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 March 31, 2020

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 incorporation or organization)	(I.R.S. Employer 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)

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

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  ☒ 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

As of May 4, 2020, there were 13,499,653 shares of the Registrant's common stock, $0.01 par value, outstanding.

Part I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Unaudited Condensed Consolidated Balance Sheets	Page	1
Unaudited Condensed Consolidated Statements of Operations	Page	2
Unaudited Condensed Consolidated Statements of Stockholders' Equity	Page	2
Unaudited Condensed Consolidated Statements of Cash Flows	Page	4
Notes to Unaudited Condensed Consolidated Financial Statements	Page	5
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	25
Item 4.  Controls and Procedures	Page	25
Part II - OTHER INFORMATION
Item 1.  Legal Proceedings	Page	26
Item 1A.  Risk Factors	Page	26
Item 6.  Exhibits	Page	27
Signatures	Page	29

PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements

NATURAL GAS SERVICES GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts) (unaudited)
	March 31,		December 31,
	2020		2019
ASSETS
Current Assets:
Cash and cash equivalents	$	13,051	$	11,592
Trade accounts receivable, net of allowance for doubtful accounts of $939 and $918, respectively	10,519		9,106
Inventory	19,424		21,080
Federal income tax receivable	14,992		—
Prepaid income taxes	68		40
Prepaid expenses and other	225		597
Total current assets	58,279		42,415
Long-term inventory, net of allowance for obsolescence of $37 and $24, respectively	1,108		1,068
Rental equipment, net of accumulated depreciation of $167,998 and $162,348, respectively	217,846		217,742
Property and equipment, net of accumulated depreciation of $12,682 and $12,847, respectively	22,236		21,869
Right of use assets - operating leases, net of accumulated amortization of $208 and $158, respectively	559		604
Intangibles, net of accumulated amortization of $1,914 and $1,883, respectively	1,245		1,276
Other assets	1,396		1,603
Total assets	$	302,669	$	286,577
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable	$	2,255	$	1,975
Accrued liabilities	3,020		2,287
Line of credit	417		417
Current operating leases	187		189
Deferred income	1,190		640
Total current liabilities	7,069		5,508
Deferred income tax liability	41,683		31,243
Long-term operating leases	372		415
Other long-term liabilities	1,416		1,718
Total liabilities	50,540		38,884
Commitments and contingencies (Notes 6, 12 and 14)
Stockholders’ Equity:
Preferred stock, 5,000 shares authorized, no shares issued or outstanding	—		—
Common stock, 30,000 shares authorized, par value $0.01; 13,273 and 13,178 shares issued, respectively	133		132
Additional paid-in capital	110,926		110,573
Retained earnings	141,560		137,478
Treasury Shares, at cost, 38 shares	(490)		(490)
Total stockholders' equity	252,129		247,693
Total liabilities and stockholders' equity	$	302,669	$	286,577

See accompanying notes to these unaudited condensed consolidated financial statements.

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NATURAL GAS SERVICES GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except earnings per share) (unaudited)
	Three months ended
	March 31,
	2020		2019
Revenue:
Rental income	$	16,100	$	13,387
Sales	1,450		4,125
Service and maintenance income	340		479
Total revenue	17,890		17,991
Operating costs and expenses:
Cost of rentals, exclusive of depreciation stated separately below	7,897		6,220
Cost of sales, exclusive of depreciation stated separately below	1,739		3,699
Cost of service and maintenance, exclusive of depreciation stated separately below	125		147
Selling, general and administrative expenses	2,162		2,493
Depreciation and amortization	6,240		5,577
Total operating costs and expenses	18,163		18,136
Operating loss	(273)		(145)
Other income (expense):
Interest expense	(3)		(4)
Other (expense) income, net	(185)		305
Total other (expense) income, net	(188)		301
(Loss) income before provision for income taxes	(461)		156
Income tax benefit (expense)	4,543		(58)
Net income	$	4,082	$	98
Earnings per share:
Basic	$	0.31	$	0.01
Diluted	$	0.30	$	0.01
Weighted average shares outstanding:
Basic	13,157		13,064
Diluted	13,416		13,268

