10-K

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

[ x ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended    December 31, 2009

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.)
508 W. Wall St, Suite 550 Midland, Texas	79701
(Address of principal executive offices)	(Zip Code)
Registrant’s telephone number, including area code:	(432) 262-2700
Securities registered pursuant to Section 12(b) of the Act:
Title of each class	Name of each exchange on which registered
Common Stock, $.01 par value	New York Stock Exchange

Securities registered pursuant to section 12(g) of the Act:  None.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o                  No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes o                  No þ

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 þ                 No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.[   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large Accelerated Filer ¨ Accelerated Filer þ     Non-Accelerated Filer ¨     Smaller Reporting Company ¨

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

Yes o                  No þ

The aggregate market value of voting and non-voting common equity held by non-affiliates of the Registrant as of March 1, 2010 was approximately $194,096,335, based on the closing price of the common stock on the same date.

At March 1, 2010, there were 12,100,769 shares of common stock outstanding.

Documents Incorporated by Reference

Certain information called for in Items 10, 11, 12, 13 and 14 of Part III are incorporated by reference from the registrant’s definitive proxy statement for the annual meeting of shareholders to be held on June 15, 2010.

FORM 10-K
NATURAL GAS SERVICES GROUP, INC.
TABLE OF CONTENTS
Item No.		Page
PART I
Item 1.	Business	1
Item 1A.	Risk Factors	7
Item 1B.	Unresolved Staff Comments	14
Item 2.	Properties	15
Item 3.	Legal Proceedings	15
Item 4.	Submission of Matters to a Vote of Security Holders	15
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	15
Item 6.	Selected Financial Data	17
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	29
Item 8.	Financial Statements and Supplementary Data	29
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	29
Item 9A.	Controls and Procedures	30
Item 9B.	Other Information	32
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	32
Item 11.	Executive Compensation	32
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	32
Item 13.	Certain Relationships, and Related Transactions, and Director Independence	32
Item 14.	Principal Accounting Fees and Services	32
PART IV
Item 15.	Exhibits, Financial Statement Schedules	33

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains certain forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and information pertaining to us, our industry and the oil and natural gas industry that is based on the beliefs of our management, as well as assumptions made by and information currently available to our management.  All statements, other than statements of historical facts contained in this Annual Report on Form 10-K, including statements regarding our future financial position, growth strategy, budgets, projected costs, plans and objectives of management for future operations, are forward-looking statements.  We use the words “may,” “will,” “expect,” “anticipate,” “estimate,” “believe,” “continue,” “intend,” “plan,” “budget” and other similar words to identify forward-looking statements.  You should read statements that contain these words carefully and should not place undue reliance on these statements because they discuss future expectations, contain projections of results of operations or of our financial condition and/or state other “forward-looking” information.  We do not undertake any obligation to update or revise publicly any forward-looking statements.  Although we believe our expectations reflected in these forward-looking statements are based on reasonable assumptions, no assurance can be given that these expectations or assumptions will prove to have been correct.  Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements include, but are not limited to, the following factors and the other factors described in this Annual Report on Form 10-K under the caption “Risk Factors”:

· conditions in the oil and natural gas industry, including the demand for natural gas and wide fluctuations in the prices of oil and natural gas;

· competition among the various providers of compression services and products;

· changes in safety, health and environmental regulations;

· changes in economic or political conditions in the markets in which we operate;

· failure of our customers to continue to rent equipment after expiration of the primary rental term;

· the inherent risks associated with our operations, such as equipment defects, malfunctions and natural disasters;

· our inability to comply with covenants in our debt agreements and the decreased financial flexibility associated with our substantial debt;

· future capital requirements and availability of financing;

· fabrication and manufacturing costs;

· general economic conditions;

· events similar to September 11, 2001; and

· fluctuations in interest rates.

We believe that it is important to communicate our expectations of future performance to our investors.  However, events may occur in the future that we are unable to accurately predict or that we are unable to control.  When considering our forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this Annual Report on Form 10-K.

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PART I

ITEM 1.                 BUSINESS

Unless the context otherwise requires, references in this Annual Report on Form 10-K to “Natural Gas Services Group,” the “Company”, “we,” “us,” “our” or “ours” refer to Natural Gas Services Group, Inc.  Certain specialized terms used in describing our natural gas compressor business are defined in "Glossary of Industry Terms" on page 6.

The Company

We are a leading provider of small to medium horsepower compression equipment to the natural gas industry.  We focus primarily on the non-conventional natural gas production business in the United States (such as coal bed methane, gas shale and tight gas), which, according to data from the Energy Information Administration, is the single largest and fastest growing segment of U.S. gas production.  We manufacture, fabricate and rent natural gas compressors that enhance the production of natural gas wells and provide maintenance services for those compressors.  In addition, we sell custom fabricated natural gas compressors to meet customer specifications dictated by well pressures, production characteristics and particular applications.  We also manufacture and sell flare systems for oil and gas plant and production facilities.

The vast majority of our rental operations are in non-conventional natural gas regions, which typically have lower initial reservoir pressures and faster well decline rates.  These areas usually require compression to be installed sooner and with greater frequency.

We were incorporated in Colorado on December 17, 1998.

   Natural gas compressors are used in a number of applications for the production and enhancement of gas wells and in gas transportation lines and processing plants.  Compression equipment is often required to boost a well’s production to economically viable levels and enable gas to continue to flow in the pipeline to its destination.

We increased our revenue to $67.8 million in 2009 from $10.3 million in 2002, the year we completed our initial public offering.  During the same period, income from operations increased to $17.8 million from $1.8 million.  Our compressor rental fleet has grown from 302 compressors at the end of 2002 to 1,776 compressors at December 31, 2009.

    Our revenue decreased from $85.3 million to $67.8 million for the year ended December 31, 2009, compared to the same period ended December 31, 2008.

Net income for the year ended December 31, 2009 decreased 29.4% to $11.0 million ($.91 per diluted share), as compared to $15.6 million ($1.28 per diluted share) for the year ended December 31, 2008.

At December 31, 2009, current assets were $56.2 million, which included $23.0 million of cash.  Current liabilities were $15.9 million, and long-term debt, net of current portion, was $2.8 million.  Our stockholders' equity as of December 31, 2009 was $142.1 million.

We maintain our principal offices at 508 W. Wall St., Suite 550, Midland, Texas 79701 and our telephone number is (432) 262-2700.  Our website is located at http://www.ngsgi.com.  The information on or that can be accessed through our website is not part of this Annual Report on Form 10-K.

Overview and Outlook

The market for compression equipment and services is substantially dependent on the condition of the natural gas industry and, to a lesser extent, the oil industry.  In particular, the willingness of natural gas and oil companies to make capital expenditures on exploration, drilling and production of natural gas and oil in the U.S.  The level of activity and capital expenditures has generally been dependent upon the prevailing view of future gas and oil prices, which are influenced by numerous factors, including the level of supply or demand for natural gas and the impact on price of natural gas, worldwide economic activity, interest rates and the cost of capital, environmental regulation, seasonal fluctuations and weather patterns.  Natural gas and oil prices and the level of production activity have historically been characterized by significant volatility.  Increasing oil and gas prices from 2005 through mid-2008 resulted in natural gas and oil operators increasing capital spending for exploration, development and production programs.  However, in mid-2008, natural gas and oil prices began to decline. This decline resulted in reduced production and capital spending by some natural gas and oil companies and may result in additional reductions in capital spending.

The reduction in capital expenditures and production in the natural gas and oil industry, combined with continuing problems in the global economy, led to a downturn in the demand for our products and services in 2009, including reductions in the utilization rate on our rental fleet and in our sales backlog.  See “Item 1 -- Business – Our Operating Units” and “Business – Backlog” for more information.

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According to the U.S. Energy Information Administration (“EIA”), total consumption of natural gas in the United States declined 2.4% for the twelve months ended November 2009 compared to the same period 2008.  EIA expects total natural gas consumption to increase 0.4 percent in 2010 and another 0.4 percent in 2011.  While we anticipate long-term increased demand for natural gas, we do expect our business to remain flat for 2010.

Long-Term Industry Trends

Natural gas prices historically have been volatile, and this volatility is expected to continue.  Uncertainty continues to exist as to the direction of future United States and worldwide natural gas and crude oil price trends.  We believe that natural gas is a more environmentally friendly source of energy which is likely to result in increases in demand.  Being primarily a provider of services and equipment to natural gas producers, we are more significantly impacted by changes in natural gas prices than by changes in crude oil and condensate prices.  Longer term natural gas prices will be determined by the supply and demand for natural gas as well as the prices of competing fuels, such as oil and coal.

We believe part of the growth of the rental compression capacity in the U.S. market has been driven by the trend toward outsourcing by energy producers and processors.  Renting does not require the purchaser to make large capital expenditures for new equipment or to obtain financing through a lending institution.  This allows the customer’s capital to be used for additional exploration and production of natural gas and oil.

Notwithstanding the current downturn, we believe that there will continue to be a growing demand for natural gas.  We expect long-term demand for our products and services will rise as a result of:

· the increasing demand for and limited supply of energy, both domestically and abroad;

· continued non-conventional gas exploration and production;

· environmental considerations which provide strong incentives to use natural gas in place of other carbon fuels;

· the cost savings of using natural gas rather than electricity for heat generation;

· implementation of international environmental and conservation laws;

· the aging of producing natural gas reserves worldwide; and

· the extensive supply of undeveloped non-conventional natural gas reserves.

Our Operating Units

   We identify our segments based upon major revenue sources as Gas Compressor Rental, Engineered Equipment Sales, Service and Maintenance and Corporate.  Please refer to Footnote 11 on page F-16 of the Notes to Financial Statements.

Gas Compressor Rental.  Our rental business is primarily focused on non-conventional gas production.  We provide rental of small to medium horsepower compression equipment to customers under contracts typically having minimum initial terms of six to 24 months.  Historically, in our experience, most customers retain the equipment beyond the expiration of the initial term.  By outsourcing their compression needs, we believe our customers are able to increase their revenues by producing a higher volume of natural gas due to greater equipment run-time.  Outsourcing also allows our customers to reduce their compressor downtime, operating and maintenance costs and capital investments and more efficiently meet their changing compression needs.  As of December 31, 2009, the utilization rate of our rental fleet was 65.3% compared to 84.9% as of December 31, 2008.

The size, type and geographic diversity of our rental fleet enables us to provide our customers with a range of compression units that can serve a wide variety of applications, and to select the correct equipment for the job, rather than the customer trying to fit the job to its own equipment.  We base our gas compressor rental rates on several factors, including the cost and size of the equipment, the type and complexity of service desired by the customer, the length of contract and the inclusion of any other services desired, such as rental, installation, transportation and daily operation.

As of December 31, 2009, we had 1,776 natural gas compressors in our rental fleet totaling approximately 223,694 horsepower, as compared to 1,730 natural gas compressors totaling approximately 217,085 horsepower at December 31, 2008.  As of December 31, 2009, we had 1,159 natural gas compressors totaling approximately 146,512 horsepower rented to 91 third parties, compared to 1,469 natural gas compressors totaling approximately 184,831 horsepower rented to 112 third parties at December 31, 2008.

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Engineered Equipment Sales.  This segment includes the following components:

· Compressor fabrication.  Fabrication involves the assembly of compressor components manufactured by us or other third parties into compressor units that are ready for rental or sale.  In addition to fabricating compressors for our rental fleet, we engineer and fabricate natural gas compressors for sale to customers to meet their specifications based on well pressure, production characteristics and the particular applications for which compression is sought.

· Compressor manufacturing.  We design and manufacture our own proprietary line of reciprocating compressor frames, cylinders and parts known as our “CiP”, or Cylinder-in-Plane, product line.  We use the finished components to fabricate compressor units for our rental fleet or for sale to third parties.  We also sell finished components to other fabricators.

· Flare fabrication.  We design, fabricate, sell, install and service flare stacks and related ignition and control devices for the onshore and offshore incineration of gas compounds such as hydrogen sulfide, carbon dioxide, natural gas and liquefied petroleum gases.  Applications for this equipment are often environmentally and regulatory driven, and we believe we are a leading supplier to this market.

· Parts sales and compressor rebuilds.  To provide customer support for our compressor and flare sales businesses, we stock varying levels of replacement parts at our Midland, Texas facility and at field service locations.  We also provide an exchange and rebuild program for screw compressors and maintain an inventory of new and used compressors to facilitate this part of our business.

Service and Maintenance.  We service and maintain compressors owned by our customers on an “as needed” basis.  Natural gas compressors require routine maintenance and periodic refurbishing to prolong their useful life.  Routine maintenance includes physical and visual inspections and other parametric checks that indicate a change in the condition of the compressors.  We perform wear-particle analysis on all packages and perform overhauls on a condition-based interval or a time-based schedule.  Based on our past experience, these maintenance procedures maximize component life and unit availability and minimize downtime.

Business Strategy

During the downturn in the economy, our strategy is to reduce expenses in line with the lower anticipated business activity, and fabricate compressor equipment only in direct response to market requirements.  See “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recession Strategy” for more information.  Our long-term intentions to grow our revenue and profitability are based on the following business strategies:

· Expand rental fleet.  We intend to increase the size of our rental fleet by fabricating compressor units in numbers that correspond to the growth of the market and in relation to market share gains we may experience.  We believe our growth will continue to be primarily driven through our placement of small to medium horsepower wellhead natural gas compressors for non-conventional natural gas production, which is the single largest and fastest growing segment of U.S. gas production according to data from the Energy Information Administration.

· Geographic expansion.  We will continue to consolidate our operations in existing areas, as well as pursue focused expansion into new geographic regions as opportunities are identified.

· Expand our ‘secondary’ product lines.   In addition to our primary rental and engineered product business lines, we will emphasize the growth of our other products, e.g., flares, CiP compressor products and general compressor maintenance and repair services.

· Selectively pursue acquisitions.  We will continue to evaluate potential acquisitions that would provide us withaccess to new markets or enhance our current market position.

Competitive Strengths

We believe our competitive strengths include:

· Superior customer service.  Our emphasis on the small to medium horsepower markets has enabled us to effectively meet the evolving needs of our customers.  We believe these markets have been under-serviced by our larger competitors which, coupled with our personalized services and in-depth knowledge of our customers’ operating needs and growth plans, have allowed us to enhance our relationships with existing

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customers as well as attract new customers.  The size, type and geographic diversity of our rental fleet enable us to provide customers with a range of compression units that can serve a wide variety of applications.  We are able to select the correct equipment for the job, rather than the customer trying to fit its application to our equipment.

· Diversified product line.  Our compressors are available as high and low pressure rotary screw and reciprocating packages.  They are designed to meet a number of applications, including wellhead production, natural gas gathering, natural gas transmission, vapor recovery and gas and plunger lift.  In addition, our compressors can be built to handle a variety of gas mixtures, including air, nitrogen, carbon dioxide, hydrogen sulfide and hydrocarbon gases.  A diversified product line helps us compete by being able to satisfy widely varying pressure, volume and production conditions that customers encounter.

· Purpose built rental compressors.  Our rental compressor packages have been designed and built to address the primary requirements of our customers in the producing regions in which we operate.  Our units are compact in design and are easy, quick and inexpensive to move, install and start-up.  Our control systems are technically advanced and allow the operator to start and stop our units remotely and/or in accordance with well conditions.  We believe our rental fleet is also one of the newest.

· Experienced management team.  On average, our executive and operating management team has over 30 years of oilfield services industry experience.  We believe our management team has successfully demonstrated its ability to grow our business both organically and through selective acquisitions.

· Broad geographic presence.  We presently provide our products and services to a customer base of oil and natural gas exploration and production companies operating in New Mexico, Texas, Michigan, Colorado, Wyoming, Utah, Oklahoma, Pennsylvania, West Virginia and Kansas.  Our footprint allows us to service many of the natural gas producing regions in the United States.  We believe that operating in diverse geographic regions allows us better utilization of our compressors, minimal incremental expenses, operating synergies, volume-based purchasing, leveraged inventories and cross-trained personnel.

· Long-standing customer relationships.  We have developed long-standing relationships providing compression equipment to many major and independent oil and natural gas companies.  Our customers generally continue to rent our compressors after the expiration of the initial terms of our rental agreements, which we believe reflects their satisfaction with the reliability and performance of our services and products.

Major Customers

   Sales and rental income to Devon Energy Production Inc. and XTO Energy Inc. in the year ended December 31, 2009 amounted to a total of 21% and 21% of revenue, respectively.  Sales and rental income to XTO Energy, Inc. and Devon Energy, Inc. in the year ended December 31, 2008 amounted to 26% and 14% of revenue, respectively.  Sales and rental income to XTO Energy, Inc. and Devon Energy, Inc. in the year ended December 31, 2007 amounted to 40% and 12% of revenue, respectively.  No other single customer accounted for more than 10% of our revenues in 2009, 2008 or 2007.  XTO Energy Inc. and Devon Energy Production Inc. amounted to 33% and 11% of our accounts receivable as of December 31, 2009, respectively.  XTO Energy, Inc. and Equipos y Sistemas Dinamicos amounted to 35% and 14%, respectively, of our accounts receivable as of December 31, 2008.  No other customers amounted to more than 10% of our accounts receivable as of December 31, 2008 and 2009.  The loss of either of the above customers could have a material adverse effect on our business, financial condition, results of operations and cash flows, depending upon the demand for our compressors at the time of such loss and our ability to attract new customers.

Sales and Marketing

Our sales force pursues the rental and sales market for compressors and flare equipment and other services in their respective territories.  Additionally, our personnel coordinate with each other to develop relationships with customers who operate in multiple regions.  Our sales and marketing strategy is focused on communication with current customers and potential customers through frequent direct contact, technical assistance, print literature, direct mail and referrals.  Our sales and marketing personnel coordinate with our operations personnel in order to promptly respond to and address customer needs.  Our overall sales and marketing efforts concentrate on demonstrating our commitment to enhancing the customer’s cash flow through enhanced product design, fabrication, manufacturing, installation, customer service and support.

