UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2019

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to

Commission File Number 1-31398

NATURAL GAS SERVICES GROUP, INC.

(Exact name of registrant as specified in its charter)

Colorado	75-2811855
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

404 Veterans Airpark Ln., Ste 300

Midland, Texas 79705

(Address of principal executive offices)

(432) 262-2700

(Registrant’s telephone number, including area code)

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

Yes   x No   o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes   x No   o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated filer   x Non-accelerated filer o Smaller reporting company ☒ Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.o

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

Yes ☐ No x

APPLICABLE ONLY TO CORPORATE ISSUERS

As of July 29, 2019, there were 13,226,971 shares of the Registrant's common stock, $0.01 par value, outstanding.

Securities registered pursuant to Section 12(b) of the Act:
Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.01 par value	NGS	NYSE

Part I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Unaudited Condensed Consolidated Balance Sheets	Page	1
Unaudited Condensed Consolidated Income Statements	Page	2
Unaudited Condensed Consolidated Statements of Stockholders' Equity	Page	3
Unaudited Condensed Consolidated Statements of Cash Flows	Page	5
Notes to Unaudited Condensed Consolidated Financial Statements	Page	6
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations	Page	18
Item 3.  Quantitative and Qualitative Disclosures about Market Risk	Page	23
Item 4.  Controls and Procedures	Page	23
Part II - OTHER INFORMATION
Item 1.  Legal Proceedings	Page	24
Item 1A.  Risk Factors	Page	24
Item 6.  Exhibits	Page	25
Signatures	Page	27

PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements

NATURAL GAS SERVICES GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts) (unaudited)
	June 30,		December 31,
	2019		2018
ASSETS
Current Assets:
Cash and cash equivalents	$	29,911	$	52,628
Trade accounts receivable, net of allowance for doubtful accounts of $333 and $291, respectively	11,383		7,219
Inventory	30,302		30,974
Prepaid income taxes	3,146		3,148
Prepaid expenses and other	1,880		2,430
Total current assets	76,622		96,399
Long-term inventory, net of allowance for obsolescence of $21 and $19, respectively	3,873		3,980
Rental equipment, net of accumulated depreciation of $173,282 and $165,428, respectively	190,704		175,886
Property and equipment, net of accumulated depreciation of $11,777 and $11,556, respectively	20,146		16,587
Right of use assets - operating leases, net of accumulated amortization $83	494		—
Goodwill	10,039		10,039
Intangibles, net of accumulated amortization of $1,821 and $1,758, respectively	1,338		1,401
Other assets	1,339		1,109
Total assets	$	304,555	$	305,401
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable	$	2,579	$	2,122
Accrued liabilities	3,999		8,743
Current operating leases	129		—
Deferred income	113		81
Total current liabilities	6,820		10,946
Line of credit	417		417
Deferred income tax liability	32,514		32,158
Long-term operating leases	365		—
Other long-term liabilities	1,869		1,699
Total liabilities	41,985		45,220
Commitments and contingencies (Note 9)
Stockholders’ Equity:
Preferred stock, 5,000 shares authorized, no shares issued or outstanding	—		—
Common stock, 30,000 shares authorized, par value $0.01; 13,138 and 13,005 shares issued and outstanding, respectively	131		130
Additional paid-in capital	109,218		107,760
Retained earnings	153,221		152,291
Total stockholders' equity	262,570		260,181
Total liabilities and stockholders' equity	$	304,555	$	305,401

See accompanying notes to these unaudited condensed consolidated financial statements.

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NATURAL GAS SERVICES GROUP, INC. CONDENSED CONSOLIDATED INCOME STATEMENTS (in thousands, except earnings per share) (unaudited)
	Three months ended				Six months ended
	June 30,				June 30,
	2019		2018		2019		2018
Revenue:
Rental income	$	13,572	$	11,427	$	26,959	$	22,898
Sales	5,814		6,383		9,939		9,381
Service and maintenance income	509		394		988		643
Total revenue	19,895		18,204		37,886		32,922
Operating costs and expenses:
Cost of rentals, exclusive of depreciation stated separately below	6,359		5,195		12,244		9,899
Cost of sales, exclusive of depreciation stated separately below	4,419		4,924		8,118		7,115
Cost of service and maintenance	159		101		306		166
Selling, general and administrative expense	2,682		2,309		5,175		4,330
Depreciation and amortization	5,683		5,449		11,241		10,836
Total operating costs and expenses	19,302		17,978		37,084		32,346
Operating income	593		226		802		576
Other income (expense):
Interest expense	(4)		(3)		(8)		(6)
Other income, net	181		78		486		5
Total other income (expense), net	177		75		478		(1)
Income before provision for income taxes	770		301		1,280		575
Income tax expense	197		54		350		103
Net income	$	573	$	247	$	930	$	472
Earnings per share:
Basic	$	0.04	$	0.02	$	0.07	$	0.04
Diluted	$	0.04	$	0.02	$	0.07	$	0.04
Weighted average shares outstanding:
Basic	13,134		12,963		13,100		12,941
Diluted	13,462		13,261		13,368		13,215

See accompanying notes to these unaudited condensed consolidated financial statements.

