##### 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, 2008
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF EXCHANGE ACT
 Commission File No. 0-12185
 NGAS Resources, Inc.
 (Exact name of registrant as specified in its charter)
 Province of British Columbia
(State or other jurisdiction of 
incorporation or organization)
    
    Not Applicable
(I.R.S. Employer
Identification No.)120 Prosperous Place, Suite 201
Lexington, Kentucky
(Address of principal executive offices)
    
    40509-1844
(Zip Code)
 Registrants telephone number, including area code: (859) 263-3948
  þ o
  Large accelerated filer oAccelerated filer þNon-accelerated filer o(Do not check if a smaller reporting company)Smaller reporting company o o þ
  Title of Class
    
    Outstanding at November 3, 2008Common Stock
    
    26,543,646




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##### 



NGAS Resources, Inc.
 INDEX
 PagePart I. Financial InformationItem 1. Financial Statements:Condensed Consolidated Balance Sheets  September 30, 2008 (unaudited) and December 31, 2007
    
    
    1Condensed Consolidated Statement of Operations  Three months and nine months ended
September 30, 2008 and 2007
    
    
    2Condensed Consolidated Statement of Cash Flows  Three months and nine months ended
September 30, 2008 and 2007
    
    
    3Notes to Condensed Consolidated Financial Statements
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    21Item 4. Controls and Procedures
    
    
    22Part II. Other InformationItem 6. Exhibits
    
    
    22EX-31.1EX-31.2EX-32.1EX-32.2
  ADDITIONAL INFORMATION
 www.ngas.com NGAS we our us Dth Mcf Bcf Mcfe Bcfe




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##### Table of Contents



NGAS Resources, Inc.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 September 30,
    
    
    December 31,2008
    
    
    2007(Unaudited)ASSETSCurrent assets:Cash
    
    $
    682,209
    
    
    $
    2,816,678Accounts receivable
    
    
    13,144,876
    
    
    
    7,909,943Prepaid expenses and other current assets
    
    
    733,316
    
    
    
    505,778Loans to related parties
    
    
    7,445
    
    
    
    7,654Total current assets
    
    
    14,567,846
    
    
    
    11,240,053Bonds and deposits
    
    
    666,195
    
    
    
    535,445Oil and gas properties
    
    
    213,371,524
    
    
    
    183,823,702Property and equipment
    
    
    3,464,974
    
    
    
    3,689,636Loans to related parties
    
    
    245,081
    
    
    
    249,410Deferred financing costs
    
    
    1,729,957
    
    
    
    1,706,852Other non-current assets
    
    
    
    
    
    
    3,242,790Goodwill
    
    
    313,177
    
    
    
    313,177Total assets
    
    $
    234,358,754
    
    
    $
    204,801,065LIABILITIESCurrent liabilities:Accounts payable
    
    $
    10,334,393
    
    
    $
    6,649,809Accrued liabilities
    
    
    4,125,283
    
    
    
    3,655,684Customer drilling deposits
    
    
    
    
    
    
    2,857,806Deferred compensation
    
    
    2,229,086
    
    
    
    Long term debt, current portion
    
    
    24,000
    
    
    
    388,856Total current liabilities
    
    
    16,712,762
    
    
    
    13,552,155Deferred income taxes
    
    
    12,591,234
    
    
    
    9,218,770Long term debt
    
    
    100,998,235
    
    
    
    80,160,915Deferred compensation
    
    
    
    
    
    
    1,960,020Total liabilities
    
    
    130,302,231
    
    
    
    104,891,860SHAREHOLDERS EQUITYCapital stockAuthorized:5,000,000     Preferred shares100,000,000     Common sharesIssued:26,543,646      Common shares (2007  26,136,064)
    
    
    110,626,912
    
    
    
    108,842,52621,100      Common shares held in treasury, at cost
    
    
    (23,630
    )
    
    
    (23,630
    )Paid-in capital  options and warrants
    
    
    3,482,083
    
    
    
    3,484,148Contributed surplus
    
    
    778,583
    
    
    
    1,043,222To be issued:9,185     Common shares
    
    
    45,925
    
    
    
    45,925114,909,873
    
    
    
    113,392,191Deficit
    
    
    (10,853,350
    )
    
    
    (13,482,986
    )Total shareholders equity
    
    
    104,056,523
    
    
    
    99,909,205Total liabilities and shareholders equity
    
    $
    234,358,754
    
    
    $
    204,801,065
 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 30,2008
    
    
    2007
    
    
    2008
    
    
    2007REVENUEContract drilling
    
    $
    9,799,561
    
    
    $
    6,730,929
    
    
    $
    24,027,035
    
    
    $
    23,435,852Oil and gas production
    
    
    11,222,879
    
    
    
    6,690,916
    
    
    
    30,891,933
    
    
    
    20,174,095Gas transmission, compression
and processing
    
    
    2,567,852
    
    
    
    1,793,970
    
    
    
    7,662,504
    
    
    
    5,628,950Total revenue
    
    
    23,590,292
    
    
    
    15,215,815
    
    
    
    62,581,472
    
    
    