Competition

We have a number of competitors in the natural gas compression segment, some of which have greater financial resources.  We believe that we compete effectively on the basis of price, customer service, including the ability to place personnel in remote locations, flexibility in meeting customer needs, and quality and reliability of our compressors and related services.

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Compressor industry participants can achieve significant advantages through increased size and geographic breadth.  As the number of rental compressors in our rental fleet increases, the number of sales, support, and maintenance personnel required and the minimum level of inventory do not increase commensurately.

Backlog

As of December 31, 2009, we had a sales backlog of approximately $211,000 compared to $18.0 million as of December 31, 2008.  We expect to fulfill the backlog in 2010.  Sales backlog consists of firm customer orders for which a purchase or work order has been received, satisfactory credit or a financing arrangement exists, and delivery is scheduled.  In addition, the major components of our compressors are acquired from suppliers through periodic purchase orders that in many instances require three or four months of lead time prior to delivery of the order.

Employees

As of December 31, 2009, we had 199 total employees.  No employees are represented by a labor union and we believe we have good relations with our employees.

Liability and Other Insurance Coverage

Our equipment and services are provided to customers who are subject to hazards inherent in the oil and gas industry, such as blowouts, explosions, caterings, fires, and oil spills.  We maintain liability insurance that we believe is customary in the industry and which includes environment cleanup, but excludes product warranty insurance because the majority of components on our compressor unit are covered by the manufacturers.  We also maintain insurance with respect to our facilities.  Based on our historical experience, we believe that our insurance coverage is adequate.  However, there is a risk that our insurance may not be sufficient to cover any particular loss or that insurance may not cover all losses.  In addition, insurance rates have in the past been subject to wide fluctuation, and changes in coverage could result in less coverage, increases in cost or higher deductibles and retentions.

Government Regulation

All of our operations and facilities are subject to numerous federal, state, foreign and local laws, rules and regulations related to various aspects of our business, including containment and disposal of hazardous materials, oilfield waste, other waste materials and acids.

To date, we have not been required to expend significant resources in order to satisfy applicable environmental laws and regulations.  We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future.  However, compliance costs under existing laws or under any new requirements could become material and we could incur liabilities for noncompliance.

Our business is generally affected by political developments and by federal, state, foreign and local laws and regulations, which relate to the oil and natural gas industry.  The adoption of laws and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase our costs and could have an adverse effect on our operations.  The state and federal environmental laws and regulations that currently apply to our operations could become more stringent in the future.

We have utilized operating and disposal practices that were or are currently standard in the industry.  However, materials such as solvents, thinner, waste paint, waste oil, wash down waters and sandblast material may have been disposed of or released in or under properties currently or formerly owned or operated by us or our predecessors.  In addition, some of these properties have been operated by third parties over whom we have no control either as to such entities' treatment of materials or the manner in which such materials may have been disposed of or released.

The federal Comprehensive Environmental Response Compensation and Liability Act of 1980, commonly known as CERCLA, and comparable state statutes impose strict liability on:

· owners and operators of sites,

· persons who disposed of or arranged for the disposal of "hazardous substances" found at sites.

The federal Resource Conservation and Recovery Act and comparable state statutes govern the disposal of "hazardous wastes." Although CERCLA currently excludes certain materials from the definition of "hazardous substances," and the Resource Conservation and Recovery Act also excludes certain materials from regulation, such exemptions by Congress under both CERCLA and the Resource Conservation and Recovery Act may be deleted, limited or modified in the future.  We could become

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subject to requirements to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties.

The federal Water Pollution Control Act and the Oil Pollution Act of 1990 and implementing regulations govern:

· the prevention of discharges, including oil and produced water spills, and

· liability for drainage into waters.

Our operations are also subject to federal, state, and local regulations for the control of air emissions.  The federal Clean Air Act and various state and local laws impose on us certain air quality requirements.  Amendments to the Clean Air Act revised the definition of "major source" such that emissions from both wellhead and associated equipment involved in oil and natural gas production may be added to determine if a source is a "major source." As a consequence, more facilities may become major sources and thus may require us to make increased compliance expenditures.

   We believe that our existing environmental control procedures are adequate and that we are in substantial compliance with environmental laws and regulations, and the phasing in of emission controls and other known regulatory requirements should not have a material adverse affect on our financial condition or operational results.  However, it is possible that future developments, such as new or increasingly strict requirements and environmental laws and enforcement policies there under, could lead to material costs of environmental compliance by us.  While we may be able to pass on the additional cost of complying with such laws to our customers, there can be no assurance that attempts to do so will be successful.  Some risk of environmental liability and other costs are inherent in the nature of our business, however, and there can be no assurance that environmental costs will not rise.

In recent years, increased concern has been raised over the protection of the environment. Legislation to regulate emissions of greenhouse gases has been introduced in Congress, and there has been a wide-ranging policy debate, both nationally and internationally, regarding the impact of these gases and possible means for their regulation. In addition, efforts have been made and continue to be made in the international community toward the adoption of international treaties or protocols that would address global climate change issues, such as the United Nations Climate Change Conference in Copenhagen in 2009. Also, the EPA has undertaken new efforts to collect information regarding greenhouse gas emissions and their effects. Recently, the EPA declared that certain greenhouse gases represent a danger to human health and proposed to expand its regulations relating to those emissions.  To the extent that new laws or other governmental actions restrict the energy industry or impose additional environmental protection requirements that result in increased costs to the oil and gas industry, we could be adversely affected.  We cannot determine to what extent our future operations and earnings may be affected by new legislation, new regulations or changes in existing regulations.

Patents, Trademarks and Other Intellectual Property

We believe that the success of our business depends more on the technical competence, creativity and marketing abilities of our employees than on any individual patent, trademark, or copyright.  Nevertheless, as part of our ongoing research, development and manufacturing activities, we may seek patents when appropriate on inventions concerning new products and product improvements.  We currently own one United States patent covering certain flare system technologies; however, it expired in January 2010.  We do not own any foreign patents.  Although we continue to use the patented technology and consider it useful in certain applications, we do not consider the expired patent to be material to our business as a whole.

Suppliers and Raw Materials

Fabrication of our rental compressors involves the purchase by us of engines, compressors, coolers and other components, and the assembly of these components on skids for delivery to customer locations.  These major components of our compressors are acquired through periodic purchase orders placed with third-party suppliers on an "as needed" basis, which typically requires a three to four month lead time with delivery dates scheduled to coincide with our estimated production schedules.  Although we do not have formal continuing supply contracts with any major supplier, we believe we have adequate alternative sources available.  In the past, we have not experienced any sudden and dramatic increases in the prices of the major components for our compressors.  However, the occurrence of such an event could have a material adverse effect on the results of our operations and financial condition, particularly if we were unable to increase our rental rates and sale prices proportionate to any such component price increases.

Glossary of Industry Terms

"coal bed methane" – A natural gas generated during coal formation and provided from coal seams or adjacent sandstones.

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"gas shale" – Fine grained rocks where the predominant gas storage mechanism is sorption and gas is stored in volumes that are potentially economic.

"reciprocating compressors" – A reciprocating compressor is a type of compressor which compresses vapor by using a piston in a cylinder and a back-and-forth motion.

"screw compressors" – A type of compressor used in vapor compression where two intermesh rotors create pockets of continuously decreasing volume, in which the vapor is compressed and its pressure is increased.

"tight gas" – A gas bearing sandstone or carbonate matrix (which may or may not contain natural fractures) which exhibits a low-permeability (tight) reservoir.

ITEM 1A.              RISK FACTORS

You should carefully consider the following risks associated with owning our common stock.  If any of the following risks actually occur, our business, financial condition or results of operations would likely suffer.  If this occurs, the trading price of our common stock could decline, and you could lose all or part of your investment in our common stock.  Although the risks described below are the risks that we believe are material, they are not the only risks relating to our industry, our business and our common stock.  Additional risks and uncertainties, including those that are not yet identified or that we currently believe are immaterial, may also adversely affect our business, financial condition or results of operations.

Risks Associated With Our Industry

Adverse macroeconomic and business conditions may significantly and negatively affect our results of operations.

Continued weak economic conditions in the United States and abroad have, and will likely continue to, substantially affect our revenue and profitability. The domestic and global financial crisis, the associated fluctuating oil and gas prices, and the unprecedented levels of disruption and continuing illiquidity in the credit markets have had an adverse effect on our operating results and financial condition, and if sustained or worsened, such adverse effects could continue or worsen.  Uncertainty and turmoil in the credit markets may negatively impact the ability of our customers to finance purchases of our products and services and could result in a decrease in, or cancellation of, orders included in our backlog or adversely affect the collectability of our receivables. If the availability of credit to our customers is reduced, they may reduce their drilling and production expenditures, thereby decreasing demand for our products and services, which could have a negative impact on our financial condition.

Changes in governmental banking, monetary and fiscal policies to restore liquidity and increase credit availability may not be effective. It is difficult to determine the breadth and duration of the domestic and global financial crisis and the many ways in which it may affect our suppliers, customers and our business in general.  The continuation or further deterioration of these difficult financial and macroeconomic conditions could have a significant adverse effect on our results of operations and cash flows.

Decreased oil and natural gas prices and oil and gas industry expenditure levels could adversely affect our revenue.

Our revenue is derived from expenditures in the oil and natural gas industry, which, in turn, are based on budgets to explore for, develop and produce oil and natural gas.  If these expenditures decline, our revenue will suffer.  The industry’s willingness to explore for, develop and produce oil and natural gas depends largely upon the prevailing view of future oil and natural gas prices.  Prices for oil and gas historically have been, and are likely to continue to be, highly volatile.  Many factors affect the supply and demand for oil and natural gas and, therefore, influence oil and natural gas prices, including:

· the level of oil and natural gas production;

· the level of oil and natural gas inventories;

· domestic and worldwide demand for oil and natural gas;

· the expected cost of developing new reserves;

· the cost of producing oil and natural gas;

· the level of drilling and completions activity;

· inclement weather;

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· domestic and worldwide economic activity;

· regulatory and other federal and state requirements in the United States;

· the ability of the Organization of Petroleum Exporting Countries and other large producers to set and maintain production levels and prices for oil;

· political conditions in or affecting oil and natural gas producing countries;

· terrorist activities in the United States and elsewhere;

· the cost of developing alternate energy sources;

· environmental regulation; and

· tax policies.

Depending on the market prices of oil and natural gas, companies exploring for oil and natural gas may cancel or curtail their drilling programs, thereby reducing demand for our equipment and services.  Our rental contracts are generally short-term, and oil and natural gas companies tend to respond quickly to upward or downward changes in prices.  Any reduction in drilling and production activities may materially erode both pricing and utilization rates for our equipment and services and adversely affects our financial results.  As a result, we may suffer losses, be unable to make necessary capital expenditures and be unable to meet our financial obligations.

The intense competition in our industry could result in reduced profitability and loss of market share for us.

In our business segments, we compete with the oil and natural gas industry’s largest equipment and service providers who have greater name recognition than we do.  These companies also have substantially greater financial resources, larger operations and greater budgets for marketing, research and development than we do.  They may be better able to compete because of their broader geographic dispersion and ability to take advantage of international opportunities, the greater number of compressors in their fleet or their product and service diversity.  As a result, we could lose customers and market share to those competitors.  These companies may also be better positioned than us to successfully endure downturns in the oil and natural gas industry.

Our operations may be adversely affected if our current competitors or new market entrants introduce new products or services with better prices, features, performance or other competitive characteristics than our products and services.  Competitive pressures or other factors also may result in significant price competition that could harm our revenue and our business.  Additionally, we may face competition in our efforts to acquire other businesses.

Our industry is highly cyclical, and our results of operations may be volatile.

Our industry is highly cyclical, with periods of high demand and high pricing followed by periods of low demand and low pricing.  Periods of low demand intensify the competition in the industry and often result in rental equipment being idle for long periods of time.  We may be required to enter into lower rate rental contracts in response to market conditions, and our sales may decrease as a result of such conditions.

Due to the short-term nature of most of our rental contracts, changes in market conditions can quickly affect our business.  As a result of the cyclicality of our industry, our results of operations may be volatile in the future.

We are subject to extensive environmental laws and regulations that could require us to take costly compliance actions that could harm our financial condition.

Our fabrication and maintenance operations are significantly affected by stringent and complex federal, state and local laws and regulations governing the discharge of substances into the environment or otherwise relating to environmental protection.  In these operations, we generate and manage hazardous wastes such as solvents, thinner, waste paint, waste oil, wash down wastes, and sandblast material.  We attempt to use generally accepted operating and disposal practices and, with respect to acquisitions, will attempt to identify and assess whether there is any environmental risk before completing an acquisition.  Based on the nature of the industry, however, hydrocarbons or other wastes may have been disposed of or released on or under properties owned or leased by us or on or under other locations where such wastes have been taken for disposal.  The waste on these properties may be subject to federal or state environmental laws that could require us to remove the wastes or remediate sites where they have been released.  We could be exposed to liability for cleanup costs, natural resource and other damages as a result of our conduct or the conduct of, or conditions caused by, prior owners, lessees or other third parties.  Environmental laws and

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regulations have changed in the past, and they are likely to change in the future.  If current existing regulatory requirements or enforcement policies change, we may be required to make significant unanticipated capital and operating expenditures.

Any failure by us to comply with applicable environmental laws and regulations may result in governmental authorities taking actions against our business that could harm our operations and financial condition, including the:

· issuance of administrative, civil and criminal penalties;

· denial or revocation of permits or other authorizations;

· reduction or cessation in operations; and

· performance of site investigatory, remedial or other corrective actions.

Risks Associated With Our Company

We might be unable to employ qualified technical personnel, which could hamper our plans for expansion or increase our costs.

Many of the compressors that we sell or rent are mechanically complex and often must perform in harsh conditions.  We believe that our success depends upon our ability to employ and retain a sufficient number of technical personnel who have the ability to design, utilize, enhance and maintain these compressors.  Our ability to expand our operations depends in part on our ability to increase our skilled labor force.  The demand for skilled workers is high and supply is limited.  A significant increase in the wages paid by competing employers could result in a reduction of our skilled labor force or cause an increase in the wage rates that we must pay or both.  If either of these events were to occur, our cost structure could increase and our operations and growth potential could be impaired.

We could be subject to substantial liability claims that could harm our financial condition.

Our products are used in hazardous drilling and production applications where an accident or a failure of a product can cause personal injury, loss of life, damage to property, equipment or the environment, or suspension of operations.

While we maintain insurance coverage, we face the following risks under our insurance coverage:

· we may not be able to continue to obtain insurance on commercially reasonable terms;

· we may be faced with types of liabilities that will not be covered by our insurance, such as damages from significant product liabilities and from environmental contamination;

· the dollar amount of any liabilities may exceed our policy limits; and

· we do not maintain coverage against the risk of interruption of our business.

Any claims made under our policies will likely cause our premiums to increase.  Any future damages caused by our products or services that are not covered by insurance, are in excess of policy limits or are subject to substantial deductibles, would reduce our earnings and our cash available for operations.

We will require a substantial amount of capital to expand our compressor rental fleet and grow our business.

During 2010, capital expenditures related to rental compression equipment will be determined primarily by the activity of our customers, and we do not anticipate that demand exceeding what we can fund with internally generated funds.  The amount and timing of any of these capital expenditures may vary depending on a variety of factors, including the level of activity in the oil and natural gas exploration and production industry and the presence of alternative uses for our capital, including any acquisitions that we may pursue.

Historically, we have funded our capital expenditures through internally generated funds, borrowings under bank credit facilities and the proceeds of equity financings.  Although we believe that cash flows from our operations will provide us with sufficient cash to fund our planned capital expenditures for 2010, we cannot assure you that these sources will be sufficient.  We may require additional capital to fund any unanticipated capital expenditures, including any acquisitions, and to fund our growth beyond 2010, and necessary capital may not be available to us when we need it or on acceptable terms.  Our ability to raise additional capital will depend on the results of our operations and the status of various capital and industry markets at the time we seek such capital.  Failure to generate sufficient cash flow, together with the absence of alternative sources of capital, could have a material adverse effect on our business, financial condition, results of operations or cash flows.

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Disruptions in the credit and financial markets have adversely affected financial institutions, inhibited lending and limited access to capital and credit for many companies. Several large financial institutions have either recently failed or been dependent on the assistance of the U.S. federal government to continue to operate as a going concern.  Our $40 million line of credit, which we owe $7.0 million on as of December 31, 2009, expires on May 1, 2010.  All outstanding principal and unpaid interest is due on May 1, 2010.  As of January 2010, we have paid down the line of credit to $ 500,000.   Although we believe that we will be able to renew our existing line of credit, or obtain a new line of credit with another lender, we can provide no assurance that we will be successful in renewing our line of credit or obtaining a new line.  In addition, any renewal of our existing line of credit or creation of a new line of credit may be on terms less favorable that our existing line.  For instance, changes in the terms of a new line of credit may include, but not be limited to:  a reduction in the borrowing amount, an increase in interest rate to be paid on borrowings under the line, or restrictive covenants that are more onerous than those on our existing line of credit.

We believe that the lender participating in our current credit facility (or any lender(s) in future credit facilities) has adequate capital and resources; however, we can provide no assurance that these lenders will continue to operate as a going concern in the future. If any of the lenders in our lending group were to fail, it is possible that the borrowing capacity under our credit facility would be reduced or eliminated. In the event that the availability under our credit facility was reduced significantly, we could be required to obtain capital from alternate sources in order to finance our capital needs. Our options for addressing such capital constraints would include, but not be limited to (1) obtaining commitments from the remaining banks (if any) in the lending group or from new banks to fund increased amounts under the terms of our credit facility, (2) accessing the public capital markets, or (3) delaying certain projects. If it became necessary to access additional capital, any alternatives at the time may be on terms less favorable than under our existing credit facility terms, which could have a material effect on our consolidated financial position, results of operations and cash flows.  If future financing is not available to us when required, as a result of limited access to the credit markets or otherwise, or is not available to us on acceptable terms, we may be unable take advantage of business opportunities or respond to competitive pressures, either of which could have a material adverse effect on our consolidated financial position, results of operations and cash flows.