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NATURAL GAS SERVICES GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands) (unaudited)
	Preferred Stock			Common Stock			Additional Paid-In Capital		Retained Earnings		Total Stockholders' Equity
	Shares	Amount		Shares	Amount
BALANCES, January 1, 2018	—	$	—	12,880	$	129	$	105,325	$	151,865	$	257,319
Exercise of common stock options	—	—		9	—		157		—		157
Compensation expense on common stock options	—	—		—	—		66		—		66
Issuance of restricted stock	—	—		60	—		—		—		—
Compensation expense on restricted common stock	—	—		—	—		362		—		362
Taxes paid related to net shares settlement of equity awards	—	—		—	—		(495)		—		(495)
Net income	—	—		—	—		—		225		225
BALANCES, March 31, 2018	—	$	—	12,949	$	129	$	105,415	$	152,090	$	257,634
Compensation expense on common stock options	—	—		—	—		31		—		31
Issuance of restricted stock	—	—		19	—		—		—		—
Compensation expense on restricted common stock	—	—		—	1		616		—		617
Taxes paid related to net shares settlement of equity awards	—	—		—	—		(134)		—		(134)
Net income	—	—		—	—		—		247		247
BALANCES, June 30, 2018	—	$	—	12,968	$	130	$	105,928	$	152,337	$	258,395

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NATURAL GAS SERVICES GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands) (unaudited)
	Preferred Stock			Common Stock			Additional Paid-In Capital		Retained Earnings		Total Stockholders' Equity
	Shares	Amount		Shares	Amount
BALANCES, January 1, 2019	—	$	—	13,005	$	130	$	107,760	$	152,291	$	260,181
Exercise of common stock options	—	—		57	—		555		—		555
Compensation expense on common stock options	—	—		—	—		31		—		31
Issuance of restricted stock	—	—		71	—		—		—		—
Compensation expense on restricted common stock	—	—		—	1		463		—		464
Taxes paid related to net shares settlement of equity awards	—	—		—	—		(192)		—		(192)
Net income	—	—		—	—		—		357		357
BALANCES, March 31, 2019	—	$	—	13,133	$	131	$	108,617	$	152,648	$	261,396
Exercise of common stock options	—	—		—	—		(50)		—		(50)
Compensation expense on common stock options	—	—		—	—		30		—		30
Issuance of restricted stock	—	—		5	—		—		—		—
Compensation expense on restricted common stock	—	—		—	—		612		—		612
Taxes paid related to net shares settlement of equity awards	—	—		—	—		(9)		—		(9)
Net income	—	—		—	—		—		573		573
BALANCES, June 30, 2019	—	$	—	13,138	$	131	$	109,218	$	153,221	$	262,570

See accompanying notes to these unaudited condensed consolidated financial statements.

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NATURAL GAS SERVICES GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
	Six months ended
	June 30,
	2019		2018
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	930	$	472
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	11,241		10,836
Deferred income taxes	356		170
Stock-based compensation	1,137		1,076
Bad debt allowance (recovery)	55		(102)
Gain on sale of assets	(37)		(49)
(Gain) loss on company owned life insurance	(131)		55
Changes in operating assets and liabilities:
Trade accounts receivables	(4,219)		(739)
Inventory	1,200		2,673
Prepaid expenses and prepaid income taxes	(22)		321
Accounts payable and accrued liabilities	(4,287)		(4,327)
Deferred income	32		302
Other	192		172
NET CASH PROVIDED BY OPERATING ACTIVITIES	6,447		10,860
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of rental equipment and property and equipment	(29,402)		(16,945)
Purchase of company owned life insurance	(111)		(191)
Proceeds from sale of property and equipment	26		49
Proceeds from insurance claims of property and equipment	11		—
NET CASH USED IN INVESTING ACTIVITIES	(29,476)		(17,087)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments from other long-term liabilities, net	(10)		(19)
Proceeds from exercise of stock options	505		157
Taxes paid related to net share settlement of equity awards	(183)		(629)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES	312		(491)
NET CHANGE IN CASH AND CASH EQUIVALENTS	(22,717)		(6,718)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD	52,628		69,208
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	29,911	$	62,490
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid	$	8	$	6
Income taxes paid	$	45	$	66
NON-CASH TRANSACTIONS
Transfer of rental equipment components to inventory	$	347	$	144
Transfer of prepaids to rental equipment and inventory	$	574	$	—
Right of use acquired through an operating lease	$	126	$	—

See accompanying notes to these unaudited condensed consolidated financial statements.