    49,238,897DIRECT EXPENSESContract drilling
    
    
    7,570,698
    
    
    
    5,291,342
    
    
    
    18,447,544
    
    
    
    18,391,079Oil and gas production
    
    
    3,922,629
    
    
    
    1,873,413
    
    
    
    9,794,679
    
    
    
    5,355,613Gas transmission, compression
and processing
    
    
    1,039,597
    
    
    
    783,970
    
    
    
    3,087,391
    
    
    
    2,663,406Impairment of oil and gas assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    964,000Total direct expenses
    
    
    12,532,924
    
    
    
    7,948,725
    
    
    
    31,329,614
    
    
    
    27,374,098OTHER EXPENSES (INCOME)Selling, general and administrative
    
    
    3,551,908
    
    
    
    2,572,348
    
    
    
    10,282,485
    
    
    
    9,636,594Options, warrants and deferred compensation
    
    
    229,209
    
    
    
    261,327
    
    
    
    601,691
    
    
    
    931,627Depreciation, depletion and amortization
    
    
    3,318,320
    
    
    
    2,493,219
    
    
    
    9,451,272
    
    
    
    7,160,865Bad debt expense
    
    
    342,195
    
    
    
    215,000
    
    
    
    749,035
    
    
    
    215,000Interest expense
    
    
    1,457,300
    
    
    
    1,834,852
    
    
    
    4,138,913
    
    
    
    4,593,824Interest income
    
    
    (10,774
    )
    
    
    (81,063
    )
    
    
    (89,577
    )
    
    
    (214,806
    )Other, net
    
    
    87,584
    
    
    
    (96,385
    )
    
    
    115,939
    
    
    
    41,520Total other expenses
    
    
    8,975,742
    
    
    
    7,199,298
    
    
    
    25,249,758
    
    
    
    22,364,624INCOME (LOSS) BEFORE INCOME TAXES
    
    
    2,081,626
    
    
    
    67,792
    
    
    
    6,002,100
    
    
    
    (499,825
    )INCOME TAX EXPENSE
    
    
    1,136,441
    
    
    
    126,356
    
    
    
    3,372,464
    
    
    
    573,427NET INCOME (LOSS)
    
    $
    945,185
    
    
    $
    (58,564
    )
    
    $
    2,629,636
    
    
    $
    (1,073,252
    )NET INCOME (LOSS) PER SHAREBasic
    
    $
    0.04
    
    
    $
    0.00
    
    
    $
    0.10
    
    
    $
    (0.05
    )Diluted
    
    $
    0.04
    
    
    $
    0.00
    
    
    $
    0.10
    
    
    $
    (0.05
    )WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING:Basic
    
    
    26,508,570
    
    
    
    21,804,959
    
    
    
    26,364,158
    
    
    
    21,798,275Diluted
    
    
    26,977,438
    
    
    
    21,804,959
    
    
    
    27,019,313
    
    
    
    21,798,275
 See accompanying notes.
 2




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##### Table of Contents



NGAS Resources, Inc.
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007OPERATING ACTIVITIESNet income (loss)
    
    $
    945,185
    
    
    $
    (58,564
    )
    
    $
    2,629,636
    
    
    $
    (1,073,252
    )Adjustments to reconcile net income to
net cash used in operating activities:Incentive bonus paid in common shares
    
    
    228,120
    
    
    
    
    
    
    
    259,690
    
    
    
    3,010Compensation from options and warrants
    
    
    229,209
    
    
    
    261,327
    
    
    
    601,691
    
    
    
    931,627Depreciation, depletion and amortization
    
    
    3,318,320
    
    
    
    2,493,219
    
    
    
    9,451,272
    
    
    
    7,160,865Bad debt expense
    
    
    342,195
    
    
    
    215,000
    
    
    
    749,035
    
    
    
    215,000Impairment of oil and gas assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    964,000Gain (loss) on sale of assets
    
    
    (10,761
    )
    
    
    (28,834
    )
    
    
    (11,116
    )
    
    
    49,307Deferred income taxes
    
    
    1,136,441
    
    
    
    126,356
    
    
    
    3,372,464
    
    
    
    573,427Changes in assets and liabilitiesAccounts receivable
    
    
    (1,840,648
    )
    
    
    800,805
    
    
    
    (5,983,968
    )
    
    
    1,944,462Prepaid expenses and other current assets
    
    
    (345,152
    )
    
    
    65,317
    
    
    
    (227,538
    )
    
    
    307,937Other non-current assets
    
    
    
    
    
    
    116,221
    
    
    
    3,242,790
    
    
    
    (751,737
    )Accounts payable
    
    
    2,979,900
    
    
    
    808,096
    
    
    
    3,684,584
    
    
    
    (1,819,754
    )Accrued liabilities
    
    
    261,981
    
    
    
    (59,711
    )
    
    
    469,599
    
    
    
    (538,872
    )Customers drilling deposits
    
    
    (1,630,304
    )
    
    
    (4,380,328
    )
    
    
    (2,857,806
    )
    
    
    (11,686,100
    )Net cash provided by (used in)
operating activities
    
    
    5,614,486
    
    
    