Our current debt level may negatively impact our current and future financial stability.

As of December 31, 2009, we had an aggregate of approximately $13.2 million of outstanding indebtedness, and accounts payable and accrued expenses of approximately $3.7 million.  As a result of our significant indebtedness, we might not have the ability to incur any substantial additional indebtedness.  The level of our indebtedness could have several important effects on our future operations, including:

· our ability to obtain additional financing for working capital, acquisitions, capital expenditures and other purposes may be limited;

· a significant portion of our cash flow from operations may be dedicated to the payment of principal and interest on our debt, thereby reducing funds available for other purposes; and

· our significant leverage could make us more vulnerable to economic downturns.

If we are unable to service our debt, we will likely be forced to take remedial steps that are contrary to our business plan.

As of December 31, 2009, our principal payments for our debt service requirements were approximately $282,000 on a monthly basis; $845,000 on a quarterly basis; and $3.4 million on an annual basis.  It is possible that our business will not generate sufficient cash flow from operations to meet our debt service requirements and the payment of principal when due.  If this were to occur, we may be forced to:

· sell assets at disadvantageous prices;

· obtain additional financing; or

· refinance all or a portion of our indebtedness on terms that may be less favorable to us.

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Our current bank loan agreement contains covenants that limit our operating and financial flexibility and, if breached, could expose us to severe remedial provisions.

Under the terms of our loan agreement, we must:

· comply with a minimum current ratio;

· maintain minimum levels of tangible net worth;

· not exceed specified levels of debt;

· comply with a debt service coverage ratio; and

· comply with a debt to tangible net worth ratio.

Our ability to meet the financial ratios and tests under our bank loan agreement can be affected by events beyond our control, and we may not be able to satisfy those ratios and tests.  A breach of any one of these covenants could permit the bank to accelerate the debt so that it is immediately due and payable.  If a breach occurred, no further borrowings would be available under our loan agreement.  If we were unable to repay the debt, the bank could proceed against and foreclose on our assets, substantially all of which have been pledged as collateral to secure payment of our indebtedness.

If we fail to acquire or successfully integrate additional businesses, our growth may be limited and our results of operations may suffer.

As part of our business strategy, we intend to evaluate potential acquisitions of other businesses or assets.  However, there can be no assurance that we will be successful in consummating any such acquisitions.  Successful acquisition of businesses or assets will depend on various factors, including, but not limited to, our ability to obtain financing and the competitive environment for acquisitions.  In addition, we may not be able to successfully integrate any businesses or assets that we acquire in the future.  The integration of acquired businesses is likely to be complex and time consuming and place a significant strain on management and may disrupt our business.  We also may be adversely impacted by any unknown liabilities of acquired businesses, including environmental liabilities.  We may encounter substantial difficulties, costs and delays involved in integrating common accounting, information and communication systems, operating procedures, internal controls and human resources practices, including incompatibility of business cultures and the loss of key employees and customers.  These difficulties may reduce our ability to gain customers or retain existing customers, and may increase operating expenses, resulting in reduced revenues and income and a failure to realize the anticipated benefits of acquisitions.

As of December 31, 2009, a significant majority of our compressor rentals were for terms of six months or less which, if terminated or not renewed, would adversely impact our revenue and our ability to recover our initial equipment costs.

The length of our compressor rental agreements with our customers varies based on customer needs, equipment configurations and geographic area.  In most cases, under currently prevailing rental rates, the initial rental periods are not long enough to enable us to fully recoup the average cost of acquiring or fabricating the equipment.  We cannot be sure that a substantial number of our customers will continue to renew their rental agreements or that we will be able to re-rent the equipment to new customers or that any renewals or re-rentals will be at comparable rental rates.  The inability to timely renew or re-rent a substantial portion of our compressor rental fleet would have a material adverse effect upon our business, financial condition, results of operations and cash flows.

The loss of one or more of our current customers could adversely affect our results of operations.

Our business is dependent not only on securing new customers but also on maintaining current customers.  We had two customers that accounted for approximately 21% each of our revenue for the year ended December 31, 2009, and approximately 26% and 14% of our revenue for the year ended December 31, 2008.  Unless we are able to retain our existing customers, or secure new customers if we lose one or more of our significant customers, our revenue and results of operations would be adversely affected.

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Loss of key members of our management could adversely affect our business.

We depend on the continued employment and performance of key members of our executive and senior management team.  If any of our key managers resign or become unable to continue in his present role and is not adequately replaced, our business operations could be materially adversely affected.  We do not carry any key-man insurance on any of our officers or directors.

Failure to effectively manage our growth and expansion could adversely affect our business and operating results and our internal controls.

We have rapidly and significantly expanded our operations in recent years and anticipate that our growth will continue if we are able to execute our strategy.  Our rapid growth has placed significant strain on our management and other resources which, given our expected future growth rate, is likely to continue.  To manage our future growth, we must be able to, among other things:

· accurately assess the number of additional officers and employees we will require and the areas in which they will be required;

· attract, hire and retain additional highly skilled and motivated officers and employees;

· train and manage our work force in a timely and effective manner;

· upgrade and expand our office infrastructure so that it is appropriate for our level of activity; and

· improve our financial and management controls, reporting systems and procedures.

Liability to customers under warranties may materially and adversely affect our earnings.

We provide warranties as to the proper operation and conformance to specifications of the equipment we manufacture.  Our equipment is complex and often deployed in harsh environments.  Failure of this equipment to operate properly or to meet specifications may increase our costs by requiring additional engineering resources and services, replacement of parts and equipment or monetary reimbursement to a customer.  We have in the past received warranty claims and we expect to continue to receive them in the future.  To the extent that we incur substantial warranty claims in any period, our reputation, our ability to obtain future business and our earnings could be materially and adversely affected.

Failure to maintain effective internal controls could have a material adverse effect on our operations.

Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our internal control over financial reporting.  If we fail to maintain effective internal controls, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act.  Moreover, effective internal controls are necessary for us to produce reliable financial reports and to help prevent financial fraud.  If, as a result of deficiencies in our internal controls, we cannot provide reliable financial reports or prevent fraud, our business decision process may be adversely affected, our business and operating results could be harmed, investors could lose confidence in our reported financial information, and the price of our stock could decrease as a result.

We must evaluate our intangible assets annually for impairment.

Our intangible assets are recorded at cost less accumulated amortization and consist of goodwill and patent costs and other identifiable intangibles.

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We did not indentify any impairment based on an independent valuation as of June 2006 and internal evaluations in December 2007, 2008 and 2009 of our reporting units with goodwill and other identifiable intangibles.  Future impairment tests could result in impairments of our intangible assets or goodwill.  We expect to continue to amortize our intangible assets with finite lives over the same time periods as previously used, and we will test our intangible assets with indefinite lives for impairment at least once each year.  In addition, we are required to assess the consumptive life, or longevity, of our intangible assets with finite lives and adjust their amortization periods accordingly.  Our net goodwill and intangible assets were recorded on our balance sheet at approximately $13.1 million and $12.8 million as of December 31, 2008 and 2009, respectively.  Our identifiable intangibles are currently amortized at a rate of $299,000 per year.  Any impairment in future periods of those assets, or a reduction in their consumptive lives, could materially and adversely affect our statements of income and financial position.

A reduction in demand for oil or natural gas or prices for those commodities and credit markets could adversely affect our business.

   Our results of operations depend upon the level of activity in the energy market, including natural gas development, production, processing and transportation. Oil and natural gas prices and the level of drilling and exploration activity can be volatile. For example, oil and natural gas exploration and development activity and the number of well completions typically decline when there is a significant reduction in oil and natural gas prices or significant instability in energy markets. As a result, the demand for our natural gas compression services could be adversely affected. A reduction in demand could also force us to reduce our pricing substantially. Additionally, our customers’ production from unconventional natural gas sources such as tight sands, shale and coal beds constitute the majority percentage of our business.  Such unconventional sources are generally less economically feasible to produce in lower natural gas price environments. These factors could in turn negatively impact the demand for our products and services. A decline in demand for oil and natural gas or prices for those commodities and credit markets could have a material adverse effect on our business, financial condition, results of operations.

The erosion of the financial condition of our customers could adversely affect our business.

   Many of our customers finance their exploration and development activities through cash flow from operations, the incurrence of debt or the issuance of equity. During times when the oil or natural gas markets weaken, our customers are more likely to experience a downturn in their financial condition. Many of our customers’ equity values have substantially declined in recent months, and the capital markets have been unavailable as a source of financing to these customers. The combination of a reduction in cash flow resulting from declines in commodity prices, a reduction in borrowing bases under reserve-based credit facilities and the lack of availability of debt or equity financing will result in a reduction in our customers’ spending for our products and services in 2010. For example, our customers could seek to preserve capital by canceling month-to-month contracts, canceling or delaying scheduled maintenance of their existing natural gas compression equipment or determining not to enter into any new natural gas compression service contracts or purchase new compression equipment.

Risks Associated With Our Common Stock

The price of our common stock may fluctuate which may cause our common stock to trade at a substantially lower price than the price paid for our common stock.

The trading price of our common stock and the price at which we may sell securities in the future is subject to substantial fluctuations in response to various factors, including our ability to successfully accomplish our business strategy, the trading volume of our stock, changes in governmental regulations, actual or anticipated variations in our quarterly or annual financial results, our involvement in litigation, general market conditions, the prices of oil and natural gas, announcements by us and our competitors, our liquidity, our ability to raise additional funds, and other events.

Future sales of our common stock could adversely affect our stock price.

Substantial sales of our common stock in the public market, or the perception by the market that those sales could occur, may lower our stock price or make it difficult for us to raise additional equity capital in the future.  These potential sales could include sales of shares of our common stock by our Directors and officers, who beneficially owned approximately 3.8% of the outstanding shares of our common stock as of March 1, 2010.

We currently have on file with the SEC an effective “universal” shelf registration statement on form S-3, which enables us to sell, from time to time, our common stock and other securities covered by the registration statement in one or more public offerings. The shelf registration statement allows us to enter the public markets and consummate sales of the registered securities in rapid fashion and with little or no notice.  Issuances of securities under our shelf registration statement may dilute our existing shareholders.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

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If we issue debt or equity securities, you may lose certain rights and be diluted.

If we raise funds in the future through the issuance of debt or equity securities, the securities issued may have rights and preferences and privileges senior to those of holders of our common stock, and the terms of the securities may impose restrictions on our operations or dilute your ownership in Natural Gas Services Group, Inc.

If securities analysts downgrade our stock or cease coverage of us, the price of our stock could decline.

The trading market for our common stock relies in part on the research and reports that industry or financial analysts publish about us or our business.  We do not control these analysts.  Furthermore, there are many large, well-established, publicly traded companies active in our industry and market, which may mean that it is less likely that we will receive widespread analyst coverage.  If one or more of the analysts who do cover us downgrade our stock, our stock price would likely decline rapidly.  If one or more of these analysts cease coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline.

We do not intend to pay, and have restrictions upon our ability to pay, dividends on our common stock.

We have not paid cash dividends in the past and do not intend to pay dividends on our common stock in the foreseeable future.  Net income from our operations, if any, will be used for the development of our business, including capital expenditures, and to retire debt.  In addition, our bank loan agreement contains restrictions on our ability to pay cash dividends on our common stock.

We have a comparatively low number of shares of common stock outstanding and, therefore, our common stock may suffer from limited liquidity and its prices will likely be volatile and its value may be adversely affected.

Because of our relatively low number of outstanding shares of common stock, the trading price of our common stock will likely be subject to significant price fluctuations and limited liquidity.  This may adversely affect the value of your investment.  In addition, our common stock price could be subject to fluctuations in response to variations in quarterly operating results, changes in management, future announcements concerning us, general trends in the industry and other events or factors as well as those described above.

Provisions contained in our governing documents could hinder a change in control of us.

Our articles of incorporation and bylaws contain provisions that may discourage acquisition bids and may limit the price investors are willing to pay for our common stock.  Our articles of incorporation and bylaws provide that:

· directors are elected for three-year terms, with approximately one-third of the board of directors standing for election each year;

· cumulative voting is not allowed, which limits the ability of minority shareholders to elect any directors;

· the unanimous vote of the board of directors or the affirmative vote of the holders of not less than 80% of the votes entitled to be cast by the holders of all shares entitled to vote in the election of directors is required to change the size of the board of directors; and

· directors may be removed only for cause and only by the holders of not less than 80% of the votes entitled to be cast on the matter.

Our Board of Directors has the authority to issue up to five million shares of preferred stock.  The Board of Directors can fix the terms of the preferred stock without any action on the part of our stockholders.  The issuance of shares of preferred stock may delay or prevent a change in control transaction.  In addition, preferred stock could be used in connection with the Board of Directors’ adoption of a shareholders’ rights plan (also known as a poison pill), which would make it much more difficult to effect a change in control of our company through acquiring or controlling blocks of stock.  Also, our directors and officers as a group will continue to beneficially own stock and although this is not a majority of our stock, it confers substantial voting power in the election of directors and management of our company.  This would make it difficult for other minority stockholders to effect a change in control or otherwise extend any significant control over the management of our company.  This may adversely affect the market price and interfere with the voting and other rights of our common stock.

ITEM 1B.              UNRESOLVED STAFF COMMENTS

We have not received any written comments from the Staff of the Securities and Exchange Commission that remain unresolved as of the date of this Report.

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ITEM 2.PROPERTIES

The table below describes the material facilities owned or leased by Natural Gas Services Group as of December 31, 2009:

Location	Status	Square Feet	Uses
Tulsa, Oklahoma	Owned and Leased	91,780	Compressor fabrication, rental and services
Midland, Texas	Owned	58,000	Compressor fabrication, rental and services
Midland, Texas (1)	Owned	24,600	Compressor fabrication, rental and services
Lewiston, Michigan	Owned	15,360	Compressor fabrication, rental and services
Midland, Texas	Leased	13,135	Corporate offices
Bloomfield, New Mexico	Leased	4,672	Office and parts and services
Bridgeport, Texas	Leased	4,500	Office and parts and services
Midland, Texas	Owned	4,100	Parts and services
Godley, Texas	Leased	5,000	Parts and services
		221,147

(1)             We currently are not using this facility and have it listed for sale.

   We believe that our properties are generally well maintained and in good condition and adequate for our purposes.

ITEM 3.                 LEGAL PROCEEDINGS

From time to time, we are a party to various legal proceedings in the ordinary course of our business.  While management is unable to predict the ultimate outcome of these actions, it believes that any ultimate liability arising from these actions will not have a material effect on our financial position, results of operations or cash flow.  We are not currently a party to any bankruptcy, receivership, reorganization, adjustment or similar proceeding, and we are not aware of any other threatened litigation.

ITEM 4.                 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

We did not submit any matters to a vote of our stockholders during the fourth quarter of 2009.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

   Our common stock currently trades on the New York Stock Exchange under the symbol “NGS”. Prior to October 30, 2008 our common stock traded on the American Stock Exchange (AMEX). The following table sets forth for the periods indicated the high and low sales prices for our common stock as reported by these Exchanges.

2008
First Quarter	$	16.63	$	23.35
Second Quarter		22.28		32.56
Third Quarter		15.77		29.70
Fourth Quarter		6.60		16.81

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2009
First Quarter	$	6.72	$	12.60
Second Quarter		9.02		15.91
Third Quarter		10.97		18.01
Fourth Quarter		16.32		19.18

   As of December 31, 2009 in accordance with our transfer agent records, we had 21 record holders of our common stock.  This number does not include any beneficial owners for whom shares of common stock may be held in “nominee” or “street” name.  On March 1, 2010, the last reported sale price of our common stock as reported by the New York Stock Exchange was $16.04 per share.

   The following graph shows a five year comparison of the cumulative total stockholder return on Natural Gas Services Group common stock as compared to the cumulative total return of two other indexes:  a custom composite index of the Oilfield Service Index (the “OSX”) and the Standard & Poor’s 500 Composite Stock Price Index.  These comparisons assume an initial investment of $100 and the reinvestment of dividends.

The performance graph shall not be deemed incorporated by reference by any general statement incorporating by reference the Annual Report on Form 10-K into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that we specifically incorporate this information by reference, and shall not otherwise be deemed filed under those Acts.

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Dividends

   To date, we have not declared or paid any dividends on our common stock. We currently do not anticipate paying any cash dividends in the foreseeable future on our common stock.  Although we intend to retain our earnings, if any, to finance the growth of our business, our Board of Directors will have the discretion to declare and pay dividends in the future. Payment of dividends in the future will depend upon our earnings, capital requirements, and other factors, which our Board of Directors may deem relevant.  Our loan agreements also contain restrictions on paying dividends.

Equity Compensation Plans

The following table summarizes certain information regarding our equity compensation plans as of December 31, 2009:

Plan Category	(a) Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights			(b) Weighted-average Exercise Price of Outstanding Options, Warrants and Rights		(c) Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a))
Equity compensation plans approved by security holders:
1998 Stock Option Plan		162,667	(1)	$	14.10		324,190
2009 Restricted Stock / Unit Plan		─			─		300,000	(3)
Equity compensation plans not approved by security holders		45,000	(2)	$	9.22

 (1) Total number of shares to be issued upon exercise of options granted to employees, officers, and directors under our 1998 stock option plan.

 (2) Total number of shares to be issued upon exercise of options granted outside of our 1998 stock option plan to Stephen C. Taylor, our Chief Executive Officer, under the terms of his employment agreement.

 (3) No securities had been issued or granted under the 2009 Restricted Stock/Unit Plan as of December 31, 2009.

Repurchase of Equity Securities

No repurchases of our securities were made by us or on our behalf by any “affiliated purchaser” during the fourth quarter of the fiscal year ended December 31, 2009.