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		Treasury Stock			Total Stockholders' Equity
	Shares	Amount		Shares	Amount						Shares	Amount
BALANCES, January 1, 2019	—	$	—	13,005	$	130	$	107,760	$	151,342	—	$	—	$	259,232
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	—	—		—	—		—		98		—	—		98
BALANCES, March 31, 2019	—	$	—	13,133	$	131	$	108,617	$	151,440	—	$	—	$	260,188
BALANCES, January 1, 2020	—	$	—	13,178	$	132	$	110,573	$	137,478	38	$	(490)	$	247,693
Compensation expense on common stock options	—	—		—	—		17		—		—	—		17
Issuance of restricted stock	—	—		95	—		—		—		—	—		—
Compensation expense on restricted common stock	—	—		—	1		485		—		—	—		486
Taxes paid related to net shares settlement of equity awards	—	—		—	—		(149)		—		—	—		(149)
Net income	—	—		—	—		—		4,082		—	—		4,082
BALANCES, March 31, 2020	—	$	—	13,273	$	133	$	110,926	$	141,560	38	$	(490)	$	252,129

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NATURAL GAS SERVICES GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
	Three months ended
	March 31,
	2020		2019
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	4,082	$	98
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	6,240		5,577
Deferred income taxes	337		68
Stock-based compensation	502		495
Bad debt allowance	21		10
Gain on sale of assets	(68)		(22)
Loss (gain) on company owned life insurance	262		(99)
Changes in operating assets and liabilities:
Trade accounts receivables	(1,434)		(3,089)
Inventory	1,616		(3,986)
Federal income tax receivable	(14,992)		—
Prepaid expenses and prepaid income taxes	344		149
Accounts payable and accrued liabilities	1,013		(3,074)
Deferred income	550		52
Deferred tax liability increase due to tax law change	10,103		—
Other	(301)		75
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES	8,275		(3,746)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of rental equipment and property and equipment	(6,679)		(9,230)
Purchase of company owned life insurance	(54)		(40)
Proceeds from sale of property and equipment	68		11
Proceeds from insurance claims of property and equipment	—		11
NET CASH USED IN INVESTING ACTIVITIES	(6,665)		(9,248)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments from other long-term liabilities, net	(2)		(5)
Proceeds from exercise of stock options	—		555
Taxes paid related to net share settlement of equity awards	(149)		(192)
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES	(151)		358
NET CHANGE IN CASH AND CASH EQUIVALENTS	1,459		(12,636)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD	11,592		52,628
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	13,051	$	39,992
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid	$	3	$	4
Income taxes paid	$	40	$	2
NON-CASH TRANSACTIONS
Transfer of prepaids to rental equipment and inventory	$	—	$	574
Right of use acquired through an operating lease	$	4	$	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. Description of Business

Natural Gas Services Group, Inc. (the "Company", “NGS”, "Natural Gas Services Group", "we" or "our") (a Colorado corporation), is a leading provider of natural gas compression equipment and services to the energy industry. The Company manufactures, fabricates, rents, sells and maintains natural gas compressors and flare systems for oil and natural gas production and plant facilities. NGS is headquartered in Midland, Texas, with fabrication facilities located in Tulsa, Oklahoma and Midland, Texas, and service facilities located in major oil and natural gas producing basins in the U.S.

Recent Events

On January 30, 2020, the World Health Organization (“WHO”) announced a global health emergency because of a new strain of coronavirus known as COVID-19 due to the risks it imposes on the international community as the virus spreads globally. In March 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally. The effects of the COVID-19 outbreak, including actions taken by businesses and governments to contain the spread of the virus, have resulted in a significant, rapid decline in global and U.S. economic conditions. This significant drop in economic activity has caused global demand for crude oil to drastically decline. According to the International Energy Agency’s (“IEA”) Oil Market Report for April 2020, global crude oil demand during the second quarter of 2020 is expected to decline 23.1 million barrels per day compared to the second quarter of 2019, a decrease of more than 20%.

In March 2020, discussion between OPEC and Russia (“OPEC+”) resulted in Saudi Arabia significantly discounting the price of its crude oil, as well as Saudi Arabia and Russia significantly increasing their oil supply in April 2020. The dramatic decline in crude oil demand combined with this increase in supply resulted in unprecedented storage issues and a resulting severe lack of takeaway capacity for oil producers. As a result, crude oil prices reached record or multi-year lows in April. West Texas Intermediate (“WTI”) crude oil traded below $20 per barrel and Brent crude oil traded below $30 per barrel during the second half of April, including an anomalous trading day where WTI traded at negative values on low volume close to the end of a contract trading month. On May 6, 2020, WTI closed at $23.99 per barrel, while Brent closed at $29.72 per barrel.