    358,904
    
    
    
    15,380,333
    
    
    
    (3,720,080
    )INVESTING ACTIVITIESProceeds from sale of assets
    
    
    15,855
    
    
    
    355,000
    
    
    
    54,555
    
    
    
    389,700Purchase of property and equipment
    
    
    (155,170
    )
    
    
    (340,590
    )
    
    
    (459,671
    )
    
    
    (1,327,094
    )Change in bonds and deposits
    
    
    (95,250
    )
    
    
    105,500
    
    
    
    (130,750
    )
    
    
    68,500Additions to oil and gas properties, net
    
    
    (11,615,165
    )
    
    
    (13,187,693
    )
    
    
    (37,940,322
    )
    
    
    (38,711,872
    )Net cash used in investing activities
    
    
    (11,849,730
    )
    
    
    (13,067,783
    )
    
    
    (38,476,188
    )
    
    
    (39,580,766
    )FINANCING ACTIVITIESDecrease in loans to related parties
    
    
    1,861
    
    
    
    1,889
    
    
    
    4,538
    
    
    
    5,599Proceeds from issuance of common shares
    
    
    81,200
    
    
    
    151,250
    
    
    
    1,190,006
    
    
    
    191,550Payments of deferred financing costs
    
    
    (297,440
    )
    
    
    
    
    
    
    (440,983
    )
    
    
    Proceeds from issuance of long term debt
    
    
    5,500,000
    
    
    
    15,100,000
    
    
    
    22,240,000
    
    
    
    34,100,000Payments of long term debt
    
    
    (6,000
    )
    
    
    (6,000
    )
    
    
    (2,032,175
    )
    
    
    (18,000
    )Net cash provided by financing activities
    
    
    5,279,621
    
    
    
    15,247,139
    
    
    
    20,961,386
    
    
    
    34,279,149Change in cash
    
    
    (955,623
    )
    
    
    2,538,260
    
    
    
    (2,134,469
    )
    
    
    (9,021,697
    )Cash, beginning of period
    
    
    1,637,832
    
    
    
    2,872,020
    
    
    
    2,816,678
    
    
    
    14,431,977Cash, end of period
    
    $
    682,209
    
    
    $
    5,410,280
    
    
    $
    682,209
    
    
    $
    5,410,280SUPPLEMENTAL DISCLOSUREInterest paid
    
    $
    1,456,786
    
    
    $
    1,754,715
    
    
    $
    4,138,104
    
    
    $
    4,512,167Income taxes paid
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 See accompanying notes.
 3




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##### Table of Contents



NGAS Resources, Inc.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 Note 1. Summary of Significant Accounting Policies
 General NGAS U.S. GAAP
 Basis of Presentation DPI Company we our us
 Estimates .
 Note 2. Oil and Gas Properties
 Capitalized Costs and DD&A DD&A
 September 30,
    
    
    December 31,2008
    
    
    2007Proved oil and gas properties
    
    $
    176,990,690
    
    
    $
    148,981,923Unproved oil and gas properties
    
    
    4,765,413
    
    
    
    3,876,721Gathering facilities and well equipment
    
    
    64,413,858
    
    
    
    55,370,995246,169,961
    
    
    
    208,229,639Accumulated DD&A
    
    
    (32,798,437
    )
    
    
    (24,405,937
    )Net oil and gas properties and equipment
    
    $
    213,371,524
    
    
    $
    183,823,702
 Suspended Well Costs Accounting for Suspended Well
Costs
 4




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##### Table of Contents



Note 3. Property and Equipment
  September 30,
    
    
    December 31,2008
    
    
    2007Land
    
    $
    12,908
    
    
    $
    12,908Building improvements
    
    
    62,365
    
    
    
    58,051Machinery and equipment
    
    
    3,304,744
    
    
    
    3,170,601Office furniture and fixtures
    
    
    175,862
    
    
    
    168,217Computer and office equipment
    
    
    656,828
    
    
    
    578,317Vehicles
    
    
    1,989,666
    
    
    
    1,869,5516,202,373
    
    
    
    5,857,645Accumulated depreciation
    
    
    (2,737,399
    )
    
    
    (2,168,009
    )Net other property and equipment
    
    $
    3,464,974
    
    
    $
    3,689,636
 Note 4. Deferred Financing Costs
  Note 5. Goodwill
 SFAS Goodwill and Other Intangible Assets
 Note 6. Customer Drilling Deposits
  Note 7. Long Term Debt
 Convertible Notes
 5




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##### Table of Contents



Credit Facility
 Equipment Loan
 Acquisition Debt
 Total Long Term Debt and Maturities
 Principal Amount OutstandingSeptember 30,
    
    
    December 31,2008
    
    
    2007Total long term debt (including current portion)(1)
    
    $
    101,022,235
    
    
    $
    80,549,771Less current portion
    
    
    24,000
    
    
    
    388,856Total long term debt(1)
    
    $
    100,998,235
    
    
    $
    80,160,915Maturities of DebtRemainder of 2008
    
    $
    6,0002009
    
    
    24,0002010
    
    
    36,245,417
    (1)2011
    
    
    64,524,0002012 and thereafter
    
    
    222,818
 
 (1)
    