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Natural Gas Services Group, Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

(1) Basis of Presentation and Summary of Significant Accounting Policies

These notes apply to the unaudited condensed consolidated financial statements of Natural Gas Services Group, Inc. a Colorado corporation (the "Company", “NGSG”, "Natural Gas Services Group", "we" or "our").  The accompanying unaudited condensed consolidated financial statements include the accounts of the Company, its subsidiary, NGSG Properties, LLC and the rabbi trust associated with the Company's deferred compensation plan, see Note 4. All significant intercompany accounts and transactions for the periods presented have been eliminated in consolidation.

These financial statements include all adjustments, consisting of only normal recurring adjustments, which are necessary to make our financial position at June 30, 2019 and the results of our operations for the three and six months ended June 30, 2019 and 2018 not misleading.  As permitted by the rules and regulations of the Securities and Exchange Commission (SEC), the accompanying condensed consolidated financial statements do not include all disclosures normally required by generally accepted accounting principles in the United States of America (GAAP).  These financial statements should be read in conjunction with the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2018 on file with the SEC.  In our opinion, the condensed consolidated financial statements are a fair presentation of the financial position, results of operations, changes in stockholders' equity and cash flows for the periods presented.

The results of operations for the three and six months ended June 30, 2019 are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2019.

Revenue Recognition Policy

The Company adopted ASC 606, Revenue from Contracts with Customers ("ASC 606") on January, 1, 2018. As a result, the Company has changed its accounting policy for revenue recognition as detailed below.    

The Company applied ASC 606 using the cumulative effect method. We had no significant changes in our recognition of revenue at adoption and our review of all open revenue from contracts with customers on January 1, 2018 indicated we had no adjustment to be made. If an adjustment had been needed, we would have recognized the cumulative effect of initially applying ASC 606 with an adjustment to the opening balance of equity at January 1, 2018.

Revenue is measured based on a consideration specified in a customer’s contract, excluding any sale incentives and taxes collected on behalf of third parties (i.e. sales and property taxes). We recognize revenue once our performance obligation has been satisfied and control over a product or service has transferred to the customer. Shipping and handling costs incurred are accounted for as fulfillment costs and are included in cost of revenues in our condensed consolidated income statement.

Nature of Goods and Services

The following is a description of principal activities from which the Company generates its revenue:

Rental Revenue. The Company generates revenue from renting compressors and flare systems to our customers. These contracts may also include a fee for servicing the compressor or flare during the rental contract. Our rental contracts range from six to twenty-four months, with revenue being recognized over time, in equal payments over the term of the contract. After the term of a contract has expired, a customer may renew their contract or continue renting on a monthly basis thereafter. In accordance ASC 842 – Leases, we have applied the practical expedient ASC 842-10-15-42A, which allows the Company to combine lease and non-lease components.

Sales Revenue. The Company generates revenue by the sale of custom/fabricated compressors, flare systems and parts, as well as, exchange/rebuilding customer owned compressors and sale of used rental equipment.

Custom/fabricated compressors and flare systems - The Company designs and fabricates compressors and flares based on the customer’s specifications outlined in their contract. Though the equipment being built is customized by the customer, control under these contracts does not pass to the customer until the compressor or flare package is complete and shipped, or in accordance with a bill and hold arrangements the customer accepts title and assumes the risk and rewards of ownership. We request some of our customers to make progressive payments as the product is being built; these payments are recorded as a contract liability on the Deferred Income line on the condensed consolidated balance sheet until control has been transferred.  

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These contracts also may include an assurance warranty clause to guarantee the product is free from defects in material and workmanship for a set duration of time; this is a standard industry practice and is not considered a performance obligation.

From time to time, upon the customer’s written request, we recognize revenue when manufacturing is complete and the equipment is ready for shipment. At the customer’s request, we will bill the customer upon completing all performance obligations, but before shipment. The customer will formally request that we ship the equipment per their direction from our manufacturing facility at a later specified date and that we segregate the equipment from our finished goods, such that they are not available to fill other orders. Per the customer’s agreement change of control is passed to the customer once the equipment is complete and ready for shipment. We have operated using bill and hold agreements with certain customers for many years, with consistent satisfactory results for both the customer and us. The credit terms on these agreements are consistent with the credit terms on all other sales. All control is shouldered by the customer and there are no exceptions to the customer’s commitment to accept and pay for the manufactured equipment. Revenues recognized related to bill and hold arrangements for the six months ended June 30, 2019 was approximately $6.1 million.