Given current price levels and takeaway issues, domestic producers have been rapidly shutting in production, and drilling and completion activities among exploration and production companies have dramatically declined. In April 2020, OPEC+ agreed to cut production by 9.7 million barrels per day starting in May 2020, and the IEA is projecting global oil production to drop by approximately 12 million barrels per day in May 2020. Nevertheless, given the massive decline in crude oil demand due to COVID-19, the imbalance in the global oil markets is expected to keep prices down through the remainder of 2020.

These issues have resulted in an increasing number of unit returns and shut-in notices from our customers during April 2020. While we witnessed minimal change in our unit and horsepower utilization during the first quarter of 2020 compared to year-end 2019, we expect a meaningful drop in utilization among our small and medium horsepower units during the second and third quarters of 2020. Accordingly, we expect this drop in utilization and pricing pressures to negatively impact our rental revenue, rental margins and overall financial performance for the remainder of 2020. In addition, given the current economic and industry backdrop, we expect compressor sales to be minimal for the remainder of 2020, as exploration and production companies have significantly reduced their capital expenditures budgets.

We have implemented various cost cutting measures with respect to operating expenses and capital expenditures. Our operating expense reductions include reductions in our headcount from both layoffs and attrition, wage freezes, centralization of certain processes for better cost control, and the enlistment of our suppliers in our cost cutting efforts. We continue to review additional opportunities to become more efficient. In addition, as we have done during prior downturns, we have reduced our capital expenditures budget. After we spent $6.7 million in capital expenditures during the first quarter of 2020, we plan to only incur another $5-$7 million in capital expenditures for the remainder of 2020, bringing our 2020 capital expenditures budget to $12-$14 million, down from $69.9 million in 2019.

Finally, in keeping with current commercial precautions and practices in our industry, we have implemented new guidelines to mitigate health risks to our employees and customers during this outbreak. We have adopted remote and staggered work processes at our Midland headquarters, and have adapted our field and fabrication work processes as well. To

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date, our field operations have continued largely uninterrupted, as the U.S. Department of Homeland Security designated our industry as part of our country’s critical infrastructure. Remote work and work process adjustments related to COVID-19 have not impacted our ability to maintain operations or caused us to incur significant costs. In addition, we have not experienced any supply chain issues in connection with the COVID-19 outbreak.

The full impact of the COVID-19 outbreak continues to evolve as of the date of this report. As such, it is uncertain as to the full magnitude that the pandemic will have on the Company's financial condition, liquidity, and future results of operations. Management is actively monitoring the global situation on its financial condition, liquidity, operations, suppliers, industry, and workforce. Given the daily evolution of the COVID-19 outbreak and the global responses to curb its spread, the Company is not able to estimate the effects of the COVID-19 outbreak on its results of operations, financial condition, or liquidity during 2020.

2. Summary of Significant Accounting Policies

Principles of Consolidation and Basis of Presentation

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 7). 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 March 31, 2020 and the results of our operations for the three months ended March 31, 2020 and 2019 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 consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2019 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 months ended March 31, 2020 are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2020.

Revenue Recognition Policy

The Company recognizes revenue in accordance with ASC 606, Revenue from Contracts with Customers ("ASC 606"). Under ASC 606, 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). Revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration that we expect to receive for those goods or services. To recognize revenue, we (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when, or as, we satisfy the performance obligation(s). Shipping and handling costs incurred are accounted for as fulfillment costs and are included in cost of revenues in our consolidated statements of operations.

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, which all qualify as operating leases under ASC Topic 842, Leases (ASC 842), may also include a fee for servicing the compressor or flare during the rental contract. Our rental contracts typically range from six to 24 months, with our larger horsepower compressors having contract terms of up to 60 months. Our revenue is recognized over time, with equal monthly payments over the term of the contract. After the terms of the contract have 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.

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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 arrangement, 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. 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 three months ended March 31, 2020 and 2019 was approximately $852,000 and $2.7 million, respectively.