    Excludes allocations of $778,583 at September 30, 2008 and $1,043,222 at December 31, 2007
from our 6% convertible notes in the principal amount of $37,000,000 based on equity
components of their conversion features and related warrants, which expired unexercised in
2006. Note 8. Capital Stock
 Preferred Shares
 Common Shares
 6




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##### Table of Contents



Number ofCommon Shares Issued
    
    Shares
    
    
    AmountBalance, December 31, 2006
    
    
    21,788,551
    
    
    $
    84,531,832Issued in registered direct placement
    
    
    4,200,000
    
    
    
    23,687,955Issued as stock awards under incentive plan
    
    
    10,430
    
    
    
    61,010Issued upon exercise of stock options and warrants
    
    
    137,083
    
    
    
    561,729Balance, December 31, 2007
    
    
    26,136,064
    
    
    
    108,842,526Issued to employees as incentive bonus
    
    
    50,000
    
    
    
    259,690Issued upon exercise of stock options
    
    
    357,582
    
    
    
    1,524,696Balance, September 30, 2008
    
    
    26,543,646
    
    
    $
    110,626,912Paid In Capital  Options and WarrantsBalance, December 31, 2006
    
    
    
    
    
    $
    3,073,287Recognized
    
    
    
    
    
    
    529,062Exercised
    
    
    
    
    
    
    (118,201
    )Balance, December 31, 2007
    
    
    
    
    
    
    3,484,148Recognized
    
    
    
    
    
    
    332,625Exercised
    
    
    
    
    
    
    (334,690
    )Balance, September 30, 2008
    
    
    
    
    
    $
    3,482,083Contributed SurplusBalance, December 31, 2006
    
    
    
    
    
    $
    1,396,074Accreted(1)
    
    
    
    
    
    
    (352,852
    )Balance, December 31, 2007
    
    
    
    
    
    
    1,043,222Accreted(1)
    
    
    
    
    
    
    (264,639
    )Balance, September 30, 2008
    
    
    
    
    
    $
    778,583Common Shares to be IssuedBalance, September 30, 2008 and December 31, 2007
    
    
    9,185
    
    
    $
    45,925
 
 (1)
    
    Reflects accretion of the equity components allocated to our 6% convertible notes and related
warrants issued in 2005. Stock Options and Awards
 Weighted AverageStock Options
    
    Issued
    
    Exercisable
    
    Exercise PriceBalance, December 31, 2006
    
    
    2,815,000
    
    
    
    945,833
    
    
    $
    4.68Vested
    
    
    
    
    
    
    920,833
    
    
    
    6.03Exercised
    
    
    (127,083
    )
    
    
    (127,083
    )
    
    
    3.17Forfeited
    
    
    (6,667
    )
    
    
    
    
    
    
    6.02Balance, December 31, 2007
    
    
    2,681,250
    
    
    
    1,739,583
    
    
    
    4.75Granted
    
    
    650,000
    
    
    
    
    
    
    
    6.53Vested
    
    
    
    
    
    
    41,667
    
    
    
    6.02Exercised
    
    
    (357,582
    )
    
    
    (357,582
    )
    
    
    3.33Forfeited
    
    
    (10,000
    )
    
    
    (10,000
    )
    
    
    7.04Balance, September 30, 2008
    
    
    2,963,668
    
    
    
    1,413,668
    
    
    
    5.28
 7




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##### Table of Contents



Options Outstanding
    
    Options ExercisableWeighted
    
    Weighted
    
    
    
    
    
    WeightedExercise
    
    
    
    
    
    Average
    
    Average
    
    
    
    
    
    AveragePrice
    
    
    
    
    
    Remaining
    
    Exercise
    
    
    
    
    
    Exerciseor Range
    
    Number
    
    Life (years)
    
    Price
    
    Number
    
    Price$4.03 4.09
    
    
    1,540,000
    
    
    
    1.07
    
    
    $
    4.05
    
    
    
    740,000
    
    
    $
    4.066.02 7.64
    
    
    1,423,668
    
    
    
    2.61
    
    
    
    6.66
    
    
    
    673,668
    
    
    
    6.882,963,668
    
    
    
    
    
    
    
    
    
    
    
    1,413,668
 Share-Based Payment
 Common Stock Purchase Warrants
 Note 9. Income (Loss) Per Share
 EPS
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Numerator:Net income (loss) as reported for basic EPS
    
    $
    945,185
    
    
    $
    (58,564
    )
    
    $
    2,629,636
    
    
    $
    (1,073,252
    )Adjustments to income for diluted EPS
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss) for diluted EPS
    
    $
    945,185
    
    
    $
    (58,564
    )
    
    $
    2,629,636
    
    
    $
    (1,073,252
    )Denominator:Weighted average shares for basic EPS
    
    
    26,508,570
    
    
    
    21,804,959
    
    
    
    26,364,158
    
    
    
    21,798,275Effect of dilutive securities  stock options
    
    
    468,868
    
    
    
    
    
    
    
    655,155
    
    
    