Sale of Unregistered Securities

   We made no sales of unregistered securities during the year ended December 31, 2009.

ITEM 6. SELECTED FINANCIAL DATA

In the table below, we provide you with selected historical financial data.  We have derived this information from our audited financial statements for each of the years in the five-year period ended December 31, 2009.  This information is only a summary and it is important that you read this information along with our audited financial statements and related notes, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Item 7 below, which discusses factors affecting the comparability of the information presented.  The selected financial information provided is not necessarily indicative of our future results of operations or financial performance.

	Year Ended December 31,
	2005			2006			2007		2008			2009
	(in thousands, except per share amounts)
STATEMENTS OF INCOME AND OTHER INFORMATION:
Revenues	$	49,311		$	62,729		$	72,489	$	85,336		$	67,796
Costs of revenue, exclusive of depreciation shown separately below		31,338			39,308			41,106		44,994			32,157
Gross margin(1)		17,973			23,421			31,383		40,342			35,639
Depreciation and amortization		4,224			6,020			7,470		9,925			11,686
Other operating expenses		4,890			5,270			5,324		5,842			6,190
Operating income		8,859			12,131			18,589		24,575			17,763
Total other income (expense)		(1,798	)		(256	)		144		(355	)		(536	)

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Income before income taxes		7,061		11,875		18,733		24,220		17,227
Income tax expense		2,615		4,287		6,455		8,627		6,212
Net income available to common stockholders	$	4,446	$	7,588	$	12,278	$	15,593	$	11,015
Net income per common share:
Basic	$	0.59	$	0.67	$	1.02	$	1.29	$	0.91
Diluted	$	0.52	$	0.66	$	1.01	$	1.28	$	0.91
Weighted average shares of common stock outstanding:
Basic		7,564		11,405		12,071		12,090		12,096
Diluted		8,481		11,472		12,114		12,143		12,118
EBITDA(2)	$	13,282	$	19,541	$	27,358	$	34,887	$	29,519
	As of December 31,
	2005		2006		2007		2008		2009
	(in thousands)
BALANCE SHEET INFORMATION:
Current assets	$	24,642	$	55,170	$	55,222	$	47,032	$	56,203
Total assets		86,369		135,552		153,233		181,050		186,871
Long-term debt (including current portion)		28,205		18,392		13,950		17,013		13,753
Stockholders’ equity		45,690		101,201		114,380		130,450		142,098

 (1) Gross margin is defined, reconciled to net income and discussed further below under “-- Non-GAAP Financial Measures”.

 (2) EBITDA is defined, reconciled to net income and discussed further below under “-- Non-GAAP Financial Measures”.

Non-GAAP Financial Measures

Our definition and use of EBITDA

“EBITDA” is a non-GAAP financial measure of earnings (net income) from continuing operations before interest, taxes, depreciation, and amortization.  This term, as used and defined by us, may not be comparable to similarly titled measures employed by other companies and is not a measure of performance calculated in accordance with GAAP.  EBITDA should not be considered in isolation or as a substitute for operating income, net income or loss, cash flows provided by operating, investing and financing activities, or other income or cash flow statement data prepared in accordance with GAAP.  However, management believes EBITDA is useful to an investor in evaluating our operating performance because:

· it is widely used by investors in the energy industry to measure a company’s operating performance without regard to items excluded from the calculation of EBITDA, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired, among other factors;

· it helps investors to more meaningfully evaluate and compare the results of our operations from period to period by removing the impact of our capital structure and asset base from our operating structure; and

· it is used by our management for various purposes, including as a measure of operating performance, in presentations to our Board of Directors, as a basis for strategic planning and forecasting, and as a component for setting incentive compensation.

EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under generally accepted accounting principles.  Some of these limitations are:

·          EBITDA does not reflect our cash expenditures, or future requirements for capital expenditures or contractualcommitments;

·          EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

·          EBITDA does not reflect the cash requirements necessary to service interest or principal payments on our debts; and;

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· although depreciation and amortization are non-cash charges, the assets being depreciated and amortized willoften have to be replaced in the future, and EBITDA does not reflect any cash requirements for suchreplacements.

There are other material limitations to using EBITDA as a measure of performance, including the inability to analyze the impact of certain recurring items that materially affect our net income or loss, and the lack of comparability of results of operations of different companies.  Please read the table below under “Reconciliation” to see how EBITDA reconciles to our net income, the most directly comparable GAAP financial measure.

Definition and use of gross margin

   We define gross margin as total revenue less cost of sales (excluding depreciation and amortization expense).  Gross margin is included as a supplemental disclosure because it is a primary measure used by our management as it represents the results of revenue and cost of sales (excluding depreciation and amortization expense), which are key components of our operations.  Gross margin differs from gross profit, in that gross profit includes depreciation expense.  We believe gross margin is important because it focuses on the current operating performance of our operations and excludes the impact of the prior historical costs of the assets acquired or constructed that are utilized in those operations, the indirect costs associated with our selling, general and administrative activities, the impact of our financing methods and income taxes.  Depreciation expense may not accurately reflect the costs required to maintain and replenish the operational usage of our assets and therefore may not portray the costs from current operating activity.  Rather, depreciation expense reflects the systematic allocation of historical fixed asset values over the estimated useful lives.

   Gross margin has certain material limitations associated with its use as compared to net income.  These limitations are primarily due to the exclusion of certain expenses.  Each of these excluded expenses is material to our results of operations.  Because we use capital assets, depreciation expense is a necessary element of our costs and our ability to generate revenue and selling, general and administrative expense is a necessary cost to support our operations and required corporate activities.  In order to compensate for these limitations, management uses this non-GAAP measure as a supplemental measure to other GAAP results to provide a more complete understanding of our performance.

As an indicator of our operating performance, gross margin should not be considered an alternative to, or more meaningful than, net income as determined in accordance with GAAP.  Our gross margin may not be comparable to a similarly titled measure of another company because other entities may not calculate gross margin in the same manner.

Reconciliation

   The following table reconciles EBITDA and gross margin to our net income, the most directly comparable GAAP financial measure:

	Year Ending December 31,
	2005				2006				2007				2008				2009
	(in thousands)
Net Income		$	4,446			$	7,588			$	12,278			$	15,593			$	11,015
Interest expense, net			1,997				1,646				1,155				742				606
Income taxes			2,615				4,287				6,455				8,627				6,212
Depreciation & amortization			4,224				6,020				7,470				9,925				11,686
EBITDA		$	13,282			$	19,541			$	27,358			$	34,887			$	29,519
Other operating expenses			4,890				5,270				5,324				5,842				6,190
Other expenses (income)			(199	)			(1,390	)			(1,299	)			(387	)			(70	)
Gross Margin		$	17,973			$	23,421			$	31,383			$	40,342			$	35,639

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is intended to assist you in understanding our financial position and results of operations for each of the years ended December 31, 2007, 2008, and 2009.  You should read the following discussion and analysis in conjunction with our audited financial statements and the related notes.

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The following discussion contains forward-looking statements.  For a description of limitations inherent in forward-looking statements, see “Special Note Regarding Forward-Looking Statements” on page (ii).

Overview

We fabricate, manufacture, rent and sell natural gas compressors and related equipment.  Our primary focus is on the rental of natural gas compressors.  Our rental contracts generally provide for initial terms of six to 24 months.  After the initial term of our rental contracts, most of our customers have continued to rent our compressors on a month-to-month basis.  Rental amounts are paid monthly in advance and include maintenance of the rented compressors.  As of December 31, 2009, we had 1,159 natural gas compressors totaling approximately 146,512 horsepower rented to 91 third parties, compared to 1,469 natural gas compressors totaling approximately 184,831 horsepower rented to 112 third parties at December 31, 2008.  Of the 1,159 compressors rented at December 31, 2009, 919 were rented on a month-to-month basis.

We also fabricate natural gas compressors for sale to our customers, designing compressors to meet unique specifications dictated by well pressures, production characteristics and particular applications for which compression is sought.  Fabrication of compressors involves the purchase by us of engines, compressors, coolers and other components, and then assembling these components on skids for delivery to customer locations.  These major components of our compressors are acquired through periodic purchase orders placed with third-party suppliers on an “as needed” basis, which presently requires a three to four month lead time with delivery dates scheduled to coincide with our estimated production schedules.  Although we do not have formal continuing supply contracts with any major supplier, we believe we have adequate alternative sources available.  In the past, we have not experienced any sudden and dramatic increases in the prices of the major components for our compressors.  However, the occurrence of such an event could have a material adverse effect on the results of our operations and financial condition, particularly if we were unable to increase our rental rates and sales prices proportionate to any such component price increases.

We also manufacture a proprietary line of compressor frames, cylinders and parts, known as our CiP (Cylinder-in-Plane) product line.  We use finished CiP component products in the fabrication of compressor units for sale or rental by us or sell the finished component products to other compressor fabricators.  We also design, fabricate, sell, install and service flare stacks and related ignition and control devices for onshore and offshore incineration of gas compounds such as hydrogen sulfide, carbon dioxide, natural gas and liquefied petroleum gases.  To provide customer support for our compressor and flare sales businesses, we stock varying levels of replacement parts at our Midland, Texas facility and at field service locations.  We also provide an exchange and rebuild program for screw compressors and maintain an inventory of new and used compressors to facilitate this business.

We provide service and maintenance to our customers under written maintenance contracts or on an as required basis in the absence of a service contract.  Maintenance agreements typically have terms of six months to one year and require payment of a monthly fee.

The following table sets forth our revenues from each of our three business segments for the periods presented:

	Year Ended December 31,
	2007		2008		2009
	(in thousands)
Sales	$	41,088	$	41,380	$	21,657
Rental		30,437		42,864		45,146
Service and maintenance		964		1,092		993
Total	$	72,489	$	85,336	$	67,796

Our strategy for growth is focused on our compressor rental business as indicated in the table above.  Margins for our rental business historically run in the high 50% to low 60% range, while margins for the compressor sales business tend to be in the mid 20% range.  As our rental business grows and contributes a larger percentage of our total revenues, we expect our overall company-wide margins to improve over time.

The oil and gas equipment rental and services industry is cyclical in nature.  The most critical factor in assessing the outlook for the industry is the worldwide supply and demand for natural gas and the corresponding changes in commodity prices.  As demand and prices increase, oil and gas producers increase their capital expenditures for drilling, development and production activities.  Generally, the increased capital expenditures ultimately result in greater revenues and profits for service and equipment companies.

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In general, we expect our overall business activity and revenues to track the level of activity in the natural gas industry, with changes in domestic natural gas production and consumption levels and prices more significantly affecting our business than changes in crude oil and condensate production and consumption levels and prices.  We also believe that demand for compression services and products is driven by declining reservoir pressure in maturing natural gas producing fields and, more recently, by increased focus by producers on non-conventional natural gas production, such as coal bed methane, gas shale and tight gas, which typically requires more compression than production from conventional natural gas reservoirs.

   Demand for our products and services were strong throughout most of 2008, but in 2009 the demand declined due to lower natural gas prices, decreased demand for natural gas and the economic recession.

   For fiscal year 2010, our forecasted capital expenditures will be directly dependent upon our customers’ compression requirements and are not anticipated to exceed our internally generated cash flows.  Any required capital will be for additions to our compressor rental fleet and/or addition or replacement of service vehicles.  We believe that cash flows from operations will be sufficient to satisfy our capital and liquidity requirements through 2010.  We may require additional capital to fund any unanticipated expenditures, including any acquisitions of other businesses, although that capital may not be available to us when we need it or on acceptable terms.

   Notwithstanding the current weak economy and financial crisis, we believe the long-term trend in our market is favorable.

Critical Accounting Policies and Practices

We have identified the policies below as critical to our business operations and the understanding of our results of operations.  In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our financial statements in conformity with accounting principles generally accepted in the United States.  Actual results could differ significantly from those estimates under different assumptions and conditions.  We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require our most difficult, subjective, and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Our critical accounting policies are as follows:

· revenue recognition;

· estimating the allowance for doubtful accounts receivable;

· accounting for income taxes;

· valuation of long-lived and intangible assets and goodwill; and

· valuation of inventory

Revenue Recognition

Revenue from the sales of custom and fabricated compressors and flare systems is recognized upon shipment of the equipment to customers.  Revenue from sale of rental units is included in sales revenue when equipment is shipped or title is transferred to the customer.  Exchange and rebuild compressor revenue is recognized when both the replacement compressor has been delivered and the rebuild assessment has been completed.  Revenue from compressor services is recognized upon providing services to the customer.  Maintenance agreement revenue is recognized as services are rendered.  Rental revenue is recognized over the terms of the respective rental agreements based upon the classification of the rental agreement.  Deferred income represents payments received before a product is shipped.

Allowance for Doubtful Accounts Receivable

We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer’s current credit worthiness, as determined by our review of their current credit information.  We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified.  While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past.  At December 31, 2009, two customers accounted for approximately 33% and 11%, respectively, of our accounts receivable, and at December 31, 2008, two customers accounted for approximately 35% and 14% of

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our accounts receivable, respectively.  A significant change in the liquidity or financial position of these customers could have a material adverse impact on the collectability of our accounts receivables and our future operating results.

Accounting for 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.  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 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.

Valuation of Long-Lived and Intangible Assets and Goodwill

We assess the impairment of identifiable intangibles, long-lived assets and related goodwill annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable.  Factors we consider important which could trigger an impairment review include the following:

· significant underperformance relative to expected historical or projected future operating results;

· significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and

· significant negative industry or economic trends.

When we determine that the carrying value of intangibles, long-lived assets and related goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model.

We did not indentify any impairment based on an independent valuation as of June 2006 and internal evaluations in December 2007, 2008 and 2009 of our reporting units with goodwill and other identifiable intangibles.  Future impairment tests could result in impairments of our intangible assets or goodwill.  We expect to continue to amortize our intangible assets with finite lives over the same time periods as previously used, and we will test our intangible assets with indefinite lives for impairment at least once each year.  In addition, we are required to assess the consumptive life, or longevity, of our intangible assets with finite lives and adjust their amortization periods accordingly.  Our net goodwill and intangible assets were recorded on our balance sheet at approximately $12.8 million and $13.1 million as of December 31, 2009 and 2008, respectively.  Our identifiable intangibles are currently amortized at a rate of $299,000 per year.  Any impairment in future periods of those assets, or a reduction in their consumptive lives, could materially and adversely affect our statements of income and financial position.

Inventories

We value our inventory at the lower of the actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory.  We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements.

Our Performance Trends and Outlook

   Given the current economic environment in North America and anticipated impact of lower natural gas prices and capital spending by customers, we expect that the overall activity levels in 2010 to be comparable to 2009. Currently, we believe the recent decline in commodity prices and the impact of uncertain credit and capital market conditions resulting from the recent financial crisis will negatively impact the level of capital spending by our customers in 2010 and 2011. We believe that a slow recovery from the current recession will lower capital spending by our customers and therefore negatively impact demand for our products and services.  We anticipate industry capital spending will remain flat in 2010 compared 2009 levels, and we believe our fabrication business segment will likely remain at a lower production level though 2010. We believe our rental operations business will increase as the nation recovers from the recession in 2010 and 2011, although we can give no assurances that this will occur.

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Results of Operations

Year Ended December 31, 2009 Compared to the Year Ended December 31, 2008

The table below shows our revenues, percentage of total revenues, gross margin, exclusive of depreciation, and gross margin percentage of each of our segments for the years ended December 31, 2009 and December 31, 2008.  Gross margin is the difference between revenue and cost of sales, exclusive of depreciation.

		Revenue				Gross Margin, Exclusive of Depreciation(1)
		Year Ended December 31,				Year Ended December 31,
		2008		2009		2008		2009
	(dollars in thousands) (unaudited)
Sales		$41,380	48.5%	$21,657	31.9%	$13,328	32.2%	$6,777	31.3%
Rental		42,864	50.2%	45,146	66.6%	26,671	62.2%	28,546	63.2%
Service and maintenance		1,092	1.3%	993	1.5%	343	31.4%	316	31.8%
Total		$85,336		$67,796		$40,342	47.3%	$35,639	52.6%

 (1) For a reconciliation of gross margin to its most directly comparable financial measure calculated and presented in accordance with GAAP, please read “Item 6. Selected Financial Data – Non-GAAP Financial Measures” in this Report.

   Total revenue decreased from $85.3 million to $67.8 million, or 20.6%, for the twelve months ended December 31, 2009, compared to the same period ended December 31, 2008. This was mainly the result of a 47.7% decrease in sales revenue and a 9.1% decrease in service and maintenance revenue offset by a 5.3% increase in rental revenue.

   Sales revenue decreased from $41.4 million to $21.7 million, or 47.7%, for the twelve months ended December 31, 2009, compared to the same period ended December 31, 2008. This decrease is the result of lower demand for our products due to an industry slowdown which resulted in fewer compressor units sold to third parties from our Tulsa and Michigan operations.  Sales included: (1) compressor unit sales, (2) flare sales, (3) parts sales, (4) compressor rebuilds and (5) rental unit sales.

Rental revenue increased from $42.9 million to $45.2 million, or 5.3%, for the twelve months ended December 31, 2009, compared to the same period ended December 31, 2008.  This increase was the result of a revenue increase during the first six months but was offset by price concessions and returned rental units during the third and fourth quarters of 2009. As of December 31, 2009, we had 1,776 natural gas compressors in our rental fleet totaling approximately 223,694 horsepower, as compared to 1,730 natural gas compressors totaling approximately 217,085 horsepower at December 31, 2008.  As of December 31, 2009, we had 1,159 natural gas compressors totaling approximately 146,512 horsepower rented to 91 third parties, compared to 1,469 natural gas compressors totaling approximately 184,831 horsepower rented to 112 third parties at December 31, 2008. The rental fleet had a utilization of 65.3% as of December 31, 2009.