Parts - Revenue is recognized after the customer obtains control of the parts. Control is passed either by the customer taking physical possession or the parts being shipped. The amount of revenue recognized is not adjusted for expected returns, as our historical part returns have been de minimis.

Exchange or rebuilding customer owned compressors - Based on the contract, the Company will either exchange a new/rebuilt compressor for the customer’s malfunctioning compressor or rebuild the customer’s compressor. Revenue is recognized after control of the replacement compressor has transferred to the customer by physical delivery, delivery and installment or shipment of the compressor.

Used compressors or flares - From time to time, a customer may request to purchase a used compressor or flare out of our rental fleet. Revenue from the sale of rental equipment is recognized when the control has passed to the customer, when the customer has taken physical possession or the equipment has been shipped.

Service and Maintenance Revenue. The Company provides routine or call-out services on customer owned equipment. Revenue is recognized after services in the contract are rendered.

Payment terms for sales revenue and service and maintenance revenue discussed above are generally 30 to 60 days although terms for specific customers can vary. Also, the transaction prices are not subject to variable consideration constraints.

Disaggregation of Revenue

The following table shows the Company's revenue disaggregated by product or service type for the three and six months ended June 30, 2019 and 2018:

	Three months ended June 30,				Six months ended June 30,
	(in thousands)				(in thousands)
	2019		2018		2019		2018
Compressors - sales	$	4,788	$	4,735	$	7,496	$	6,564
Flares - sales	106		969		541		1,491
Other (Parts/Rebuilds) - sales	920		679		1,902		1,326
Service and maintenance	509		394		988		643
Total revenue from contracts with customers	6,323		6,777		10,927		10,024
Add: non-ASC 606 rental revenue	13,572		11,427		26,959		22,898
Total revenue	$	19,895	$	18,204	$	37,886	$	32,922

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Contract Balances

As of June 30, 2019 and December 31, 2018, we had the following receivables and deferred income from contracts with customers:

	June 30, 2019		December 31, 2018
	(in thousands)
Accounts Receivable
Accounts receivable - contracts with customers	$	5,458	$	2,250
Accounts receivable - non-ASC 606	6,258		5,260
Total Accounts Receivable	$	11,716	$	7,510
Less: Allowance for doubtful accounts	(333)		(291)
Total Accounts Receivable, net	$	11,383	$	7,219
Deferred income	$	113	$	81

The Company recognized $35,000 in revenue for the six months ended June 30, 2019 that was included in deferred income at the beginning of 2019. For the year ended December 31, 2018, the Company recognized revenue of $176,000 from amounts related to sales that were included in deferred income at the beginning of 2018.

The changes in the balance of accounts receivable and deferred income were primarily due to normal timing differences between our performance and the customers’ payments.

Transaction Price Allocated to the Remaining Performance Obligations

As of June 30, 2019, the Company did not have revenue related to performance obligations under ASC 606-10-50-13.

Contract Costs 

The Company applies the practical expedient in ASC 340-40-25-4 and recognizes the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that the Company otherwise would have recognized is one year or less. These costs are included in selling, general and administrative expense on our consolidated income statement.

Leases

On January 1, 2019, we adopted ASC 842, Leases ("ASC 842") and all the related amendments using the modified retrospective method. We recognized the cumulative effect of initially applying the new lease standard and had no adjustments to retained earnings. The comparative information has not been restated and continues to be reported under the lease accounting standard in effect for those periods. We do not expect the adoption of the new lease standard to have a material impact to our net income on an ongoing basis.

The new lease standard requires all leases to be reported on the balance sheet as right-of-use assets and lease obligations. We elected the practical expedients permitted under the transition guidance of the new standard that retained the lease classification and initial direct costs for any leases that existed prior to adoption of the standard. We did not reassess whether any contracts or land easements entered into prior to adoption are leases or contain leases.

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The cumulative effect of the changes made to our consolidated balance sheet at January 1, 2019, for the adoption of ASU 2016-02, Leases, was as follows (in thousands):

	Balance at December 31, 2018		Adjustments due to ASU 2016-02		Balance at January 1, 2019
Balance Sheet
Assets
Right of use assets	$	—	$	451	$	451
Liabilities
Current portion of operating leases	$	—	$	126	$	126
Long term portion of operating leases	—		325		325
Total lease liabilities	$	—	$	451	$	451

The Company, as a lessee, applies the practical expedient in ASC 842-10-15-37, and does not separate non-lease components from lease components, therefore, accounting for each separate lease component and its associated non-lease component, as a single lease component.

The Company, as a lessor, applies the practical expedient in ASC 842-10-15-42A, in leases that contain the same timing and pattern of transfer for lease and non-lease components and are deemed operating leases, the lessor is not required to separate non-lease components from lease components. Therefore, on any lease that meets these qualifications we have chosen to account for each separate lease component and its associated non-lease component, as a single lease component.