    Adjusted weighted average shares and
assumed conversions for diluted EPS
    
    
    26,977,438
    
    
    
    21,804,959
    
    
    
    27,019,313
    
    
    
    21,798,275Basic EPS
    
    $
    0.04
    
    
    $
    0.00
    
    
    $
    0.10
    
    
    $
    (0.05
    )Diluted EPS
    
    $
    0.04
    
    
    $
    0.00
    
    
    $
    0.10
    
    
    $
    (0.05
    )
 Note 10. Segment Information
 Disclosure about
Segments of an Enterprise and Related Information
 8




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##### Table of Contents



Note 11. Commitments
  Operating
    
    
    OtherYear
    
    Leases
    
    
    Commitments(1)
    
    
    TotalRemainder of 2008
    
    $
    562,189
    
    
    $
    
    
    
    $
    562,1892009
    
    
    2,250,846
    
    
    
    2,045,000
    
    
    
    4,295,8462010
    
    
    2,182,717
    
    
    
    
    
    
    
    2,182,7172011
    
    
    1,976,039
    
    
    
    
    
    
    
    1,976,0392012 and thereafter
    
    
    920,725
    
    
    
    
    
    
    
    920,725Total
    
    $
    7,892,516
    
    
    $
    2,045,000
    
    
    $
    9,937,516
 
 (1)
    
    Reflects commitments under a purchase contract for an airplane. Note 12. Recent Accounting Standards
 Oil and Gas Reporting Requirements
 SFAS No. 162 The Hierarchy of Generally
Accepted Accounting Principles The Meaning
of Present Fairly in Conformity With Generally Accepted Accounting Principles
 SFAS No. 161 Disclosures About
Derivative Instruments and Hedging Activities
 FSP No. 157-2 Effective Date of
FASB Statement No. 157,
 SFAS No. 160 Noncontrolling
Interests in Consolidated Financial Statements
 9




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##### Table of Contents



SFAS No. 141(R) Business
Combinations
 EITF 07-1 EITF Accounting for Collaborative Arrangements Reporting Revenue Gross as a Principal Versus Net as an Agent
 10




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##### Table of Contents



NGAS Resources, Inc.
 
 Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 General
  Strategy
  
    
    Growth through the Drillbit with Reduced Capital Spending. Development
drilling is our mainstay for production and reserve growth. During the first nine
months of 2008, we drilled 64 gross (58.9 net) wells on our operated properties in the
Appalachian and Illinois Basins, along with 90 gross (12.9 net) non-operated wells. In
the same period last year, we drilled 96 gross (47.4 net) operated wells and 73 gross
(12.9 net) non-operated wells. This reflects the evolution of our business model for
accelerating organic growth by retaining all of our available working interest in wells
drilled on our core operated properties. We implemented this strategy late in 2007,
resulting in an average working interest of 92% in wells drilled on operated properties
during the first nine months of 2008, compared to 56% during the prior year. While we
are committed to continue expanding our reserves and production through the drillbit,
we are addressing current conditions in the financial and energy markets with a planned
reduction in capital spending to approximately $32.5 million for 2009. This is in line
with our anticipated cash flow from operations and available funding under our
revolving credit facility.
    
    Horizontal Drilling Initiatives. Horizontal drilling is enhancing the
value proposition for many of our properties by substantially increasing our recovery
volumes and rates at lower finding costs. Thus far, we have focused these initiatives
in our Leatherwood field, where we have completed ten horizontal wells through the end
of the third quarter. Each well has a single lateral leg up to 3,500 feet through the
lower Huron section of the Devonian shale, which is present throughout most of our
operating areas. For the initial month in production, we had average daily flow rates
of 313 Mcf from nine completed wells in Leatherwood. During the third quarter, we
expanded this program with our first horizontal New Albany shale well in our Haleys
Mill field, with very encouraging initial results. Based on our current capital
spending plan, we expect to drill a total of 22 horizontal wells by year end and up to
34 horizontal wells in 2009.
    
    Control of Field-Wide Infrastructure. We construct and operate field-wide
gas gathering facilities to provide compression, connection and local distribution
capabilities for most of our Appalachian production. Because we control third-party
access to these facilities, they provide us with competitive advantages in acquiring
and developing nearby acreage. We continually upgrade this infrastructure to keep pace
with our expanding production base. Recent additions include 54 miles of gathering
lines installed during the first nine months of 2008, including infrastructure for
producing our New Albany shale project in western Kentucky, which we brought on line in
late August 2008. We also completed
 11




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##### Table of Contents



facilities to provide deliverability from our
Fonde field through a 14-mile, six-inch steel line to our
midstream system. Historically, production in Fonde had been limited by pipeline
capacity constraints. Completion of our new facilities has enabled us to connect a
backlog of wells drilled in Fonde over the last several years and open nearly 50,000
acres for future development in this field.
 