                  The overall gross margin percentage increased to 52.6% for the twelve months ended December 31, 2009, from 47.3% for the same period ended December 31, 2008. This increase is result of two factors: (1) rentals, which have a higher margin than our other sources of revenue, (rental revenue increased to 66.6% from 50.2% of our total revenue for the year ended December 31, 2009 compared to the same period ended December 31, 2008); and (2) our rental margin increased to 63.2% from 62.2% for the year ended December 31, 2009 compared to the same period ended December 31, 2008. This margin increase is also the result of greater efficiencies in our field service operations.

   Selling, general, and administrative expense increased from $5.8 million, to $6.2 million, or 6.0%, for the twelve months ended December 31, 2009, as compared to the same period ended December 31, 2008. This increase is mainly due to an increase in stock compensation expenses.

   Depreciation and amortization expense increased from $9.9 million, to $11.7 million, or 17.7%, for the twelve months ended December 31, 2009, compared to the same period ended December 31, 2008.  This increase was the result of 46 new gas compressor rental units being added to the rental fleet from December 31, 2008 to December 31, 2009, thus increasing the depreciable base along with a full year of depreciation related to the 377 rental units added in 2008.

   Other income net of other expense decreased $317,000 for the twelve months ended December 31, 2009, compared to the same period ended December 31, 2008. This decrease is mainly the result of redemption of our short-term investments creating a decrease in interest income.

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   Interest expense decreased 18.3% for the twelve months ended December 31, 2009, compared to the same period ended December 31, 2008, mainly due to the pay down of our term bank loan facility.

   Provision for income tax decreased from $8.6 million to $6.2 million, or 28.0%, and is the result of the decrease in taxable income.

Year Ended December 31, 2008 Compared to the Year Ended December 31, 2007

The table below shows our revenues, percentage of total revenues, gross margin, exclusive of depreciation, and gross margin percentage of each of our segments for the years ended December 31, 2008 and December 31, 2007.  Gross margin is the difference between revenue and cost of sales, exclusive of depreciation.

		Revenue				Gross Margin, Exclusive of Depreciation(1)
		Year Ended December 31,				Year Ended December 31,
		2007		2008		2007		2008
	(dollars in thousands) (unaudited)
Sales		$41,088	56.7%	$41,380	48.5%	$12,964	31.6%	$13,328	32.2%
Rental		30,437	42.0%	42,864	50.2%	18,055	59.3%	26,671	62.2%
Service and maintenance		964	1.3%	1,092	1.3%	364	37.8%	343	31.4%
Total		$72,489		$85,336		$31,383	43.3%	$40,342	47.3%

(1) For a reconciliation of gross margin to its most directly comparable financial measure calculated and presented in accordance with GAAP, please read “Item 6. Selected Financial Data – Non-GAAP Financial Measures” in this Report.

Total revenues for the year ended December 31, 2008 increased 17.7% to $85.3 million, as compared to $72.5 million for the year ended December 31, 2007.  The increase mainly reflects the increase in our rental revenues.

Sales revenue increased from $41.1 million to $41.4 million, or less than 1.0%, for the year ended December 31, 2008, compared to the year ended December 31, 2007. This increase is mainly represented by a 38.7% increase in part sales which is only 1.9% of our total sales. The total category includes (1) compressor unit sales (including used rental equipment), (2) flare sales, (3) parts sales, and (4) compressor rebuilds.

Rental revenue increased from $30.4 million to $42.9 million, or 40.8%, for the year ended December 31, 2008, compared to the year ended December 31, 2007.  The increase is mainly the result of units added to our rental fleet and rented to third parties.  As of December 31, 2008, we had 1,730 natural gas compressors in our rental fleet totaling approximately 217,085 horsepower, as compared to 1,353 natural gas compressors totaling approximately 160,733 horsepower at December 31, 2007.  As of December 31, 2008, we had 1,469 natural gas compressors rented compared to 1,194 at December 31, 2007.  The average monthly rental rate per unit increased to $2,900 at December 31, 2008 compared to $2,300 at December 31, 2007.  This increase resulted from the addition of larger horsepower units to our rental fleet and therefore has a higher rental rates.

Service and maintenance revenue increased from $964,000 to $1.1 million, or 13.3%, for the year ended December 31, 2008, compared to the year ended December 31, 2007.  This increase is the result of gain in service revenue for all districts except Midland.

                 The overall gross margin percentage, exclusive of depreciation, increased to 47.3% for the year ended December 31, 2008, as compared to 43.3% for the year ended December 31, 2007.  This increase is result of two factors: (1) rentals which have a higher margin than our other sources of revenue increased (rental revenue increased to 50.2% from 42.0% of our total revenue for the year ended December 31, 2008 compared to the same period ended December 31, 2007); and (2) our rental margin increased to 62.2% from 59.3% for the year ended December 31, 2008 compared to the same period ended December 31, 2007. This margin increase is the result of greater efficiencies in our field service operations and from increasing our rental rates.

Selling, general and administrative expense increased to $5.8 million or 6.8% of total revenue from $5.3 million or 7.3% of our total revenue, for the year ended December 31, 2008 compared to the year ended December 31, 2007.  Our selling expenses increased 29.4% and our general and administrative expenses increased 5.5% for year ended December 31, 2008, compared to same period in 2007. Selling expenses mainly increased as result of increased commissions on larger sales numbers and changes to the commission structure.  General and administrative expenses increased mainly as a result of additions to the administrative staff, salary increases and stock compensation expense.

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Depreciation and amortization expense increased 32.9% from $7.5 million to $9.9 million for the year ended December 31, 2008, compared to the same period in 2007.  There was a net increase of 377 natural gas compressor units to our rental fleet between December 31, 2007 and 2008, thus increasing our depreciable base.

Other income decreased approximately $912,000 for the year ended December 31, 2008, compared to the same period in 2007. This decrease was mainly the result of reduced interest income from our short-term investment account. Our short-term investments decreased to $2.3 million at December 31, 2008, compared to $18.7 million at December 31, 2007.  This reduction resulted from the capital funding of our natural gas compressor rental fleet.

Interest expense decreased by $413,000, or 35.8%, for the year ended December 31, 2008, compared to the same period in 2007, mainly due to a decrease in our loan balances. Our loan balance decreased $4.0 million, and our line increased, during the later part of the year, from $600,000 to $7 million.

Provision for income tax increased by $2.2 million, or 33.6%, and is mainly the result of the increase in taxable income.

Liquidity and Capital Resources

Our working capital position as of December 31, 2008 and 2009 are set forth below.

	2008		2009
	(in thousands)
Current Assets:
Cash and cash equivalents	$	1,149	$	23,017
Short-term investments		2,300	─
Trade accounts receivable, net		11,321		7,314
Inventory, net		31,931		24,037
Prepaid income taxes		244		1,556
Prepaid expenses and other		87		279
Total current assets		47,032		56,203
Current Liabilities:
Current portion of long-term debt		3,378		3,378
Line of credit	─			7,000
Accounts payable		8,410		2,239
Accrued liabilities		3,987		1,485
Current portion of tax liability		110		1,708
Deferred income		38		90
Total current liabilities		15,923		15,900
Total working capital	$	31,109	$	40,303

Historically, we have funded our operations through public and private offerings of our equity securities, subordinated debt, bank borrowings and cash flow from operations. Proceeds of financings have been primarily used to repay debt, to fund the manufacture and fabrication of additional units for our rental fleet of natural gas compressors and for acquisitions.

For the year ended December 31, 2009, we invested approximately $9.5 million in equipment for our rental fleet and service vehicles.  We financed this activity with funds from operations.  We also repaid approximately $3.9 million of our existing debt during 2009.

Cash flows

At December 31, 2009, we had cash and cash equivalents of $23.0 million, working capital of $40.3 million and total debt of $13.8 million, of which approximately $10.4 million was classified as current. We had positive net cash flow from operating activities of approximately $32.2 million during 2009. This was primarily from net income of $11.0 million, plus depreciation and amortization of $11.7 million, an increase in deferred taxes of $4.5 million, and a decrease in trade accounts receivable and inventory of $13.0 million offset by a decrease in accounts payable and accrued liabilities of $8.7 million.

  At December 31, 2008, we had cash and cash equivalents of approximately $1.1 million, working capital of $31.1 million and total debt of $17.0 million, of which approximately $3.4 million was classified as current. We had positive net cash flow from operating activities of approximately $28.3 million during 2008. This was primarily from net income of $15.6 million,

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plus depreciation and amortization of $9.9 million, an increase in deferred taxes of $8.4 million, and an increase in prepaid expenses and other of $3.9 million offset by an increase in inventory of $11.2 million.

Short term investments were $2.3 million at December 31, 2008 and were redeemed in 2009.  This amount was the remaining proceeds from our March 2006 secondary public offering.

Trade accounts receivable decreased $4.0 million from December 31, 2008 to December 31, 2009. This decrease mainly resulted from the slow down in our Tulsa compressor sales business.

Inventory and work in progress decreased to $24.0 million as of the end of 2009, as compared to $31.9 million as of the end of 2008. This increase is mainly a reflection of decreased fabrication activity in both of our engineered products and rental compression equipment lines.

Long-term debt decreased $3.3 million to $13.8 million at December 31, 2009, compared to $17.0 million at December 31, 2008.  This decrease was mainly the result of principal repayment of debt.

Recession strategy

For fiscal year 2010, our overall plan, during the downturn in the economy, is to reduce expenses in line with the lower anticipated activity, fabricate rental fleet equipment only in direct response to market requirements, emphasize marketing of our idle gas compressor units and limit bank borrowing.  Capital expenditures for the year ended December 31, 2010 are not anticipated to exceed our internal cash generating capacity.  We believe that cash flows from operations will be sufficient to satisfy our capital and liquidity requirements through 2010.  We may require additional capital to fund any unanticipated expenditures, including any acquisitions of other businesses.  As of December 31, 2009 we have a $40 million dollar bank line of credit with an available balance of $33 million which expires in May 01, 2010.  All outstanding principal and unpaid interest is due on May 1, 2010.  We are currently negotiating with several banks to renew or replace our line of credit.   As of January 2010, we have paid down the line of credit to $500,000.  Our expectations are to renew or replace this line of credit; however, in the event this line of credit is not renewed and or replaced, we anticipate this event will have little to no affect on our operations as a whole.

Contractual Obligations and Commitments

We have contractual obligations and commitments that affect our results of operations, financial condition and liquidity.  The following table is a summary of our significant cash contractual obligations:

	Obligation Due in Period
Cash Contractual Obligations	2010		2011		2012		2013		2014		Thereafter		Total
	(in thousands)
Term loan facility (secured)	$	3,378	$	2,817	$		$		$		$		$	6,195
Interest on term loan facility		186		51										237
Line of credit (secured)		7,000												7,000
Interest on line of credit		93												93
Purchase obligations		252		956		956		956		956		436		4,512
Other long term debt										558				558
Facilities and office leases		357		258		233		167		17				1,032
Total	$	11,266	$	4,082	$	1,189	$	1,123	$	1,531	$	436	$	19,627

As of December 31, 2009, we had a long-term liability of $275,000 to Midland Development Corporation.  This amount is to be recognized as income contingent upon certain staffing requirements in the future.  In addition, we entered into a purchase agreement with a vendor on July 30, 2008 pursuant to which we agreed to purchase up to $4.8 million of our paint and coating requirements exclusively from the vendor.  In connection with the execution of the agreement, the vendor paid us a $300,000 fee which is considered to be a discount toward future purchases from the vendor.  Based on our historical paint and coating

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requirements, we estimate meeting the $4.8 million purchase obligation within five years.  The $300,000 payment we received is recorded as a long-term liability and will decrease as the purchase commitment is fulfilled.  The long-term liability remaining as of December 31, 2009 was $283,000.

Senior Bank Borrowings

On May 16, 2008, we entered into an Eighth Amended and Restated Loan Agreement with Western National Bank, Midland, Texas effective April 1, 2008.  This amendment (1) decreased the interest rate on existing term loan facilities, and (2) extended and renewed our revolving line of credit facility.  Our revolving line of credit and multiple advance term loan facilities are described below.

Revolving Line of Credit Facility.  Our revolving line of credit facility allows us to borrow, repay and re-borrow funds drawn under this facility.  The total amount that we can borrow and have outstanding at any one time is the lesser of $40.0 million or the amount available for advances under a “borrowing base” calculation established by the bank.  As of December 31, 2009, the amount available for revolving line of credit advances was $33.0 million.  The amount of the borrowing base is based primarily upon our receivables, equipment and inventory.  The borrowing base is re-determined by the bank on a monthly basis.  If, as a result of the re-determination of the borrowing base, the aggregate outstanding principal amount of the notes payable to the bank under the Loan Agreement exceeds the borrowing base, we must prepay the principal of the revolving line of credit note in an amount equal to such excess.  Interest only on borrowings under our revolving line of credit facility is payable monthly on the first day of each month.  All outstanding principal and unpaid interest is due on May 1, 2010.  We are currently negotiating with several banks to renew or replace our line of credit.   As of January 2010, we have paid down the line of credit to 500,000.  Since April 1, 2008, our interest rate on the revolving line of credit is equal to prime rate minus one quarter of one percent (.25%) but never lower than four percent (4.0%) nor higher than eight and three quarter percent (8.75%).  We had $7.0 million outstanding as of December 31, 2009 and 2008.  The interest rate was 4.0% at December 31, 2009 and 2008.

$16.9 Million Multiple Advance Term Loan Facility.  This multiple advance term loan facility represents the consolidation of our previously existing advancing line of credit and term loan facilities.  Re-borrowings are not permitted under this facility.  Principal under this term loan facility is due and payable in 59 monthly installments of $282,000 each which commenced on November 1, 2006 and continuing through September 1, 2011.  Since April 1, 2008, our interest rate on the term loan is equal to prime rate minus one half of one percent (.50%) but never lower than four percent (4%) nor higher than eight and three quarter percent (8.75%).  Interest on the unpaid principal balance is due and payable on the same dates as principal payments.  All outstanding principal and unpaid interest is due on October 1, 2011.  As of December 31, 2008 and 2009, respectively, this term loan facility had a principal balance of $9.6 million and $6.2 million.  The interest rate was 4.0% as of December 31, 2008 and 2009.

Our obligations under the Loan Agreement are secured by substantially all of our properties and assets, including our equipment, trade accounts receivable and other personal property and by the real estate and related plant facilities.

The maturity dates of the loan facilities may be accelerated by the bank upon the occurrence of an event of default under the Loan Agreement.

The Loan Agreement contains various restrictive covenants and compliance requirements.  These requirements provide that we must have:

· at the end of each month, a current ratio (as defined in the Loan Agreement) of at least 1.6 to 1.0;

· at the end of each month, tangible net worth (as defined in the Loan Agreement) of at least $85.0 million;

· at the end of each fiscal quarter, a debt service coverage ratio (as defined in the Loan Agreement) of at least 1.50 to 1.00; and

· at the end of each month, a ratio of debt to tangible net worth (as defined in the Loan Agreement) of less than 2.0 to 1.0.

The Loan Agreement also contains restrictions on incurring additional debt and paying dividends.

As of December 31, 2008 and 2009, we were in compliance with all covenants in our Loan Agreement.  A default under our bank credit facility could trigger the acceleration of our bank debt so that it is immediately due and payable.  Such default would have a material adverse effect on our liquidity, financial position and operations.

Shelf Registration Statement

We have an effective $150 million “universal” shelf registration statement on form S-3 on file with the Securities and

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Exchange Commission which we filed in 2009. This shelf registration statement enables us to sell, from time to time, the securities covered by the registration statement in one or more public offerings. The securities covered by the registration statement include common stock, preferred stock, depositary shares, debt securities, rights to purchase common stock, units consisting of two or more of any of the registered securities and warrants to purchase any of the registered securities. We may offer any of these securities independently or together in any combination with other securities. The shelf registration statement allows us to enter the public markets and consummate sales of the registered securities in rapid fashion and with little or no notice.  We have no immediate plans to issue securities under the shelf registration statement, but our management believes that it may facilitate access to additional liquidity in the future.  However, there is no assurance that equity or debt capital would be available to us in the public markets should we determine to issue securities under the shelf registration statement.

Components of Our Principal Capital Expenditures

The table below shows the components of our principal capital expenditures for the three years ended December 31, 2009:

	Actual
Expenditure Category	2007		2008		2009
	(in thousands)
Rental equipment, vehicles and shop equipment	$	25,307	$	46,271	$	9,542

The level of our expenditures will vary in future periods depending on energy market conditions and other related economic factors.  Based upon existing economic and market conditions, we believe that our operating cash flow will be sufficient to fully fund our net capital expenditures requirements for 2010.  We also believe we have significant flexibility with respect to our financing alternatives and adjustment of our expenditure plans if circumstances warrant.  When considered in relation to our total financial capacity, we do not have any material continuing commitments associated with expenditure plans related to our current operations.

Off-Balance Sheet Arrangements

From time-to-time, we enter into off-balance sheet arrangements and transactions that can give rise to off-balance sheet obligations.  As of December 31, 2009, the off-balance sheet arrangements and transactions that we have entered into include operating lease agreements and purchase agreements.  We do not believe that these arrangements are reasonably likely to materially affect our liquidity or availability of, or requirements for, capital resources.

We entered into a purchase agreement with a vendor on July 30, 2008 pursuant to which we agreed to purchase up to $4.8 million of our paint and coating requirements exclusively from the vendor.  In connection with the execution of the agreement, the vendor paid us a $300,000 fee which is considered to be a discount toward future purchases from the vendor.  Based on our historical paint and coating requirements, we estimate meeting the $4.8 million purchase obligation within five years.  As of December 31, 2009 we had met $268,000 of this obligation.  The $300,000 payment we received is recorded as a long-term liability and will decrease as the purchase commitment is fulfilled.  The long-term liability remaining as of December 31, 2009 was $283,000

Recently Issued Accounting Pronouncements

  In June 2009, Financial Accounting Standards Board (FASB) established, with the effect from July 1, 2009, the FASB Accounting Standards Codification (ASC) as the source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities.  Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants.  We adopted the Codification beginning July 1, 2009 and while it impacts the way we refer to accounting pronouncements in our disclosures; it had no affect on our financial position, results of operations or cash flows upon adoption.