The Company applies the practical expedient in ASC 842-20-25-2, to recognize the lease payments in profit or loss on a straight-line basis over the lease term and variable lease payments in the period in which the obligation for those payments is incurred for leases with terms of 12 months or less.

Fair Value of Financial Instruments

Our financial instruments consist principally of cash and cash equivalents, accounts receivable, accounts payable, deferred compensation plan (cash portion) and our line of credit. Pursuant to ASC 820 (Accounting Standards Codification), the fair value of our cash equivalents is determined based on “Level 1” inputs, which consist of quoted prices in active markets for identical assets. We believe that the recorded values of all of our other financial instruments approximate their fair values because of their nature (variable rate debt) and relatively short maturity dates or durations.

Income Taxes

As part of the process of preparing our financial statements, we are required to estimate our federal income taxes as well as income taxes in each of the states in which we operate. We use an estimated annual effective tax rate for purposes of determining the income tax provision during interim reporting periods. In calculating our estimated annual effective tax rate, we consider forecasted annual pre-tax income and estimated permanent book versus tax differences, as well as tax credits. Adjustments to the effective tax rate and estimate will occur as information and assumptions change.This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not probable, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense in the tax provision in the statement of operations.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We currently have no valuation allowance and fully expect to utilize all of our deferred tax assets.

ASC Topic 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In order to record any financial statement benefit, we are required to determine, based on technical merits of the position, whether it is more likely than not (a likelihood

9

of more than 50 percent) that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. If that step is satisfied, then we must measure the tax position to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of the benefit that has a greater than 50 percent likely of being realized upon ultimate settlement.

Our policy regarding income tax interest and penalties is to expense those items as other expense.

During the fourth quarter of 2018, the Company discovered a potential uncertain tax position attributable to the deductibility of certain executive compensation expense for federal income tax purposes aggregating approximately $168,000, $149,000 and $230,000 for the years ended December 31, 2017, 2016 and 2015, respectively. As a result, in accordance with ASC Topic 740, during the fourth quarter of 2018, the Company recorded a tax adjustment of $547,000 and accrued penalty and interest expense of $55,000 attributable to the uncertain tax position. Management of the Company determined that the effect of the potential uncertain tax position on previously reported results of operations for the years ended December 31, 2017 and 2016 was not material. The Company plans on amending its previously filed federal income tax returns and is in the process of analyzing certain offsetting deductions to reduce the uncertain tax position reserve.

Reclassification of Prior Period Balances

Certain reclassifications have been made to prior period amounts, due to our adoption of ASC 842, to conform to the current-year presentation. These reclassifications had no effect on the financial statements.

(2) Stock-Based Compensation

Stock Options:

A summary of option activity under our 1998 Stock Option Plan as of December 31, 2018, and changes during the six months ended June 30, 2019 is presented below.

	Number  of Stock Options	Weighted Average Exercise  Price		Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value (in thousands)
Outstanding, December 31, 2018	283,686	$	20.46	3.58	$	434
Exercised	(56,352)	8.97		—	474
Canceled/Forfeited	(3,000)	27.91		—	—
Outstanding, June 30, 2019	224,334	$	23.25	3.92	$	14
Exercisable, June 30, 2019	213,901	$	23.01	3.74	$	14

The following table summarizes information about our stock options outstanding at June 30, 2019:

Range of Exercise Prices	Options Outstanding				Options Exercisable
	Shares	Weighted Average Remaining Contractual Life (years)	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
$0.01-15.70	8,500	2.57	$	14.89	8,500	$	14.89
$15.71-17.81	42,000	1.08	17.54		42,000	17.54
$17.82-20.48	50,500	1.84	19.43		50,500	19.43
$20.49-33.36	123,334	5.84	27.33		112,901	27.26
	224,334	3.92	$	23.25	213,901	$	23.01

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The summary of the status of our unvested stock options as of December 31, 2018 and changes during the six months ended June 30, 2019 is presented below.

Unvested stock options:	Shares	Weighted Average Grant Date Fair Value Per Share
Unvested at December 31, 2018	20,865	$	11.93
Vested	(10,432)	11.93
Unvested at June 30, 2019	10,433	$	11.93

As of June 30, 2019, there was $75,243 of unrecognized compensation cost related to unvested options.  Such cost is expected to be recognized over a weighted-average period of one year. Total compensation expense for stock options was $60,669 and $97,140 for the six months ended June 30, 2019 and 2018, respectively.