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 based on the terms of the contract, i.e., 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 based on the terms of the contract, i.e. 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, 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 months ended March 31, 2020 and 2019:

	Three months ended March 31,
	(in thousands)
	2020		2019
Compressors - sales	$	852	$	2,708
Flares - sales	80		435
Other (parts/rebuilds) - sales	518		982
Service and maintenance	340		479
Total revenue from contracts with customers	1,790		4,604
Add: ASC 842 rental revenue	16,100		13,387
Total revenue	$	17,890	$	17,991

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Contract Balances

As of March 31, 2020 and December 31, 2019, we had the following receivables and deferred income from contracts with customers:

	(in thousands)
	March 31, 2020		December 31, 2019
Accounts Receivable
Accounts receivable - contracts with customers	$	1,290	$	3,061
Accounts receivable - ASC 842	10,168		6,963
Total Accounts Receivable	$	11,458	$	10,024
Less: Allowance for doubtful accounts	(939)		(918)
Total Accounts Receivable, net	$	10,519	$	9,106
Deferred income	$	1,190	$	640

The Company recognized rental revenue of $73,000 for the three months ended March 31, 2020 that was included in deferred income at the beginning of 2020. For the year ended December 31, 2019, the Company recognized revenue of $48,000 from amounts related to sales that were included in deferred income at the beginning of 2019.

The increases (decreases) 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 March 31, 2020, the Company did not have revenue related to unsatisfied performance obligations.

Contract Costs 

The Company 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 expenses on our condensed consolidated statements of operations.

Leases

On January 1, 2019, we adopted ASC 842 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 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.

The Company, as a lessor, applies the practical expedient to 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. Each lease that 1) contains the same timing and pattern of transfer for lease and non-lease components; and 2) if the lease component, if accounted for separately, would be classified as an operating lease, the Company elects to not separate non-lease components from lease components.

Inventory

Inventory (current and long-term) is valued at the lower of cost and net realizable value. The cost of inventories is determined by the weighted average method. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on current and anticipated customer demand and production requirements. The Company accesses anticipated customer demand based on current and upcoming capital expenditure budgets of its major

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customers as well as other significant companies in the industry, along with oil and natural gas price forecasts and other factors affecting the industry. In addition, our long-term inventory consists of raw materials that remain viable but which the Company does not expect to sell within the next year.

Rental Equipment and Property and Equipment

Rental equipment and property and equipment are recorded at cost less accumulated depreciation, except for work-in-progress on new rental equipment which is recorded at cost until it’s complete and added to the fleet. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Our rental equipment has an estimated useful life between 15 and 25 years, while our property and equipment has an estimate useful lives which range from 3 to 39 years. The majority of our property and equipment, including rental equipment, is a direct cost to generating revenue.

We assess the impairment of rental equipment and property and equipment whenever events or changes in circumstances indicate that the net recorded amount may not be recoverable. The following factors could trigger an impairment review: significant underperformance relative to historical or projected future cash flows; significant adverse changes in the extent or manner in which asset (or asset group) is being used or its condition, including a meaningful drop in fleet utilization over the prior four quarters; significant negative industry or company-specific trends or actions, including meaningful capital expenditure budget reductions by our major customers or other sizable exploration and production or midstream companies, as well as significant declines in oil and natural gas prices; legislative changes prohibiting us from leasing our units or flares; or poor general economic conditions. An impairment loss is recognized if the future undiscounted cash flows associated with the asset (or asset group) and the estimated fair value of the asset are less than the asset's carrying value.

Sales of equipment out of the rental fleet are included with sales revenue and cost of sales, while retirements of units are shown as a separate operating expense. Gains and losses resulting from sales and dispositions of other property and equipment are included within other income (expense). Maintenance and repairs are charged to cost of rentals as incurred.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases, and operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We 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 establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we include an expense in the tax provision in our condensed consolidated statements of operations.

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 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 is 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.

We account for uncertain tax positions in accordance with guidance in ASC 740, which prescribes the minimum recognition threshold a tax position taken or expected to be taken in a tax return is required to meet before being recognized in the condensed consolidated financial statements. We have no uncertain tax positions as of March 31, 2020.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted in response to the economic impact caused the COVID-19 pandemic. The CARES Act, among other things, permits federal income tax net operating loss ("NOL") carryovers and carrybacks to offset 100% of taxable income for taxable years beginning before 2021. In addition, the CARES Act allows NOLs incurred in 2018, 2019, and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid federal income taxes. Please read Note 4, Federal Income Tax Receivable for a discussion about the impact on our condensed consolidated financial statements.

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Fair Value Measurement

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. ASC Topic 820 established a fair value hierarchy, which requires an entity to maximize the use of observable inputs when measuring fair value. These inputs are categorized as follows:

Level 1- quoted prices in an active market for identical assets or liabilities;

Level 2- quoted prices in an active market for similar assets or liabilities, inputs other than quoted prices that are observable for similar assets or liabilities, inputs derived principally from or corroborated by observable market data by correlation or other means; and

Level 3- valuation methodology with unobservable inputs that are significant to the fair value measurement.

