
    Debt
    
    
    Commitments
    
    
    TotalBalance of 2005
    
    $
    138,841
    
    
    $
    9,692
    
    
    $
    240,000
    (1)
    
    $
    388,5332006
    
    
    547,048
    
    
    
    15,024,000
    
    
    
    
    
    
    
    15,571,0482007
    
    
    547,732
    
    
    
    24,000
    
    
    
    
    
    
    
    571,7322008
    
    
    287,809
    
    
    
    1,973,377
    
    
    
    100,000
    (2)
    
    
    2,361,1862009
    
    
    195,000
    
    
    
    24,000
    
    
    
    2,045,000
    (2)
    
    
    2,264,0002010 and thereafter
    
    
    97,500
    
    
    
    5,856,168
    
    
    
    
    
    
    
    5,953,668Total
    
    $
    1,813,930
    
    
    $
    22,911,237
    
    
    $
    2,385,000
    
    
    $
    27,110,167
 
 (1)
    
    Reflects obligations under a guaranty secured by a certificate of deposit provided for
bank debt of Galax Energy Concepts, LLC, a North Carolina limited liability company in which
DPI previously held a minority interest.(2)
    
    Reflects commitments under a purchase contract for an airplane. Critical Accounting Policies and Estimates
 General
 24




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##### Table of Contents



Allowance for Doubtful Accounts .
 Impairment of Long-Lived Assets .
 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk
  
 Item 4. Controls and Procedures
   25




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##### Table of Contents



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).4.1
    
    Form of 7% Convertible Promissory Note due September 5, 2008 (incorporated by reference
to Exhibit 10.2 to Current Report on Form 8-K [File No. 0-12185] dated September 10, 2003).4.1
    
    7% Convertible Promissory Note in the principal amount of $6,100,000 due October 4, 2009
(incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K [File No. 0-12185]
dated October 4, 2004).4.3
    
    Note Purchase Agreement for 7% Convertible Promissory Notes in the principal amount of
$8,000,000 due March 31, 2010 (incorporated by reference to Exhibit 10.13 to Registration
Statement on Form S-3 (File No. 333-125053) filed May 19, 2005).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
    
    Form of Common Stock Purchase Warrant dated September 10, 2003 (incorporated by reference
to Exhibit 10.3 to Current Report on Form 8-K [File No. 0-12185] dated September 10, 2003).10.5
    
    Form of Common Stock Purchase Warrant dated December 31, 2003 (incorporated by reference to
Exhibit 10.3 to Current Report on Form 8-K [File No. 0-12185] dated January 2, 2003).10.6
    
    Form of Common Stock Purchase Warrant dated April 29, 2004 (incorporated by reference to
Exhibit 10.4 to Current Report on Form 8-K [File No. 0-12185] dated September 29, 2003).10.7
    
    Form of Common Stock Purchase Warrant dated October 4, 2004 (incorporated by reference to
Exhibit 10.3 to Current Report on Form 8-K [File No. 0-12185] dated October 4, 2004).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).
 26




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibit10.9
    
    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 Share21.1
    
    Subsidiaries (incorporated by reference to Exhibit 21.1 to Annual Report on Form 10-KSB
[File No. 0-12185] for the year ended December 31, 2004).31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities
Exchange Act of 1934, as amended.31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities
Exchange Act of 1934, as amended.32.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(b) under the Securities
Exchange Act of 1934, as amended.32.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(b) under the Securities
Exchange Act of 1934, as amended.
 
 SIGNATURES
  NGAS RESOURCES, INC.Date: November 14, 2005
    
    By:
    
    /s/ William S. DaughertyWilliam S. DaughertyChief Executive Officer(Duly Authorized Officer)(Principal Executive Officer)
 27