On January 1, 2009, we adopted FASB ASC 805, Business Combinations, which replaces SFAS No. 141, Business Combinations, and requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquire at the acquisition date, measured at their fair values as of that date, with limited exceptions. ASC 805 also requires the acquirer in a business combination achieved in stages to recognize the identifiable assets and liabilities, as well as the non-controlling interest in the acquiree, at the full amounts of their fair values. Additionally, ASC 805 requires acquisition related costs to be expensed in the period in which the costs were incurred and the services are received instead of including such costs as part of the acquisition price.  ASC 805 makes various other amendments to authoritative literature intended to provide additional guidance or to confirm the guidance in that literature to that provided in ASC 805.  The adoption of ASC 805 had no impact on our financial statements.

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In April 2009, the FASB issued ASC 855, Subsequent Events.  ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. We adopted ASC 855 for the quarter ending June 30, 2009.  The adoption of ASC 855 did not have a material impact on our financial statements.

Environmental Regulations

Various federal, state and local laws and regulations covering the discharge of materials into the environment, or otherwise relating to protection of human safety and health and the environment, affect our operations and costs.  Compliance with these laws and regulations could cause us to incur remediation or other corrective action costs or result in the assessment of ,administrative, civil and criminal penalties and the issuance of injunctions delaying or prohibiting operations.  In addition, we have acquired certain properties and plant facilities from third parties whose actions with respect to the management and disposal or release of hydrocarbons or other wastes were not under our control.  Under environmental laws and regulations, we could be required to remove or remediate wastes disposed of or released by prior owners.  In addition, we could be responsible under environmental laws and regulations for properties and plant facilities we lease, but do not own.  Compliance with such laws and regulations increases our overall cost of business, but has not had a material adverse effect on our operations or financial condition.  It is not anticipated, based on current laws and regulations, that we will be required in the near future to expend amounts that are material in relation to our total expenditure budget in order to comply with environmental laws and regulations but such laws and regulations are frequently changed and we are unable to predict the ultimate cost of compliance.  We also could incur costs related to the clean up of sites to which we send equipment and for damages to natural resources or other claims related to releases of regulated substances at such sites.

ITEM 7A.               QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Commodity Risk

Our commodity risk exposure is the pricing applicable to oil and natural gas production.  Realized commodity prices received for such production are primarily driven by the prevailing worldwide price for crude oil and spot prices applicable to natural gas.  Depending on the market prices of oil and natural gas, companies exploring for oil and natural gas may cancel or curtail their drilling programs, thereby reducing demand for our equipment and services.

Interest Rate Risk

Our Loan Agreement provides for Prime Rate less 1/2 % for our term loan facility and Prime Rate less 1/4 % for our revolving line of credit facility.  Consequently, our exposure to interest rates relates primarily to interest earned on short-term investments and paying above market rates, if such rates are below the fixed rate, on our bank borrowings.  As of December 31, 2009, we were not using any derivatives to manage interest rate risk.

Financial Instruments and Debt Maturities

Our financial instruments consist of cash and cash equivalents, short-term investments, accounts receivable, accounts payable, bank borrowings, and notes.  The carrying amounts of cash and cash equivalents, accounts receivable, and accounts payable approximate fair value because of the highly liquid nature of these short-term instruments.  The fair value of our bank borrowings approximate the carrying amounts as of December 31, 2009 and 2008, and were determined based upon interest rates currently available to us.

Customer Credit Risk

We are exposed to the risk of financial non-performance by our customers.  Our ability to collect on sales to our customers is dependent on the liquidity of our customer base.  To manage customer credit risk, we monitor credit ratings of our customers.  Unless we are able to retain our existing customers, or secure new customers if we lose one or more of our significant customers, our revenue and results of operations would be adversely affected.  See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Procedures – Allowance For Doubtful Accounts Receivable” on page 23.

ITEM 8.                  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our audited financial statements and supplementary financial data are included in this Annual Report on Form 10-K beginning on page F-1.

ITEM 9.                  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

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ITEM 9A.               CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

An evaluation was carried out under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Principal Accounting Officer And Treasurer, of the effectiveness of the design of our “disclosure controls and procedures” (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended or, the “Exchange Act”) as of December 31, 2009, pursuant to Exchange Act Rule 13a-15.  Based upon that evaluation, the President and Chief Executive Officer and our Principal Accounting Officer And Treasurer have concluded that our disclosure controls and procedures as of December 31, 2009, are effective to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and include controls and procedures designed to ensure that information required to be disclosed by us in such reports is accumulated and communicated to our management, including our principal executive and financial officers as appropriate to allow timely decisions regarding required disclosures.  Due to the inherent limitations of control systems, not all misstatements may be detected.  Those inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes.  Additionally, controls could be circumvented by the individual acts of some persons or by collusion of two or more people.  Our controls and procedures can only provide reasonable, not absolute, assurance that the above objectives have been met.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

Our management, including the President and Chief Executive Officer and our Principal Accounting Officer and Treasurer, is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act.  Our internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  Our internal control over financial reporting includes those policies and procedures that:

· pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;

· provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that our receipt and expenditures are being made only in accordance with authorizations of management and our Board of Directors; and

· provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

All internal control systems, no matter how well designed, have inherent limitations.  A system of internal control may become inadequate over time because of changes in conditions or deterioration in the degree of compliance with the policies or procedures.  Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Our management assessed the effectiveness of our internal control over financial reporting as December 31, 2009 using the criteria set forth by the Commission of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.  Based on this assessment, our management concluded that, as of December 31, 2009, our internal control over financial reporting was effective.

Pursuant to the Section 404 of the Sarbanes-Oxley Act of 2002, we have included a report of managements assessment of the design and effectiveness of our internal controls as part of this annual report on Form 10-K for the fiscal year ended December 31, 2009.  Hein & Associates LLP, our registered independent public accounting firm, attest to and issued an attestation report on the effectiveness of internal control over financial reporting.

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders

Natural Gas Services Group, Inc.

Midland, Texas

We have audited Natural Gas Services Group, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria).  Natural Gas Services Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting.  Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.  Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances.  We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Natural Gas Services Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the balance sheets of Natural Gas Services Group, Inc. as of December 31, 2008 and 2009, and the related statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2009 of Natural Gas Services Group, Inc. and our report dated March 4, 2010 expressed an unqualified opinion.

/s/ HEIN & ASSOCIATES LLP

Dallas, Texas

March 4, 2010

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ITEM 9B.               OTHER INFORMATION

None.

PART III

ITEM 10.               DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this item is incorporated herein by reference to the sections “Election of Directors,”  “Executive Officers,” “Corporate Governance” and “The Board of Directors and its Committees” in our definitive proxy statement which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2009.

ITEM 11.               EXECUTIVE COMPENSATION

The information required by this item is incorporated herein by reference to the section “Executive Compensation” in our definitive proxy statement which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2009.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this item is incorporated herein by reference to the section “Principal Shareholders and Security Ownership of Management” in our definitive proxy statement which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2009.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR

INDEPENDENCE

The information required by this item is incorporated herein by reference to the sections “Related Person Transactions” and “Corporate Governance” in our definitive proxy statement which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2009.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item is incorporated herein by reference to the section “Principal Accountant Fees and Services” in our definitive proxy statement which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2009.

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PART IV

ITEM 15.               EXHIBITS, FINANCIAL STATEMENT SCHEDULES

The following documents are filed as part of this Annual Report on Form 10-K:

(a)(1) and (a)(2) Financial Statement and Financial Statement Schedules

For a list of Financial Statements and Schedules, see “Index to Financial Statements” on page F-1, and incorporated herein by reference.

(a)(3) Exhibits

See Item 15(b) below.

(b)           Exhibits:

A list of exhibits to this Annual Report on Form 10-K is set forth below:

Exhibit No.                                                                                     Description

3.1 Articles of Incorporation, as amended (Incorporated by reference to Exhibit 3.1 of the 10-QSB filed and dated November 10, 2004)

3.2 Bylaws (Incorporated by reference to Exhibit 3.4 of the Registrant's Registration Statement on Form SB-2, No.  333-88314)

4.1 Non-Statutory Stock Option Agreement (Incorporated by reference to Exhibit 10.2 to Form 8-K filed with the SEC on August 30, 2005)

4.2 Form of Senior Indenture (Incorporated by reference to Exhibit 4.1 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.3 Form of Senior Note (Incorporated by reference to Exhibit 4.2 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.4 Form of Subordinated Indenture (Incorporated by reference to Exhibit 4.3 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.4 Form of Subordinated Note (Incorporated by reference to Exhibit 4.4 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.6 Form of Deposit Agreement, including Form of Depositary Share (Incorporated by reference to Exhibit 4.5 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.7 Form of Warrant Agreement, including Form of Warrant Certificate (Incorporated by reference to Exhibit 4.6 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.8 Form of Unit Agreement (Incorporated by reference to Exhibit 4.7 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.9 Form of Preferred Stock Certificate (Incorporated by reference to Exhibit 4.8 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.10 Form of Certificate of Designation with respect to Preferred Stock (Incorporated by reference to Exhibit 4.9 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.11 Rights Agreement, including Form of Rights Certificate (Incorporated by reference to Exhibit 4.10 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

10.1 1998 Stock Option Plan, as amended (Incorporated by reference to Exhibit 10.1 of the Registrant’s Form 8-K Report dated September 20, 2006 on file with the SEC September 26, 2006)

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10.2 Lease Agreement, dated March 1, 2004, between the Registrant and the City of Midland, Texas (Incorporated by reference to Exhibit 10.19 of the Registrant's Form 10-QSB for the fiscal quarter ended March 31, 2004)

10.3 Seventh Amended and Restated Loan Agreement (Incorporated by reference to Exhibit 10.1 of the Registrant’s Form 8-K dated October 26, 2006 and filed with the Securities and Exchange Commission on November 1, 2006

10.4 Eighth Amended and Restated Loan Agreement between Natural Gas Services Group, Inc. and Western National Bank.

10.5 Revolving Line of Credit Promissory Note issued to Western National Bank.

10.6 Employment Agreement between Natural Gas Services Group, Inc. and Stephen C. Taylor dated October 25, 2008 (Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 30, 2008)

10.7 Lease Agreement, dated March 26, 2008, between WNB Tower, LTD and Natural Gas Services Group, Inc. (Incorporated by reference to Exhibit 10.15 of the Registrant’s  Form 10-K for the fiscal year ended December 31, 2008 and filed with the Securities and Exchange Commission on March 9, 2009)

10.8 2009 Restricted Stock/Unit Plan (Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K dated June 18, 2009 and filed with the Securities and Exchange Commission on June 18, 2009.)

10.9 1998 Stock Option Plan, as amended (Incorporated by reference to Exhibit 10.2 of the Registrant’s Current Report on Form 8-K dated June 18, 2009 and filed with the Securities and Exchange Commission on June 18, 2009.)

*10.10 Lease Agreement, dated December 11, 2008, between Klement-Wes Partnership, LTD and Natural Gas Services Group, Inc. and commencing on January 1, 2009.

14.0 Code of Ethics (Incorporated by reference to Exhibit 14.0 of the Registrant's Form 10-KSB for the fiscal year ended December 31, 2004, and filed with the Securities and Exchange Commission on March 30, 2005)

*23.1 Consent of Hein & Associates LLP

*31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

*31.2 Certification of Principal Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

*32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

*32.2 Certification of Principal Accounting Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 * Filed herewith.

34

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	NATURAL GAS SERVICES GROUP, INC.
Date:  March 4, 2010	By:	/s/ Stephen C. Taylor
		Stephen C. Taylor
		Chairman of the Board, President and Chief Executive Officer
		(Principal Executive Officer)

Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

Signature	Title	Date
/s/ Stephen C. Taylor	Chairman of the Board of Directors, Chief Executive Officer and President (Principal Executive Officer)	March 4, 2010
Stephen C. Taylor
/s/ Earl R. Wait	Vice President – Accounting (Principal Accounting Officer)	March 4, 2010
Earl R. Wait
/s/Charles G. Curtis	Director	March 4, 2010
Charles G. Curtis
/s/William F. Hughes, Jr.	Director	March 4, 2010
William F. Hughes, Jr.
/s/Richard L. Yadon	Director	March 4, 2010
Richard L. Yadon
/s/Gene A. Strasheim	Director	March 4, 2010
Gene A. Strasheim
/s/Alan A. Baker	Director	March 4, 2010
Alan A. Baker
	Director
John W. Chisholm

35

INDEX TO FINANCIAL STATEMENTS

	Page
Report of Independent Registered Public Accounting Firm	F-1
Balance Sheets as of December 31, 2008 and 2009	F-2
Statements of Income for the Years Ended December 31, 2007, 2008 and 2009	F-3
Statements of Stockholders' Equity for the Years Ended December 31, 2007, 2008, and 2009	F-4
Statements of Cash Flows for the Years Ended December 31, 2007, 2008 and 2009	F-5
Notes to Financial Statements	F-6

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

Natural Gas Services Group, Inc.

Midland, Texas

We have audited the accompanying balance sheets of Natural Gas Services Group, Inc. (the “Company”) as of December 31, 2008 and 2009, and the related statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2008 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Natural Gas Services Group, Inc.’s, internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 4, 2010 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ HEIN & ASSOCIATES LLP

Dallas, Texas

March 4, 2010

F-1

NATURAL GAS SERVICES GROUP, INC.

BALANCE SHEETS

(in thousands)

	December 31,
	2008		2009
ASSETS
Current Assets:
Cash and cash equivalents	$	1,149	$	23,017
Short-term investments		2,300		—
Trade accounts receivable, net of doubtful accounts of $177 and $363, respectively		11,321		7,314
Inventory, net of allowance for obsolescence of $500 and $345, respectively		31,931		24,037
Prepaid income taxes		244		1,556
Prepaid expenses and other		87		279
Total current assets		47,032		56,203
Rental equipment, net of accumulated depreciation of $24,624 and $34,008, respectively		111,967		110,263
Property and equipment, net of accumulated depreciation of $6,065 and $7,210, respectively		8,973		7,626
Goodwill, net of accumulated amortization of $325, both periods		10,039		10,039
Intangibles, net of accumulated amortization of $1,198 and $1,497 respectively		3,020		2,721
Other assets		19		19
Total assets	$	181,050	$	186,871
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt	$	3,378	$	3,378
Current portion of line of credit		—		7,000
Accounts payable		8,410		2,239
Accrued liabilities		3,987		1,485
Current income tax liability		110		1,708
Deferred income		38		90
Total current liabilities		15,923		15,900
Long term debt, less current portion		6,194		2,817
Line of credit, less current portion		7,000		—
Deferred income tax payable		21,042		25,498
Other long term liabilities		441		558
Total liabilities		50,600		44,773
Commitments and contingencies  (Notes 4, 5, 10 and 13)
Stockholders’ equity:
Preferred stock, 5,000 shares authorized, no shares issued or outstanding		—		—
Common stock, 30,000 shares authorized, par value $0.01; 12,094 and 12,101 shares issued and outstanding, respectively		121		121
Additional paid-in capital		83,937		84,570
Retained earnings		46,392		57,407
Total stockholders' equity		130,450		142,098
Total liabilities and stockholders' equity	$	181,050	$	186,871

See accompanying notes to these financial statements.

F-2

NATURAL GAS SERVICES GROUP, INC.

STATEMENTS OF INCOME

(in thousands, except earnings  per share)

	For the Years Ended December 31,
	2007			2008			2009
Revenue:
Sales, net	$	41,088		$	41,380		$	21,657
Rental income		30,437			42,864			45,146
Service and maintenance income		964			1,092			993
Total revenue		72,489			85,336			67,796
Operating costs and expenses:
Cost of sales, exclusive of depreciation stated separately below		28,124			28,052			14,880
Cost of rentals, exclusive of depreciation stated separately below		12,382			16,193			16,600
Cost of service and maintenance, exclusive of depreciation stated
separately below		600			749			677
Selling, general and administrative expense		5,324			5,842			6,190
Depreciation and amortization		7,470			9,925			11,686
Total operating costs and expenses		53,900			60,761			50,033
Operating income		18,589			24,575			17,763
Other income (expense):
Interest expense		(1,155	)		(742	)		(606	)
Other income		1,299			387			70
Total other income (expense)		144			(355)			(536)
Income before provision for income taxes		18,733			24,220			17,227
Provision for income taxes:
Current		3,525			220			1,756
Deferred		2,930			8,407			4,456
Total income tax expense		6,455			8,627			6,212
Net income	$	12,278		$	15,593		$	11,015
Earnings per common share:
Basic	$	1.02		$	1.29		$	.91
Diluted	$	1.01		$	1.28		$	.91
Weighted average common shares outstanding:
Basic		12,071			12,090			12,096
Diluted		12,114			12,143			12,118

See accompanying notes to these financial statements.

F-3

NATURAL GAS SERVICES GROUP, INC.

STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

	Preferred Stock				Common Stock				Additional				Total
									Paid-In		Retained		Stockholders'
	Shares		Amount		Shares		Amount		Capital		Earnings		Equity
BALANCES, January 1, 2007		—	$	—		12,046	$	120	$	82,560	$	18,521	$	101,201
Exercise of common stock options    and warrants		—		—		39		1		247		—		248
Compensation expense on    issuance of common stock options		—		—		—		—		541		—		541
Income tax benefit realized from the    exercise of stock options		—		—		—		—		112		—		112
Net income		—		—		—		—		—		12,278		12,278
BALANCES, December 31, 2007		—	$	—		12,085	$	121	$	83,460	$	30,799	$	114,380
Exercise of common stock options    and warrants		—		—		9		—		54		—		54
Compensation expense on issuance    of common stock options		—		—		—		—		423		—		423
Net income		—		—		—		—		—		15,593		15,593
BALANCES, December 31, 2008		—	$	—		12,094	$	121	$	83,937	$	46,392	$	130,450
Exercise of common stock options		—		—		7		—		49		—		49
Compensation expense on issuance    of common stock options		—		—		—		—		584		—		584
Net income		—		—		—		—		—		11,015		11,015
BALANCES, December 31, 2009		—	$	—		12,101	$	121	$	84,570	$	57,407	$	142,098

See accompanying notes to these financial statements.