Management believes that the fair value of our cash and cash equivalents, trade receivables, accounts payable and line of credit at March 31, 2020 and December 31, 2019 approximate their carrying values due to the short-term nature of the instruments or the use of prevailing market interest rates. 

Segments and Related Information

ASC 280-10-50, “Operating Segments”, define 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 indeed 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. 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.

Recently Issued Accounting Pronouncements

In December 2019, the FASB issued ASU 2019-12, Income Taxes (ASC Topic 740), which simplifies accounting for income taxes by removing certain exceptions to various tax accounting principles and clarifies other existing guidance in order to improve consistency of application. These amendments are effective for public entities for interim and annual periods

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beginning after December 15, 2020. We are currently evaluating the impact of ASU 2019-12 on our consolidated financial statements and note disclosures.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (ASC Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments to ASC Topic 326 require immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets, including trade receivables. For companies that qualify as smaller reporting companies, the amendments in this update are effective for interim and annual periods beginning after January 1, 2023. We are currently evaluating the impact of ASU 2016-13 on our consolidated financial statements and note disclosures.

Revisions of Prior Period Financial Statements

As stated in our Annual Report on Form 10-K for the year ended December 31, 2019, we revised our consolidated financial statements for the years ended December 31, 2018 and 2017, as well as for interim periods in 2019 and 2018, for immaterial operating costs and expenses that were inappropriately capitalized. The following is a summary of the revisions to our unaudited, condensed consolidated financial statements for the three months ended March 31, 2019:

Revised Condensed Consolidated Statement of Operations

	For the three months ended March 31, 2019
($ in thousands)	As Reported		Revisions		As Revised
Total revenue	$	17,991	$	—	$	17,991
Operating costs and expenses:
Cost of rentals, exclusive of depreciation stated separately below	5,885		335		6,220
Depreciation and amortization	5,558		19		5,577
Total operating costs and expenses	17,782		354		18,136
Operating income (loss)	209		(354)		(145)
Income before provision for income taxes	510		(354)		156
Income tax (expense) benefit	(153)		95		(58)
Net income (loss)	357		(259)		98
Earnings (loss) per share, basic	0.03		(0.02)		0.01
Earnings (loss) per share, diluted	0.03		(0.02)		0.01

Revised Condensed Consolidated Statement of Stockholders' Equity

	For the three months ended March 31, 2019
($ in thousands)	As Reported		Revisions		As Revised
Retained earnings balance at January 1, 2019	$	152,291	$	(949)	$	151,342
Total stockholders' equity at January 1, 2019	260,181		(949)		259,232
Net income (loss)	357		(259)		98
Retained earnings balance at March 31, 2019	152,648		(1,208)		151,440
Total stockholders' equity at March 31, 2019	261,396		(1,208)		260,188

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Revised Condensed Consolidated Statement of Cash Flows

	For the three months ended March 31, 2019
($ in thousands)	As Reported		Revisions		As Revised
Cash flows from operating activities:
Net income (loss)	$	357	$	(259)	$	98
Depreciation and amortization	5,558		19		5,577
Deferred taxes	157		(89)		68
Inventory (increase) decrease	(4,468)		482		(3,986)
Prepaid expenses and prepaid income taxes decrease (increase)	202		(53)		149
Net cash (used in) provided by operating activities	(3,846)		100		(3,746)
Cash flows from investing activities:
Purchase of rental equipment, property and other equipment	(9,130)		(100)		(9,230)
Net cash used in investing activities	(9,148)		(100)		(9,248)
Net change in cash and cash equivalents	(12,636)		—		(12,636)

3. Inventory

Our inventory, net of allowance for obsolescence of $37,000 at March 31, 2020 and $24,000 at December 31, 2019, consisted of the following amounts:

	(in thousands)
	March 31, 2020		December 31, 2019
Raw materials - current	$	17,407	$	19,388
Work-in-process	2,017		1,692
Inventory - current	19,424		21,080
Raw materials - long term (net of allowances of $37 and $24, respectively)	1,108		1,068
Inventory - total	$	20,532	$	22,148

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 three months ended March 31, 2020 and 2019, there were no write-offs of obsolete inventory against the allowance for obsolescence.