Restricted Shares/Units:

In accordance with the Company's employment agreement with Stephen Taylor, the Company's Chief Executive Officer, the Compensation Committee reviewed his performance in determining the issuance of restricted common stock. Based on this review which included consideration of the Company's 2018 performance, Mr. Taylor, was awarded 131,674 restricted shares/units on March 29, 2019, which vest over three years, in equal annual installments, beginning March 29, 2020. On March 29, 2019, the Compensation Committee awarded 20,000 restricted shares/units to each of G. Larry Lawrence, our CFO, and James Hazlett, our Vice President of Technical Services. The restricted shares to Messrs. Lawrence and Hazlett vest over three years, in equal annual installments, beginning March 29, 2020. We also awarded and issued 23,136 shares of restricted common stock to the independent members of our Board of Directors as partial payment for 2019 services as directors. The restricted stock issued to our directors vests over one year, in quarterly installments, beginning March 31, 2020. Total compensation expense related to restricted awards was $1.1 million and $978,432 for the six months ended June 30, 2019 and 2018, respectively. As of June 30, 2019, there was a total of $4.9 million of unrecognized compensation expense related to these shares/units which is expected to be recognized over the next three years.

(3) Inventory

Our inventory, net of allowance for obsolescence of $21,000 at June 30, 2019 and $19,000 December 31, 2018 consisted of the following amounts:

	June 30, 2019		December 31, 2018
	(in thousands)
Raw materials - current	$	24,021	$	26,152
Raw materials - long term, net	3,873		3,980
Finished Goods	1,022		1,022
Work in process	5,259		3,800
	$	34,175	$	34,954

Our long-term inventory consists of raw materials that remain viable but that the Company does not expect to sell or use within the year.

During the six months ended June 30, 2019 and 2018, there were no write-offs of obsolete inventory against the allowance for obsolescence.

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(4) Deferred Compensation Plan

The Company has a non-qualified deferred compensation plan for executive officers, directors and certain eligible employees. The assets of the deferred compensation plan are held in a rabbi trust and are subject to additional risk of loss in the event of bankruptcy or insolvency of the Company. The plan allows for deferral of up to 90% of a participant’s base salary, bonus, commissions, director fees and restricted stock unit awards. A Company owned life insurance policy held in a rabbi trust is utilized as a source of funding for the plan. The cash surrender value of the life insurance policy is $1.3 million and $1.0 million as of June 30, 2019 and 2018, respectively. For the six months ending June 30, 2019, we reported in other income (expense) in the consolidated income statement a gain related to the policy of approximately $131,000 and for the same period in 2018, a loss of approximately $55,000.

For deferrals of base salary, bonus, commissions and director fees, settlement payments are made to participants in cash, either in a lump sum or in periodic installments. The obligation to pay the deferred compensation and the deferred director fees is adjusted to reflect the positive or negative performance of investment measurement options selected by each participant and was $1.4 million and $1.1 million as of June 30, 2019 and 2018, respectively. The deferred obligation is included in other long-term liabilities in the condensed consolidated balance sheet.

For deferrals of restricted stock units, the plan does not allow for diversification, therefore, distributions are paid in shares of common stock and the obligation is carried at grant value. As of June 30, 2019 and 2018, respectively, we have 62,145 and 103,691 unvested restricted stock units being deferred. As of June 30, 2019 and 2018, respectively we have released and issued 79,688 and 32,936 shares to the deferred compensation plan with a value of $1.7 million and $837,589, respectively.

(5) Credit Facility

We have a senior secured revolving credit agreement the ("Amended Credit Agreement") with JP Morgan Chase Bank, N.A (the "Lender") with an aggregate commitment of $30 million, subject to collateral availability. We also have a right to request from the Lender, on an uncommitted basis, an increase of up to $20 million on the aggregate commitment (which could potentially increase the commitment amount to $50 million). On August 31, 2017, we amended and renewed the Amended Credit Agreement, extending the maturity date to December 31, 2020. No other material revisions were made to the credit facility.

Borrowing Base. At any time before the maturity of the Amended Credit Agreement, we may draw, repay and re-borrow amounts available under the borrowing base up to the maximum aggregate availability discussed above. Generally, the borrowing base equals the sum of (a) 80% of our eligible accounts receivable plus (b) 50% of the book value of our eligible general inventory (not to exceed 50% of the commitment amount at the time) plus (c) 75% of the book value of our eligible equipment inventory.  The Lender may adjust the borrowing base components if material deviations in the collateral are discovered in future audits of the collateral. We had $29.5 million borrowing base availability at June 30, 2019 under the terms of our Amended Credit Agreement.