F-4

NATURAL GAS SERVICES GROUP, INC.

STATEMENTS OF CASH FLOWS

(in thousands of dollars)

	For the Years Ended December 31,
	2007			2008			2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	12,278		$	15,593		$	11,015
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		7,470			9,925			11,686
Deferred taxes		2,930			8,407			4,456
Employee stock options expense		541			423			584
Loss (gain) on disposal of assets		(1	)		7			(51	)
Changes in current assets:
Trade accounts receivables, net		(2,859	)		1			4,007
Inventory, net		(3,826	)		(11,162	)		9,008
Prepaid expenses and other		(3,904	)		3,894			(1,504	)
Changes in current liabilities:
Accounts payable and accrued liabilities		3,228			4,335			(8,673	)
Current income tax liability		2,581			(3,415	)		1,598
Deferred income		(144	)		(43	)		52
Other		(25	)		285			—
NET CASH PROVIDED BY OPERATING ACTIVITIES		18,269			28,250			32,178
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment		(25,307	)		(46,271	)		(9,542	)
Purchase of short-term investments		(2,609	)		(2,620	)		—
Redemption of short-term investments		9,000			18,981			2,300
Proceeds from sale of property and equipment		95			47			143
NET CASH USED IN INVESTING ACTIVITIES		(18,821	)		(29,863	)		(7,099	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from line of credit		600			7,500			500
Proceeds from other long term liabilities, net		—			441			118
Repayments of long-term debt		(4,442	)		(4,378	)		(3,378	)
Repayment of line of credit		—			(1,100	)		(500	)
Proceeds from exercise of stock options and warrants		248			54			49
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES		(3,594	)		2,517			(3,211	)
NET CHANGE IN CASH		(4,146	)		904			21,868
CASH AT BEGINNING OF PERIOD		4,391			245			1,149
CASH AT END OF PERIOD	$	245		$	1,149		$	23,017
SUPPLEMENTAL DISCLOSURES OF CASH FLOW   INFORMATION:
Interest paid	$	1,191		$	802		$	613
Income taxes paid	$	4,620		$	294		$	1,477

See accompanying notes to these financial statements.

F-5

NATURAL GAS SERVICES GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

Organization and Principles of Consolidation

These notes apply to the financial statements of Natural Gas Services Group, Inc.  (the "Company", “NGSG”, "Natural Gas Services Group", "we" or "our") (a Colorado corporation).  Natural Gas Services Group, Inc. was formed on December 17, 1998 for the purposes of combining the operations of certain manufacturing, service and leasing entities.

On January 3, 2005, we purchased all of the outstanding shares of capital stock of Screw Compression System, Inc.  (“SCS”) a manufacturer of natural gas compressors, with its principal offices located in Tulsa, Oklahoma for the purpose of expanding the product line, production capacity and customer base.  SCS operated as a wholly owned subsidiary until June 30, 2007, when it was merged into Natural Gas Services Group, Inc.

All amounts are stated in thousands of dollars except stock options and per share data.

Nature of Operations

Natural Gas Services Group, Inc. is a leading provider of small to medium horsepower compression equipment to the natural gas industry.  We focus primarily on the non-conventional natural gas production business in the United States (such as coal bed methane, gas shale and tight gas).  We manufacture, fabricate and rent natural gas compressors that enhance the production of natural gas wells.  NGSG provides maintenance services for its natural gas compressors.  In addition, we sell custom fabricated natural gas compressors to meet customer specifications dictated by well pressures, production characteristics and particular applications.  We also manufacture and sell flare systems for oil and gas plant and production facilities.

Use of Estimates

The preparation of our financial statements in conformity with generally accepted accounting principles requires our management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes.  Actual results could differ from those estimates.  Significant estimates include the valuation of identifiable intangible assets and goodwill acquired in acquisitions, bad debt allowance and the allowance for inventory obsolescence.  It is at least reasonably possible these estimates could be revised in the near term and the revisions could be material.

Cash Equivalents

For purposes of reporting cash flows, we consider all short-term investments with an original maturity of three months or less to be cash equivalents.

Short-term Investments

At December 31, 2008 we had short-term investments invested primarily in high grade short term commercial paper for the maximum return on investments which are held to maturity that will coincide with our projected cash requirements, and had a maturity of less than one year.

Accounts Receivable

Our trade receivables consist of customer obligations for the sale of compressors and flare systems due under normal trade terms, and operating leases for the use of our natural gas compressors.  The receivables are not collateralized except as provided for under lease agreements.  However, we require deposits of as much as 50% for large custom contracts.  We extend credit based on management's assessment of the customer's financial condition, receivable aging, customer disputes and general business and economic conditions.  Management believes the allowance for doubtful accounts for trade receivables of $177,000 and $363,000 at December 31, 2008 and 2009, respectively, is adequate.

F-6

NATURAL GAS SERVICES GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

Revenue Recognition

Revenue from the sales of custom and fabricated compressors, and flare systems is recognized upon shipment of the equipment to customers.  Exchange and rebuilt compressor revenue is recognized when both the replacement compressor has been delivered and the rebuild assessment has been completed.  Revenue from compressor service and retrofitting services is recognized upon providing services to the customer.  Maintenance agreement revenue is recognized as services are rendered.  Rental revenue is recognized over the terms of the respective rental agreements.  Deferred income represents payments received before a product is shipped.  Revenue from the sale of rental units is included in sales revenue when equipment is shipped or title is transferred to the customer.

Description of Rental Arrangements

Our rental operations principally consist of the rental of natural gas compressor packages and flare stacks.  These arrangements are classified as operating leases.  See Note 2.

Major Customers and Concentration of Credit Risk

Sales and rental income to XTO Energy, Inc. and Devon Energy, Inc. in the year ended December 31, 2007 amounted to 40% and 12% of revenue, respectively.  Sales and rental income to XTO Energy, Inc. and Devon Energy, Inc. in the year ended December 31, 2008 amounted to 26% and 14% of revenue, respectively.  Sales to Devon Energy Production Inc. and XTO Energy Inc. in the year ended December 31, 2009 amounted to a total of 21% and 21% of revenue, respectively.  No other single customer accounted for more than 10% of our revenues in 2007, 2008 or 2009.  XTO Energy, Inc. and Equipos y Sistemas Dinamicos amounted to 35% and 14%, respectively, of our accounts receivable as of December 31, 2008.  XTO Energy Inc. and Devon Energy Production Inc. amounted to 33% and 11% of our accounts receivable as of December 31, 2009, respectively.  No other customers amounted to more than 10% of our accounts receivable as of December 31, 2008 and 2009.  We generally do not obtain collateral, but require deposits of as much as 50% on large custom contracts.  We extend credit based on management's assessment of the customer's financial condition, receivable aging, customer disputes and general business and economic conditions.

Inventory

Inventory is valued at the lower of cost or market.  The cost of inventories is determined by the weighted average method.  A reserve is recorded against inventory balances for estimated obsolescence.  This reserve is based on specific identification and historical experience and totaled $500,000 and $345,000 at December 31, 2008 and 2009, respectively.  Finished goods at December 31, 2008 and 2009 consist of 19 and 12 and completed compressor units respectively, which are available for sale or for use in our rental fleet.  At December 31, 2008 and 2009, respectively, inventory consisted of the following (in thousands):

	2008		2009
Raw materials	$	26,124	$	21,633
Finished goods		2,417		1,584
Work in process		3,390		820
	$	31,931	$	24,037

Property and Equipment

Property and equipment is recorded at cost less accumulated depreciation and amortization.  Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets, which range from three to forty years.  Rental equipment has an estimated useful life of fifteen years.

Gains and losses resulting from sales and dispositions of property and equipment are included in current operations.  Maintenance and repairs are charged to operations as incurred.

Goodwill

Goodwill represents the cost in excess of fair value of the identifiable net assets acquired in three acquisitions.

Goodwill and intangibles are tested for impairment annually or whenever events indicate impairment may have occurred.  We completed the most recent test for goodwill impairment based on management’s evaluation as of December 31, 2009, at which time no impairment was indicated.

F-7

NATURAL GAS SERVICES GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

 

Intangibles

At December 31, 2009, NGSG has intangible assets (excluding patents) with a gross carrying value of $4.2 million, which relate to developed technology, acquired customer contracts, distribution agreements and non-compete agreements.  The carrying amount net of accumulated amortization at December 31, 2009 was $2.7 million.  Intangible assets (excluding patents) are amortized on a straight-line basis with useful lives ranging from 5 to 20 years with a weighted average life remaining of approximately fourteen years as of December 31, 2009.  Amortization expense recognized in each of the years ending December 31, 2007, 2008, and 2009 was $299,000.  In addition, NGSG has an intangible asset with a gross carrying value of $654,000 at December 31, 2009 related to the trade name of SCS.  This asset is not being amortized as it has been deemed to have an indefinite life.

The following table represents estimated future amortization expense for the years ending December 31, (in thousands).

2010	$	260
2011		179
2012		125
2013		125
2014		125
Thereafter		1,253
	$	2,067

Our policy is to periodically review the net realizable value of intangibles, through an assessment of the estimated future cash flows related to such assets.  In the event that assets are found to be carried at amounts in excess of estimated undiscounted future cash flows, then the assets will be adjusted for impairment to a level commensurate with a discounted cash flow analysis of the underlying assets.  Based upon our most recent analysis, we believe no impairment of intangible assets exists as of December 31, 2009.

Patents

We had patents for a flare tip ignition device and flare tip burner pilot which expired in 2009.  The costs of the patents were being amortized on a straight-line basis over nine years, the remaining life of the patents when acquired.  Amortization expense for patents of $27,000 was recognized for the year ended December 31, 2007, and $4,000 for the year ended December 31, 2008.  The patents were fully amortized as of December 31, 2008.

Warranty

We accrue amounts for estimated warranty claims based upon current and historical product warranty costs and any other related information known.  The warranty reserve was $165,000 and $166,000 at December 31, 2008 and 2009, respectively.

Financial Instruments and Concentrations of Credit Risk

Management believes that, generally, the fair value of our cash, cash equivalents, and short-term investments, trade receivables, payables and notes payable at December 31, 2008 and 2009 approximate their carrying values due to the short-term nature of the instruments or the use of prevailing market interest rates.  We invest our cash primarily in deposits and money market funds with commercial banks.  At times, cash balances at banks and financial institutions may exceed federally insured amounts.

Advertising Costs

Advertising costs are expensed as incurred.  Total advertising expense was $26,000, $31,000 and $13,000 in 2007, 2008 and 2009, respectively.

Other Income

Other income in 2007, 2008, and 2009 primarily consisted of interest income from our short-term investment account.

F-8

NATURAL GAS SERVICES GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

Per Share Data

Basic earnings per common share is computed using the weighted average number of common shares outstanding during the period.  Diluted earnings per common share is computed using the weighted average number of common stock and common stock equivalent shares outstanding during the period.  There was an anti-dilutive effect of 25,000 for 2007, none for 2008 or 2009.

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):

	Year Ended December 31,
	2007		2008		2009
Numerator:
Net income	$	12,278	$	15,593	$	11,015
Denominator for basic net income per common share:
Weighted average common shares outstanding		12,071		12,090		12,096
Denominator for diluted net income per share:
Weighted average common shares outstanding		12,071		12,090		12,096
Dilutive effect of stock options and warrants		43		53		22
Diluted weighted average shares		12,114		12,143		12,118
Earnings per common share:
Basic	$	1.02	$	1.29	$	.91
Diluted	$	1.01	$	1.28	$	.91

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 carry-forwards.  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.

Fair Value Measurement

The financial assets of the company measured at fair value on a recurring basis are cash equivalents and short-term investments.  Our short-term investments are generally classified within level 1 or level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.

The types of instruments valued based on quoted market prices in active markets include most U.S. government and agency securities and most money market securities.  Such instruments are generally classified within level 1 of the fair value hierarchy.

The type of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most investment-grade corporate bonds, and state, municipal and provincial obligations.  Such instruments are generally classified within level 2 of the fair value hierarchy.

As of December 31, 2008, our short-term investments consisted of certificates of deposit classified within level 1 of the fair value hierarchy.

As of December 31, 2008 and 2009, our cash equivalents are classified with in level 1 of the fair value hierarchy.

Subsequent Events

   We have evaluated subsequent events and transactions for potential recognition or disclosure in the financial statements through March 4 , 2010 the day the financial statements were issued.

F-9

NATURAL GAS SERVICES GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

Reclassification

   Certain amounts in prior period financial statements have been reclassified to conform to the 2009 financial statement classification with no impact to operating income or net income.

Recently Issued Accounting Pronouncements

       In June 2009, Financial Accounting Standards Board (FASB) established, with the effect from July 1, 2009, the FASB Accounting Standards Codification (ASC) as the source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities.  Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants.  We adopted the Codification beginning July 1, 2009 and while it impacts the way we refer to accounting pronouncements in our disclosures; it had no affect on our financial position, results of operations or cash flows upon adoption.

On January 1, 2009, we adopted FASB ASC 805, Business Combinations, which replaces SFAS No. 141, Business Combinations, and requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. ASC 805 also requires the acquirer in a business combination achieved in stages to recognize the identifiable assets and liabilities, as well as the noncontrolling interest in the acquiree, at the full amounts of their fair values. Additionally, ASC 805 requires acquisition related costs to be expensed in the period in which the costs were incurred and the services are received instead of including such costs as part of the acquisition price.  ASC 805 makes various other amendments to authoritative literature intended to provide additional guidance or to confirm the guidance in that literature to that provided in ASC 805.  The adoption of ASC 805 had no impact on our financial statements.

      In April 2009, the FASB issued ASC 855, Subsequent Events.  ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. We adopted ASC 855 for the quarter ending June 30, 2009.  The adoption of ASC 855 did not have a material impact on our financial statements.

2.  Rental Activity

We rent natural gas compressor packages to entities in the petroleum industry.  These rental arrangements are classified as operating leases and generally have original terms of six months to two years and continue on a month-to-month basis thereafter.  Future minimum rent payments for arrangements not on a month-to-month basis at December 31, 2009 are as follows (in thousands):

Years Ending December 31, (in thousands)
2010	$	3,946
2011		161
Total	$	4,107

F-10

NATURAL GAS SERVICES GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

3.  Property and Equipment

Property and equipment consists of the following at December 31, 2008 and 2009 (in thousands):

	2008			2009
Land and building	$	5,036		$	5,036
Leasehold improvements		662			753
Office equipment and furniture		1,122			1,187
Software		525			538
Machinery and equipment		1,963			2,188
Vehicles		5,730			5,134
Less accumulated depreciation		(6,065	)		(7,210	)
Total	$	8,973		$	7,626

Depreciation expense for property and equipment and the compressors described in Note 2 was $7.1 million, $9.6 million and $11.4 million for the years ended December 31, 2007, 2008 and 2009, respectively.

4.  Credit Facility

   On May 16, 2008, we entered into an Eighth Amended and Restated Loan Agreement with Western National Bank, Midland, Texas effective April 1, 2008.  This Loan Agreement (1) decreased the interest rate on existing term loan facilities, and (2) extended and renewed our revolving line of credit facility.  Our revolving line of credit and multiple advance term loan facilities are described below.

Line of Credit

Our revolving line of credit facility allows us to borrow, repay and re-borrow funds drawn under this facility, as amended.  The total amount that we can borrow and have outstanding at any one time is the lesser of $40.0 million or the amount available for advances under a “borrowing base” calculation established by the bank.  As of December 31, 2009 and 2008, the amount available for revolving line of credit advances was $33.0 million.  The amount of the borrowing base is based primarily upon our receivables, equipment and inventory.  The borrowing base is re-determined by the bank on a monthly basis.  If, as a result of the redetermination of the borrowing base, the aggregate outstanding principal amount of the notes payable to the bank under the Loan Agreement exceeds the borrowing base, we must prepay the principal of the revolving line of credit note in an amount equal to such excess.  Interest only on borrowings under our revolving line of credit facility is payable monthly on the first day of each month.  All outstanding principal and unpaid interest is due on May 1, 2010.  We are currently negotiating with several banks to renew or replace this line of credit.  Since April 1, 2008, our interest rate on the revolving line of credit is equal to prime rate minus one quarter of one percent (.25%) but never lower than four percent (4.0%) nor higher than eight and three quarter percent (8.75%).  We had $7.0 million outstanding as of December 31, 2009 and 2008, respectively, on this revolving line of credit facility.  The interest rates were 4.0% as of December 31, 2008 and 2009, respectively.

All outstanding principal and unpaid interest on the revolving line of credit facility is due on May 1, 2010.  We are currently negotiating with several banks to renew our line of credit and are confident this line will be either be renewed or replaced.   As of January 2010, we have paid down the line of credit to 500,000.

The line of credit and note listed below are with the same bank and include certain covenants, the most restrictive of which require that we maintain certain working capital, debt to equity and cash flow ratios and certain minimum net worth.  We were in compliance with covenants at December 31, 2008 and 2009, respectively.

Term Loan Facility

   This multiple advance term loan facility represents the consolidation of our previously existing advancing line of credit and term loan facilities.  Re-borrowings are not permitted under this facility.  Principal under this term loan facility is due and payable in 59 monthly installments of $282,000 each, which commenced November 1, 2006 and continuing through September 1, 2011.  Since April 1, 2008, our interest rate on the term loan is equal to prime rate minus one half of one percent (.50%) but never lower than four percent (4%) nor higher than eight and three quarter percent (8.75%).  Interest on the unpaid principal balance is due and payable on the same dates as principal payments.  All outstanding principal and unpaid interest is due on October 1, 2011.  As of December 31, 2008 and 2009, respectively, this term loan facility had a principal balance of $9.6 million and $6.2 million.  The interest rates were 4.0% as of December 31, 2008 and 2009, respectively.