    
    Reduced Production Costs from Ownership of Midstream Assets. We own and
operate a strategically located open-access gas gathering system spanning 116 miles in
southeastern Kentucky and southwestern Virginia. We acquired this midstream system in
2006 through our NGAS Gathering subsidiary and augmented the system through two
high-pressure lateral upgrades for connections to our field-wide gathering facilities,
plus a recently completed processing plant for liquids extraction. We currently
deliver all our production from the Leatherwood, Straight Creek, Fonde and SME fields
to the interstate pipeline network through the NGAS Gathering system. As of September
30, 2008, the system had daily gross throughput of over 19,000 Dth, including
third-party deliveries. In addition to generating gas transmission and processing
revenues from third-party throughput and cost savings for our own Appalachian
production, ownership of these midstream assets gives us control over gas flow from our
connected fields and enhances our competitive position in the region.
    
    Development of Additional Drilling Prospects. We follow a disciplined
capital allocation process in selecting opportunities to expand our substantial
inventory of drilling prospects that meet our criteria for predictable, long-lived
reserves. Our goal is to consolidate our position in the Appalachian Basin, while
diversifying our asset base with similar unconventional plays outside the basin. As
part of this strategy, we are aggressively developing our New Albany shale play in the
Haleys Mill field, located within the southcentral portion of the Illinois Basin in
western Kentucky. Through the date of this report, we have drilled a
total of 37 wells
in Haleys Mill. We completed our gas gathering system for Haleys Mill and began
producing the field to sales in late August 2008, with flow rates of over 1,250 Mcf per
day from 28 wells on line as of the date of this report. Based on these encouraging
results, we have also launched a project to test the New Albany shale on recently
acquired acreage outside Haleys Mill. If market conditions improve, we will continue
developing these prospects.
    
    Purchase of Producing Properties. The purchase of third-party production
offers a means in addition to drilling for capitalizing on our operating experience and
accelerating our growth. Our acquisition criteria for producing properties include
reserve life, profit enhancement potential, geographic concentration and operating
rights. Based on those criteria, we launched a project in June 2008 to purchase the
interests of outside investors in several of our mature drilling programs on an
all-cash basis that gives effect to our reversionary interests in the programs.
Through the date of this report, we have purchased 162 Mmcfe of reserves from outside
investors for a total purchase price of $280,279. Based on the limited acceptance of
our purchase offers, we do not plan to continue this project unless market conditions
improve substantially.
 Drilling Operations
 General
 Geological Factors
 12




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##### Table of Contents



Drilling Results
 Development Wells
    
    Exploratory WellsProductive
    
    Dry
    
    Productive
    
    DryGross
    
    Net
    
    Gross
    
    Gross
    
    Net
    
    GrossYear ended December 31, 2007
    
    
    211
    
    
    
    76.1508
    
    
    
    
    
    
    
    6
    
    
    
    6.0000
    
    
    
    Nine months ended
September 30, 2008
    
    
    145
    
    
    
    63.0140
    
    
    
    
    
    
    
    9
    
    
    
    8.8125
    
    
    
    
  Participation Rights
 Producing Activities
 Regional Advantages
 Liquids Extraction
 Oil and Gas Production
 13




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##### Table of Contents



Three Months Ended
    
    Nine Months Ended
    
    Year EndedSeptember 30,
    
    September 30,
    
    December 31,2008
    
    2007
    
    2008
    
    2007
    
    2007Production volumes:Natural gas (Mcf)
    
    
    760,401
    
    
    
    750,181
    
    
    
    2,268,929
    
    
    
    2,109,831
    
    
    
    2,950,690Oil (Bbl)
    
    
    16,235
    
    
    
    13,056
    
    
    
    44,718
    
    
    
    44,398
    
    
    
    57,738Natural gas liquids (gallons)
    
    
    1,202,292
    
    
    
    22,218
    
    
    
    2,930,974
    
    
    
    118,057
    
    
    
    154,797Equivalents (Mcfe)
    
    
    947,986
    
    
    
    830,464
    
    
    
    2,778,668
    
    
    
    2,386,549
    
    
    
    3,310,665Average sales prices:Natural gas (per Mcf)
    
    $
    9.80
    
    
    $
    7.64
    
    
    $
    9.40
    
    
    $
    8.25
    
    
    $
    8.19Oil (per Bbl)
    
    
    110.26
    
    
    
    71.09
    
    
    
    106.06
    
    
    
    58.99
    
    
    
    64.97Natural gas liquids (per gallon)
    
    
    1.65
    
    
    
    1.45
    
    
    
    1.64
    
    
    
    1.31
    
    
    
    1.41
 Future Gas Sales Contracts
 Results of Operations  Three Months Ended September 30, 2008 and 2007
 Revenues
 Three Months Ended September 30,% of
    
    
    
    
    
    
    %2008
    
    
    Revenue
    
    
    2007
    
    
    ChangeRevenue:Contract drilling
    
    $
    9,799,561
    
    
    
    41
    %
    
    $
    6,730,929
    
    
    
    46
    %Oil and gas production
    
    
    11,222,879
    
    
    
    48
    
    
    
    6,690,916
    
    
    
    68Gas transmission, compression and processing
    
    
    2,567,852
    
    
    
    11
    
    
    
    1,793,970
    
    
    
    43Total
    
    $
    23,590,292
    
    
    
    100
    %
    
    $
    15,215,815
    
    
    