Interest and Fees.  Under the terms of the Amended Credit Agreement, we have the option of selecting the applicable variable rate for each revolving loan, or portion thereof, of either (a) LIBOR multiplied by the Statutory Reserve Rate (as defined in the Amended Credit Agreement), with respect to this rate, for Eurocurrency funding, plus the Applicable Margin (“LIBOR-based”), or (b) CB Floating Rate, which is the Lender's Prime Rate less the Applicable Margin; provided, however, that no more than three LIBOR-based borrowings under the agreement may be outstanding at any one time. For purposes of the LIBOR-based interest rate, the Applicable Margin is 1.50%. For purposes of the CB Floating Rate, the Applicable Margin is 1.50%. For the six month period ended June 30, 2019, our weighted average interest rate was 3.69%.

Accrued interest is payable monthly on outstanding principal amounts, provided that accrued interest on LIBOR-based loans is payable at the end of each interest period, but in no event less frequently than quarterly. In addition, fees and expenses are payable in connection with our requests for letters of credit (generally equal to the Applicable Margin for LIBOR-related borrowings multiplied by the face amount of the requested letter of credit) and administrative and legal costs.

Maturity. The maturity date of the Amended Credit Agreement is December 31, 2020, at which time all amounts borrowed under the agreement will be due and outstanding letters of credit must be cash collateralized. The agreement may be terminated early upon our request or the occurrence of an event of default.

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Security. The obligations under the Amended Credit Agreement are secured by a first priority lien on all of our inventory and accounts and leases receivables, along with a first priority lien on a variable number of our leased compressor equipment the book value of which must be maintained at a minimum of 2.00 to 1.00 commitment coverage ratio (such ratio being equal to (i) the amount of the borrowing base as of such date to (ii) the amount of the commitment as of such date).

Covenants. The Amended Credit Agreement contains customary representations and warranties, as well as covenants which, among other things, limit our ability to incur additional indebtedness and liens; enter into transactions with affiliates; make acquisitions in excess of certain amounts; pay dividends; redeem or repurchase capital stock or senior notes; make investments or loans; make negative pledges; consolidate, merge or effect asset sales; or change the nature of our business. In addition, we also have certain financial covenants that require us to maintain on a consolidated basis a leverage ratio less than or equal to 2.50 to 1.00 as of the last day of each fiscal quarter.

Events of Default and Acceleration. The Amended Credit Agreement contains customary events of default for credit facilities of this size and type, and includes, without limitation, payment defaults; defaults in performance of covenants or other agreements contained in the loan documents; inaccuracies in representations and warranties; certain defaults, termination events or similar events; certain defaults with respect to any other Company indebtedness in excess of $50,000; certain bankruptcy or insolvency events; the rendering of certain judgments in excess of $150,000; certain ERISA events; certain change in control events and the defectiveness of any liens under the secured revolving credit facility. Obligations under the Amended Credit Agreement may be accelerated upon the occurrence of an event of default.

As of June 30, 2019, we were in compliance with all covenants in our Amended Credit Agreement.  A default under our Credit Agreement could trigger the acceleration of our bank debt so that it is immediately due and payable.  Such default would likely limit our ability to access other credit. At June 30, 2019 and December 31, 2018, our outstanding balance on the line of credit was $417,000.

(6) Leases

The Company adopted the new lease standard on January 1, 2019 using the modified retrospective transition method. Prior periods were not retrospectively adjusted and continue to be reported under the accounting standards in effect for those periods. The Company elected the package of practical expedients permitted under the transition guidance within the new lease standard, which among other things, allowed the company to continue to account for existing leases based on the historical lease classification. The Company also elected the practical expedients to exclude right-of-use ("ROU") assets and lease liabilities for leases with an initial term of 12 months or less from the balance sheet, and to combine lease and non-lease components for property leases, which primarily relate to ancillary expenses such as common area maintenance charges and management fees.

The Company determines if an arrangement is a lease at inception by assessing whether it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The Company’s leases are primarily related to property leases for its field offices. The Company's leases have remaining lease terms of one to 10 years. Renewal and termination options are included in the lease term when it is reasonably certain that the Company will exercise the option.

The Company's lease agreements do not contain any contingent rental payments, material residual guarantees or material restrictive covenants.

ROU assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. As substantially all of the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate to determine the present value of lease payments. Based on the present value of lease payments for the Company's existing leases, the Company recorded net lease assets and lease liabilities of approximately $451,000, respectively, upon adoption. The Company had no finance leases. The new lease standard did not materially impact the Company's consolidated statements of operations and had no impact on the Company's consolidated statements of cash flows.

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The impact of the new lease standard on the June 30, 2019 consolidated balance sheet was as follows:

	Classification on the Condensed Consolidated Balance Sheet	June 30, 2019
		(in thousands, except years)
Operating lease assets	Right of use assets-operating leases	$	494
Current lease liabilities	Current operating leases	$	129
Noncurrent lease liabilities	Long-term operating leases	365
Total lease liabilities		$	494
Weighted average remaining lease term in years		2.8
Implicit Rate		3.8		%

Operating lease costs are recognized on a straight-line basis over the lease term. Total operating lease costs for the six months ended June 30, 2019 was approximately $385,000, which included approximately $285,000 related to short-term lease costs.