4. Federal Income Tax Receivable

As discussed in Note 2, the CARES Act allows NOLs incurred in 2018, 2019, and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid federal income taxes. The Company generated significant NOLs during 2018 and 2019, and plans to carryback these losses for five years. Accordingly, as of March 31, 2020, the Company recorded a federal income tax receivable of $15.0 million and an increase to its deferred income tax liability of $10.1 million on its condensed consolidated balance sheet. In addition, the Company recorded a current income tax benefit of $4.9 million on its condensed consolidated statement of operations for the three months ended March 31, 2020.

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5. Rental Equipment

Our rental equipment and associated accumulated depreciation as of March 31, 2020 and December 31, 2019, respectively, consisted of the following:

	(in thousands)
	March 31, 2020		December 31, 2019
Compressor units	$	378,366	$	370,961
Work-in-progress	7,478		9,129
Rental equipment	385,844		380,090
Accumulated depreciation	(167,998)		(162,348)
Rental equipment, net of accumulated depreciation	$	217,846	$	217,742

We evaluated our rental equipment for potential impairment as of March 31, 2020, and determined that no such impairment existed as of that date. We will continue to monitor the impacts of COVID-19 on industry and economic conditions. As discussed in Note 1, Description of Business, Recent Events, we expect a decrease in utilization in our small and medium horsepower units as well as pricing pressures to negatively impact our rental revenue, rental margins, cash flows and overall financial performance for the remainder of 2020. Accordingly, these negative impacts could possibly result in an impairment or retirement of rental equipment in 2020.

6. Leases

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 condensed consolidated statements of operations and had no impact on the Company's condensed consolidated statements of cash flows.

The impact of the new lease standard on the March 31, 2020 condensed consolidated balance sheet was as follows:

	Classification on the Condensed Consolidated Balance Sheet	March 31, 2020
		(in thousands, except years)
Operating lease assets	Right of use assets-operating leases	$	559
Current lease liabilities	Current operating leases	$	187
Noncurrent lease liabilities	Long-term operating leases	372
Total lease liabilities		$	559
Weighted average remaining lease term in years		2.3
Implicit Rate		3.1		%

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Operating lease costs are recognized on a straight-line basis over the lease term. Total operating lease costs for the three months ended March 31, 2020 was approximately $122,000.

	March 31, 2020
	(in thousands)
Cash paid for amounts included in the measurement of lease liabilities
Operating lease cost (1) (2)	$	122

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

(2)  Includes costs of $74,000 for leases with terms of 12 months or less and $48,000 for leases with terms greater than 12 months.

The following table shows the future maturities of lease liabilities as of March 31, 2020:

Years Ending December 31,	Lease Liabilities
	(in thousands)
2020 (excluding the three months ended March 31, 2020)	$	154
2021	174
2022	47
2023	38
2024	38
Thereafter	168
Total lease payments	619
Less: Imputed interest	(60)
Total	$	559

7. 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).

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 March 31, 2020 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 1.25%. For purposes of the CB Floating Rate, the Applicable Margin is 1.50%. For the three month period ended March 31, 2020, our weighted average interest rate was 2.88%.

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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.

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 compressors, 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 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 March 31, 2020, 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 March 31, 2020 and December 31, 2019, our outstanding balance on the line of credit was $417,000.

8. 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 $1.5 million as of March 31, 2020 and December 31, 2019, respectively. We reported in other (expense) income in the condensed consolidated statements of operations a loss related to the policy of approximately $262,000 and a gain of approximately $99,000 for the three months ended March 31, 2020 and 2019, respectively.

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. The deferred compensation liability, which is included in other long-term liabilities in the condensed consolidated balance sheet, was $1.4 million and $1.7 million as of March 31, 2020 and December 31, 2019, respectively.

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 March 31, 2020 and 2019, respectively, we had 36,500 and 63,062 unvested restricted stock units being deferred. As of March 31, 2020, we had released and issued 138,252 shares with a value of $2.2 million to the deferred compensation plan. As of March 31, 2019, we had released and issued 78,771 shares with a value of $1.7 million to the deferred compensation plan.

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9. Stock-Based Compensation

Stock Options:

A summary of all option activity as of December 31, 2019, and changes during the three months ended March 31, 2020 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, 2019	208,334	$	23.67	3.66	$	—
Granted	—	—
Expired	40,000	19.11
Outstanding, March 31, 2020	168,334	$	24.75	4.26	$	—
Exercisable, March 31, 2020	168,334	$	24.75	4.26	$	—

The following table summarizes information about our stock options outstanding at March 31, 2020:

  Range of Exercise Prices Options Outstanding Options Exercisabl