    55
    14




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##### Table of Contents



Expenses
 Three Months Ended September 30,2008
    
    
    Margin
    
    
    2007
    
    
    MarginDirect Expenses:Contract drilling
    
    $
    7,570,698
    
    
    
    23
    %
    
    $
    5,291,342
    
    
    
    21
    %Oil and gas production
    
    
    3,922,629
    
    
    
    65
    
    
    
    1,873,413
    
    
    
    72Gas transmission, compression and processing
    
    
    1,039,597
    
    
    
    60
    
    
    
    783,970
    
    
    
    56Total direct expenses
    
    
    12,532,924
    
    
    
    47
    
    
    
    7,948,725
    
    
    
    48
 % Revenue
    
    
    
    
    
    
    % RevenueOther Expenses:Selling, general and administrative
    
    
    3,551,908
    
    
    
    15
    %
    
    
    2,572,348
    
    
    
    17
    %Options, warrants and deferred compensation
    
    
    229,209
    
    
    
    1
    
    
    
    261,327
    
    
    
    2Depreciation, depletion and amortization
    
    
    3,318,320
    
    
    
    14
    
    
    
    2,493,219
    
    
    
    16Bad debt expense
    
    
    342,195
    
    
    
    1
    
    
    
    215,000
    
    
    
    1Interest expense, net of interest income
    
    
    1,446,526
    
    
    
    6
    
    
    
    1,753,789
    
    
    
    12Other, net
    
    
    87,584
    
    
    
    
    
    
    
    (96,385
    )
    
    
    N/ATotal other expenses
    
    $
    8,975,742
    
    
    
    
    
    
    $
    7,199,298
    15




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##### Table of Contents



SG&A
  DD&A
    Net Income and EPS EPS
 Results of Operations  Nine Months Ended September 30, 2008 and 2007
 Revenues
 Nine Months Ended September 30,% of
    
    
    
    
    
    
    %2008
    
    
    Revenue
    
    
    2007
    
    
    ChangeRevenue:Contract drilling
    
    $
    24,027,035
    
    
    
    39
    %
    
    $
    23,435,852
    
    
    
    3
    %Oil and gas production
    
    
    30,891,933
    
    
    
    49
    
    
    
    20,174,095
    
    
    
    53Gas transmission, compression and processing
    
    
    7,662,504
    
    
    
    12
    
    
    
    5,628,950
    
    
    
    36Total
    
    $
    62,581,472
    
    
    
    100
    %
    
    $
    49,238,897
    
    
    
    27
  16




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##### Table of Contents



Expenses
 Nine Months Ended September 30,2008
    
    
    Margin
    
    
    2007
    
    
    MarginDirect Expenses:Contract drilling
    
    $
    18,447,544
    
    
    
    23
    %
    
    $
    18,391,079
    
    
    
    22
    %Oil and gas production
    
    
    9,794,679
    
    
    
    68
    
    
    
    5,355,613
    
    
    
    73Gas transmission, compression and processing
    
    
    3,087,391
    
    
    
    60
    
    
    
    2,663,406
    
    
    
    53Impairment of oil and gas assets
    
    
    
    
    
    
    N/A
    
    
    
    964,000
    
    
    
    N/ATotal direct expenses
    
    
    31,329,614
    
    
    
    50
    
    
    
    27,374,098
    
    
    
    44
 % Revenue
    
    
    
    
    
    
    % RevenueOther Expenses:Selling, general and administrative
    
    
    10,282,485
    
    
    
    16
    %
    
    
    9,636,594
    
    
    
    20
    %Options, warrants and deferred compensation
    
    
    601,691
    
    
    
    1
    
    
    
    931,627
    
    
    
    2Depreciation, depletion and amortization
    
    
    9,451,272
    
    
    
    15
    
    
    
    7,160,865
    
    
    
    15Bad debt expense
    
    
    749,035
    
    
    
    1
    
    
    
    215,000
    
    
    
    Interest expense, net of interest income
    
    
    4,049,336
    
    
    
    6
    
    
    
    4,379,018
    
    
    
    9Other, net
    
    
    115,939
    
    
    
    
    
    
    
    41,520
    
    
    
    Total other expenses
    
    $
    25,249,758
    
    
    
    
    
    
    $
    22,364,624
   17




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##### Table of Contents



Net Income and EPS
  18




---



##### Table of Contents



Liquidity and Capital Resources
 Liquidity
  Capital Resources
  DPI
  19




---



##### Table of Contents



Forward Looking Statements and Risk Factors
  Contractual Obligations and Commercial Commitments
  Operating Leases
    
    
    Other
    
    
    Long TermYear
    
    Equipment
    
    
    Premises
    
    
    Total
    
    
    Commitments(1)
    
    
    DebtRemainder of 2008
    
    $
    500,996
    
    
    $
    61,193
    
    
    $
    562,189
    
    
    $
    
    
    
    $
    6,0002009
    
    
    2,003,982
    
    
    
    246,864
    
    
    
    2,250,846
    
    
    
    2,045,000
    
    
    
    24,0002010
    
    
    1,934,902
    
    
    