	June 30, 2019
	(in thousands)
Cash paid for amounts included in the measurement of lease liabilities
Operating lease cost(1)	$	100

(1) Lease costs are classified on the condensed consolidated statements of income in cost of sales, cost of compressors and selling, general and administrative expenses.

The following table shows the future maturities of lease liabilities:

Years Ending December 31,	Lease Liabilities
	(in thousands)
2019 (excluding the six months ended June 30, 2019)	$	83
2020	116
2021	95
2022	43
2023	35
Thereafter	190
Total lease payments	562
Less: Imputed interest	68
Total	$	494

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As previously disclosed on Form 10-K and under the previous lease standard (Topic 840), future minimum obligations under lease commitments in effect at December 31, 2018 as follows:

	Operating Leases
	(in thousands)
2019	$	298
2020	118
2021	97
2022	44
2023	35
Thereafter	15
Total	$	607

(7) Earnings per Share

The following table reconciles the numerators and denominators of the basic and diluted earnings per share computation (in thousands, except per share data):

	Three months ended				Six months ended
	June 30,				June 30,
	2019		2018		2019		2018
Numerator:
Net income	$	573	$	247	$	930	$	472
Denominator for basic net income per common share:
Weighted average common shares outstanding	13,134		12,963		13,100		12,941
Denominator for diluted net income per share:
Weighted average common shares outstanding	13,134		12,963		13,100		12,941
Dilutive effect of stock options and restricted stock	328		298		268		274
Diluted weighted average shares	13,462		13,261		13,368		13,215
Earnings per common share:
Basic	$	0.04	$	0.02	$	0.07	$	0.04
Diluted	$	0.04	$	0.02	$	0.07	$	0.04

In the three months ended June 30, 2019, options to purchase 215,834 shares of common stock with exercise prices ranging from $16.74 to $33.36 were not included in the computation of diluted income per share, due to their antidilutive effect.

In the six months ended June 30, 2019, options to purchase 205,834 shares of common stock with exercise prices ranging from $17.74 to $33.36 were not included in the computation of diluted income per share, due to their antidilutive effect

In the three and six months ended June 30, 2018, options to purchase 83,417 shares of common stock with exercise prices ranging from $28.15 to $33.36 were not included in the computation of diluted income per share, due to their antidilutive effect.

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(8) Segment Information

ASC 280-10-50, “Operating Segments", defines the characteristics of an operating segment as: a) being engaged in business activity from which it may earn revenue and incur expenses, b) being reviewed by the Company's chief operating decision maker (CODM) for decisions about resources to be allocated and assess its performance and c) having discrete financial information.  Although we look at our products to analyze the nature of our revenue, other financial information, such as certain costs and expenses, net income and EBITDA are not captured or analyzed by these categories.  Our CODM does not make resource allocation decisions or access the performance of the business based on these categories, but rather in the aggregate. Based on this, management believes that it operates in one business segment.

In their analysis of product lines as potential operating segments, management also considered ASC 280-10-50-11, “Aggregation Criteria”, which allows for the aggregation of operating segments if the segments have similar economic characteristics and if the segments are similar in each of the following areas:

•The nature of the products and services;

•The nature of the production processes;

•The type or class of customer for their products and services;

•The methods used to distribute their products or provide their services; and

•The nature of the regulatory environment, if applicable.

We are engaged in the business of designing and manufacturing compressors and flares. Our compressors and flares are sold and rented to our customers. In addition, we provide service and maintenance on compressors in our fleet and to third parties. These business activities are similar in all geographic areas.  Our manufacturing process is essentially the same for the entire Company and is performed in-house at our facilities in Midland, Texas and Tulsa, Oklahoma.  Our customers primarily consist of entities in the business of producing natural gas and crude oil.  The maintenance and service of our products is consistent across the entire Company and is performed via an internal fleet of vehicles.  The regulatory environment is similar in every jurisdiction in that the most impacting regulations and practices are the result of federal energy policy.  In addition, the economic characteristics of each customer arrangement are similar in that we maintain policies at the corporate level.

For the three months ended June 30, 2019 (in thousands):
	Rental		Sales		Service & Maintenance		Corporate		Total
Revenue	$	13,572	$	5,814	$	509	$	—	$	19,895
Operating costs and corporate expenses	6,359		4,419		159		8,365		19,302
Total other income, net	—		—		—		177		177
Income before provision for income taxes	$	7,213	$	1,395	$	350	$	(8,188)	$