    247,815
    
    
    
    2,182,717
    
    
    
    
    
    
    
    36,245,417
    (2)2011
    
    
    1,723,650
    
    
    
    252,389
    
    
    
    1,976,039
    
    
    
    
    
    
    
    64,524,0002012 and thereafter
    
    
    643,396
    
    
    
    277,329
    
    
    
    920,725
    
    
    
    
    
    
    
    222,818Total
    
    $
    6,806,926
    
    
    $
    1,085,590
    
    
    $
    7,892,516
    
    
    $
    2,045,000
    
    
    $
    101,022,235
 
 (1)
    
    Reflects commitments under a purchase contract for an airplane.(2)
    
    Excludes an allocation of $778,583 from our 6% convertible notes in the principal amount of
$37,000,000 based on equity components of their conversion features. 20




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##### Table of Contents



Critical Accounting
Policies and Estimates
 General
 Estimates of Proved Reserves and Future Net Cash Flows
 Impairment of Long-Lived Assets .
 Allowance for Doubtful Accounts .
 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk
 Commodity Price Risk
  Financial Market Risks
 Interest Rate Risk
 21




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##### Table of Contents



Foreign Market Risk
 
 Item 4. Controls and Procedures
 Managements Responsibility for Financial Statements
  Disclosure Controls and Procedures
  Managements Report on Internal Control over Financial Reporting
 Internal Control  Integrated Framework
 Changes in Internal Control over Financial Reporting
  
 PART II. OTHER INFORMATION
 
 Item 6. Exhibits
 ExhibitNumber
    
    Description of Exhibit3.1
    
    Notice of Articles, certified on June 3, 2004 by the Registrar of Corporations under the
British Columbia Business Corporations Act (incorporated by reference to Exhibit 3.1 to
Current Report on Form 8-K [File No. 0-12185], filed June 29, 2004).3.2
    
    Alteration to Notice of Articles, certified on June 25, 2004 by the Registrar of
Corporations under the British Columbia Business Corporations Act (incorporated by reference
to Exhibit 3.2 to Current Report on Form 8-K [File No. 0-12185], filed June 29, 2004).3.3
    
    Articles dated June 25, 2004, as amended and restated for corporate transition under the
British Columbia Business Corporations Act (incorporated by reference to Exhibit 3.3 to
Current Report on Form 8-K [File No. 0-12185], filed June 29, 2004).10.1
    
    1997 Stock Option Plan (incorporated by reference to Exhibit 10[a] to Annual Report on Form
10-KSB [File No. 0-12185] for the year ended December 31, 2002).
 22




---



##### Table of Contents



ExhibitNumber
    
    Description of Exhibit10.2
    
    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 June 30, 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
    
    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).10.6
    
    Amended and Restated Credit Agreement dated as of May 30, 2008 among NGAS Resources, Inc.,
Daugherty Petroleum, Inc. and KeyBank National Association, as agent for the lenders named
therein (incorporated by reference to Exhibit 10.6 to Quarterly Report on Form 10-Q [File No.
0-12185] for the quarter ended June 30, 2008).10.7
    
    Amendment No. 1 dated as of August 4, 2008 to Amended and Restated Credit Agreement dated
as of May 30, 2008 among NGAS Resources, Inc., Daugherty Petroleum, Inc. and KeyBank National
Association, as agent for the lenders named therein (incorporated by reference to Exhibit
10.7 to Quarterly Report on Form 10-Q [File No. 0-12185] for the quarter ended June 30,
2008).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 June 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
June 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 June 31, 2004).10.11
    
    Form of general partnership agreement with sponsored drilling programs (incorporated by
reference to Exhibit 10.11 to amended annual report on Form 10-K/A [File No. 0-12185] for the
year ended December 31, 2006).10.12
    
    Form of limited partnership agreement with sponsored investment partnerships (incorporated
by reference to Exhibit 10.12 to amended annual report on Form 10-K/A [File No. 0-12185] for
the year ended December 31, 2006).10.13
    
    Form of assignment of drilling rights with sponsored drilling programs (incorporated by
reference to Exhibit 10.13 to amended annual report on Form 10-K/A [File No. 0-12185] for the
year ended December 31, 2006).10.14
    
    Form of drilling and operating agreement with sponsored drilling programs (incorporated by
reference to Exhibit 10.14 to amended annual report on Form 10-K/A [File No. 0-12185] for the
year ended December 31, 2006).11.1
    
    Computation of Earnings Per Share (included in Note 9 to the accompanying consolidated
financial statements)21.0
    
    Subsidiaries (incorporated by reference to Exhibit 21.1 to annual report on Form 10-K [File
No. 0-12185] for the year ended December 31, 2006).31.1
    
    Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a), as
adopted under Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a), as
adopted under Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(b), as
adopted under Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(b), as
adopted under Section 906 of the Sarbanes-Oxley Act of 2002.
 23




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##### Table of Contents



SIGNATURES
  NGAS Resources, Inc.Date: November 5, 2008
    By:
    /s/William S. DaughertyWilliam S. DaughertyChief Executive Officer
(Duly Authorized Officer)
(Principal Executive Officer) 24