   Our obligations under the Loan Agreement are secured by substantially all of our properties and assets, including our equipment, trade accounts receivable and other personal property and by the real estate and related plant facilities.

F-11

NATURAL GAS SERVICES GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

The maturity dates of the loan facilities may be accelerated by the bank upon the occurrence of an event of default under the Loan Agreement.

The Loan Agreement contains various restrictive covenants and compliance requirements.  These requirements provide that we must have:

· At the end of each month, a current ratio (as defined in the Loan Agreement) of at least 1.6 to 1.0;

· At the end of each month, a tangible net worth (as defined in the Loan Agreement) of at least $85 million;

· At the end of each fiscal quarter, a debt service coverage ratio (as defined in the Loan Agreement) of at least 1.50 to 1.00; and

· At the end of each month, a ratio of debt to tangible net worth (as defined in the Loan Agreement) of less than 2.0 to 1.0.

   The Loan Agreement also contains restrictions on incurring additional debt and paying dividends.

   As of December 31, 2009 and 2008, we were in compliance with all covenants in our Loan Agreement.  A default under our bank credit facility could trigger the acceleration of our bank debt so that it is immediately due and payable.  Such default would have a material adverse effect on our liquidity, financial position and operations.

Maturities of long-term debt based on contractual requirements for the years ending December 31 are as follows (in thousands):

2010	$	3,378
2011		2,817
2012		—
Total	$	6,195

5.  Other Long-term Liabilities

As of December 31, 2008, we had a long-term liability of $150,000 to Midland Development Corporation.  In March of 2009, we received an additional $125,000 increasing this liability to $275,000 for the year ending December 31, 2009.  This amount is to be recognized as income contingent upon certain staffing requirements in the future.  In addition, we entered into a purchase agreement with a vendor on July 30, 2008 pursuant to which we agreed to purchase up to $4.8 million of our paint and coating requirements exclusively from the vendor.  In connection with the execution of the agreement, the vendor paid us a $300,000 fee which is considered to be a discount toward future purchases from the vendor.  Based on our historical paint and coating requirements, we estimate meeting the $4.8 million purchase obligation within five years.  The $300,000 payment we received is recorded as a long-term liability and will decrease as the purchase commitment is fulfilled.  The long-term liability remaining for the purchase commitment was $291,000 and $283,000 as of December 31, 2008 and 2009, respectively.

6.  Income Taxes

The provision for income taxes consists of the following (in thousands):

	2007		2008		2009
Current provision:
Federal	$	3,168	$	—		$	1,522
State		357		220			234
		3,525		220			1,756
Deferred provision:
Federal		2,775		8,347			4,179
State		155		60			277
		2,930		8,407			4,456
	$	6,455	$	8,627		$	6,212

F-12

NATURAL GAS SERVICES GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

The income tax effects of temporary differences that give rise to significant portions of deferred income tax assets and (liabilities) are as follows (in thousands):

	2007			2008			2009
Deferred income tax assets:
Net operating loss carryover		—			2,331			—
Other		362			650			614
Total deferred income tax assets	$	362		$	2,981		$	614
Deferred income tax liabilities:
Property and equipment		(11,623	)		(22,723	)		(24,898	)
Goodwill and other intangible assets		(1,407	)		(1,299	)		(1,214	)
Other		33			(1	)		—
Total deferred income tax liabilities		(12,997	)		(24,023	)		(26,112	)
Net deferred income tax liabilities	$	(12,635	)	$	(21,042	)	$	(25,498	)

The effective tax rate differs from the statutory rate as follows:

	2007		2008		2009
Statutory rate	34	%	34	%	34	%
State and local taxes	2	%	2	%	2	%
Other	(2)	%	0	%	0	%
Effective rate	34	%	36	%	36	%

Our policy regarding income tax interest and penalties is to expense those items as general and administrative expense but to identify them for tax purposes. During the years ended December 31, 2008 and 2009, there were no income tax interest or penalty items in the income statement or as a liability on the balance sheet.  Prepaid income taxes are estimated payments paid for the current year estimated tax liability.

We file income tax returns in the U.S. federal jurisdiction and various state jurisdictions.  With few exceptions, we are no longer subject to U.S. federal or state income tax examination by tax authorities for years before 2005.  We are currently involved in a Michigan Single Business Tax audit for the tax years 2005-2007.  The audit is not at a stage where an outcome could be determined, however, we believe it will not be material.

8.  Stockholders' Equity

Preferred Stock

We have a total of 5.0 million authorized preferred shares with rights and preferences as designated by the Board of Directors.  As of December 31, 2008 and 2009, there were no outstanding preferred shares.

Securities offering

   On August 14, 2009 we filed a universal shelf registration statement on Form S-3 with the Securities and Exchange Commission (SEC) to register up to $150,000,000 of securities, including debt securities, common stock, preferred stock, depository shares, rights to purchase common stock and warrants to purchase any of the foregoing securities.  The SEC has declared the statement effective, and we may issue any of the registered securities from time to time in one or more offerings depending on market conditions and our financing needs.

Restricted Securities

   Also on June 16, 2009, at our annual meeting of shareholders, our shareholders adopted the 2009 Restricted Stock/Unit Plan.  A total of 300,000 shares of Company common stock are reserved for issuance under the restricted stock plan.  During January 2010, we awarded 13,276 restricted shares of stock under the 2009 Restricted Stock Plan for payment of the executive bonus plan of 2009.

F-13

NATURAL GAS SERVICES GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

9.  Stock-Based Compensation

 Stock Option Plan

Our 1998 Stock Option Plan (the Plan), which is stockholder approved, permits the grant of stock options to its employees for up to 550,000 shares of common stock.  On June 16, 2009, at our annual meeting of shareholders, our shareholders approved a proposed amendment to our 1998 Stock Option Plan (the “Plan”) to add an additional 200,000 shares of common stock to the Plan, thereby authorizing the issuance of up to 750,000 shares of common stock under the Plan.  We believe that such awards better align the interests of our employees with our stockholders.  Option awards are generally granted with an exercise price equal to the market price of our stock at the date of grant; those option awards generally vest based on three years of continuous service and have ten-year contractual terms.  Certain option and share awards provide for accelerated vesting if there is a change in control of NGSG (as defined in the Plan).  The last date that grants can be made under the Plan is March 1, 2016.  As of December 31, 2009, 324,190 shares were still available for issue under the 1998 Stock Option Plan.

  The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model that uses the assumptions noted in the following table.  The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.  The expected life of options granted is based on the vesting period and historical exercise and post vesting employment termination behavior for similar grants.  We use historical data to estimate option exercise and employee termination within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes.

Weighted average Black –Scholes fair value assumption	2007		2008		2009
Risk  free rate	5.83	%	3.90	%	1.82	%
Expected life	5 yrs		5 yrs		5 yrs
Expected volatility	47.6	%	48.0	%	66.75	%
Expected dividend yield	0.0	%	0.0	%	0.0	%

A summary of all option activity as of December 31, 2009 and changes during the year then ended is presented below in thousands:

	Number of Stock Options			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (years)		Aggregate Intrinsic Value
								(in thousands)
Outstanding at December 31, 2008		264,501		$	14.61		7.94	$	194
Granted		189,933			12.49
Exercised		(6,936	)		7.08
Forfeited or expired		(9,621	)		11.19
Outstanding at December 31, 2009		437,877		$	13.88		8.02	$	2,260
Exercisable at December 31, 2009		207,667		$	13.05		6.69	$	1,257

We granted 30,000 options to an officer on January 28, 2009 at an exercise price of $9.95 with a three year vesting period.  We granted 62,433 to officers as bonuses on March 17, 2009 at an exercise price of $7.84 with a one year vesting period.  We granted 15,000 options to the board of directors on March 18, 2009 at an exercise price of $8.00 vesting within one year of the grant date.  We granted 62,500 options to employees and 20,000 options to officers on December 9, 2009 at an exercise price of $17.74 with a three year vesting schedule.

The weighted average grant date fair value of options granted during the years 2007, 2008 and 2009 was $8.49 and $8.46, and $6.68 respectively.  The total intrinsic value, or the difference between the exercise price and the market price on the date of exercise, of options exercised during the years ended December 31, 2007, 2008 and 2009 was approximately $213,000, $149,000 and $65,000 respectively.  Cash received from stock options exercised during the years ended December 31, 2007, 2008 and 2009 was $152,000, $53,000 and $49,000, respectively.

F-14

NATURAL GAS SERVICES GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

 The following table summarizes information about the options outstanding at December 31, 2009:

		Options Outstanding						Options Exercisable
Range of Exercise Prices		Shares		Weighted Average Remaining Contractual Life (years)		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price
$	0.00 – 5.58		19,000		3.05	$	4.24		19,000	$	4.24
	5.59 – 9.43		128,543		7.46		8.45		75,000		8.88
	9.44 – 15.60		73,167		7.86		12.54		41,001		14.27
	15.61 – 20.48		217,167		8.84		18.39		72,666		18.95
$	0.00 - 20.48		437,877		8.02	$	13.88		207,667	$	13.05

The summary of the status of our unvested stock options as of December 31, 2009 and changes during the year then ended is presented below:

	Unvested         Stock Options	Weighted Average Grant Date Fair Value
Unvested at December 31, 2008	106,168	$	8.15
Granted	189,933		6.68
Vested	(62,558)		6.60
Forfeited	(3,333)		5.62
Unvested at December 31, 2009	230,210	$	7.40

We recognized stock compensation expense from stock options vesting of $541,000, $423,000 and $584,000, respectively, for the years ended December 31, 2007, 2008 and 2009.  The total income tax benefit recognized in the income statement for stock based compensation was $50,000, $50,000 and $23,000, respectively, for the years ended December 31, 2007, 2008 and 2009.  As of December 31, 2009, there was approximately $1.3 million of total unrecognized compensation cost related to unvested stock options.  We expect to recognize such cost over a weighted-average period of 2 years.  The actual income tax benefit realized for the tax deductions from stock options exercised was approximately, $112,000 for the year ending 2007, and none for the years ending 2008 and 2009.

10.  Commitments

401(k) Plan

We offer a 401(k) Plan to all employees that have reached the age of eighteen and have completed six months of service.  The participants may contribute up to 100% of their salary subject to IRS limitations.  Employer contributions are subject to Board discretion and are subject to a vesting schedule of 20% each year after the first year and 100% after six years.  We contributed $161,000, $234,000, and $211,000 to the 401(k) Plan in 2007, 2008 and 2009, respectively.

Rented Facilities

We lease certain of our facilities under operating leases with terms generally ranging from month to month to five years.  Most facility leases contain renewal options.  Remaining future minimum rental payments due under these leases for the years ended December 31 are as follows (in thousands):

2010	$	357
2011		258
2012		233
2013		167
2014		17
Total	$	1032

F-15

NATURAL GAS SERVICES GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

Rent expense under such leases was $244,000, $363,000, and $466,000 for the years ended December 31, 2007, 2008, and 2009, respectively.

11.  Segment Information

   SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes standards for public companies relating to the reporting of financial and descriptive information about their operating segments in financial statements.  Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by chief operating decision makers in the allocation of resources and the assessment of performance.  Our management identifies segments based upon major revenue sources as shown in the tables below.  However, management does not track assets by segment.

For the Year Ended December 31, 2007

	Sales		Rental		Service & Maintenance		Corporate			Total
	(in thousands of dollars)
Revenue	$	41,088	$	30,437	$	964	$	—		$	72,489
Operating costs and expenses		28,124		12,382		600		12,794			53,900
Other income/(expense)		—		—		—		144			(144	)
Income before provision for  income taxes	$	12,964	$	18,055	$	364	$	(12,650	)	$	18,733

For the Year Ended December 31, 2008

	Sales		Rental		Service & Maintenance		Corporate			Total
	(in thousands of dollars)
Revenue	$	41,380	$	42,864	$	1,092	$	—		$	85,336
Operating costs and expenses		28,052		16,193		749		15,767			60,761
Other income/(expense)		—		—		—		(355	)		(355	)
Income before provision for  income taxes	$	13,328	$	26,671	$	343	$	(16,122	)	$	24,220

For the Year Ended December 31, 2009

	Sales		Rental		Service & Maintenance		Corporate			Total
	(in thousands of dollars)
Revenue	$	21,657	$	45,146	$	993	$	—		$	67,796
Operating costs and expenses		14,880		16,600		677		17,876			50,033
Other income/(expense)		—		—		—		(536	)		(536	)
Income before provision for  income taxes	$	6,777	$	28,546	$	316	$	(18,412	)	$	17,227

F-16

NATURAL GAS SERVICES GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

12.  Quarterly Financial Data (in thousands, except per share data) – Unaudited

2007		Q1		Q2		Q3		Q4	Total
Total revenue	$	16,712	$	17,624	$	18,651	$	19,502	$	72,489
Operating income		4,203		4,134		5,232		5,020		18,589
Net income applicable to common shares		2,681		2,646		3,337		3,614		12,278
Net income per share - Basic		0.22		0.22		0.28		0.30		1.02
Net income per share - Diluted		0.22		0.22		0.28		0.30		1.01

2008		Q1		Q2		Q3		Q4	Total
Total revenue	$	18,933	$	19,478	$	24,946	$	21,979	$	85,336
Operating income		5,453		5,145		7,448		6,529		24,575
Net income applicable to common shares		3,517		3,333		4,811		3,932		15,593
Net income per share - Basic		0.29		0.28		0.40		0.33		1.29
Net income per share - Diluted		0.29		0.27		0.40		0.33		1.28

2009		Q1		Q2		Q3		Q4	Total
Total revenue	$	20,025	$	16,757	$	16,380	$	14,634	$	67,796
Operating income		6,057		4,631		4,211		2,864		17,763
Net income applicable to common shares		3,797		2,872		2,643		1,703		11,015
Net income per share - Basic		0.31		0.24		0.22		0.14		0.91
Net income per share - Diluted		0.31		0.24		0.22		0.14		0.91

13.  Legal Proceedings

From time to time, we are a party to various legal proceedings in the ordinary course of our business.  While management is unable to predict the ultimate outcome of these actions, it believes that any ultimate liability arising from these actions will not have a material effect on our financial position, results of operations or cash flow.  We are not currently a party to any bankruptcy, receivership, reorganization, adjustment or similar proceeding, and we are not aware of any other threatened litigation.

14.  Subsequent events (unaudited)

On January 19, 2010 we paid $6.5 million on our line of credit to Western National Bank leaving the current balance at $500,000. All the outstanding principal and unpaid interest is due on May 1, 2010, and we are currently negotiating with several banks to renew or replace this line of credit

********

F-17

INDEX TO EXHIBITS

Exhibit No.                                                                           Description

3.1 Articles of Incorporation, as amended (Incorporated by reference to Exhibit 3.1 of the 10-QSB filed and dated November 10, 2004)

3.2 Bylaws (Incorporated by reference to Exhibit 3.4 of the Registrant's Registration Statement on Form SB-2, No.  333-88314)

4.1 Non-Statutory Stock Option Agreement (Incorporated by reference to Exhibit 10.2 to Form 8-K filed with the SEC on August 30, 2005)

4.2 Form of Senior Indenture (Incorporated by reference to Exhibit 4.1 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.3 Form of Senior Note (Incorporated by reference to Exhibit 4.2 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.4 Form of Subordinated Indenture (Incorporated by reference to Exhibit 4.3 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.4 Form of Subordinated Note (Incorporated by reference to Exhibit 4.4 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.6 Form of Deposit Agreement, including Form of Depositary Share (Incorporated by reference to Exhibit 4.5 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.7 Form of Warrant Agreement, including Form of Warrant Certificate (Incorporated by reference to Exhibit 4.6 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.8 Form of Unit Agreement (Incorporated by reference to Exhibit 4.7 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.9 Form of Preferred Stock Certificate (Incorporated by reference to Exhibit 4.8 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.10 Form of Certificate of Designation with respect to Preferred Stock (Incorporated by reference to Exhibit 4.9 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

4.11 Rights Agreement, including Form of Rights Certificate (Incorporated by reference to Exhibit 4.10 of the Registrant’s Registration Statement on Form S-3 (No. 333-161346) and filed on August 14, 2009)

10.1 1998 Stock Option Plan, as amended (Incorporated by reference to Exhibit 10.1 of the Registrant’s Form 8-K Report dated September 20, 2006 on file with the SEC September 26, 2006)

10.2 Lease Agreement, dated March 1, 2004, between the Registrant and the City of Midland, Texas (Incorporated by reference to Exhibit 10.19 of the Registrant's Form 10-QSB for the fiscal quarter ended March 31, 2004)

10.3 Seventh Amended and Restated Loan Agreement (Incorporated by reference to Exhibit 10.1 of the Registrant’s Form 8-K dated October 26, 2006 and filed with the Securities and Exchange Commission on November 1, 2006

10.4 Eighth Amended and Restated Loan Agreement between Natural Gas Services Group, Inc. and Western National Bank.

10.5 Revolving Line of Credit Promissory Note issued to Western National Bank.

10.6 Employment Agreement between Natural Gas Services Group, Inc. and Stephen C. Taylor dated October 25, 2008 (Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 30, 2008)

E-1

10.7 Lease Agreement, dated March 26, 2008, between WNB Tower, LTD and Natural Gas Services Group, Inc. (Incorporated by reference to Exhibit 10.15 of the Registrant’s  Form 10-K for the fiscal year ended December 31, 2008 and filed with the Securities and Exchange Commission on March 9, 2009)

10.8 2009 Restricted Stock/Unit Plan (Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K dated June 18, 2009 and filed with the Securities and Exchange Commission on June 18, 2009.)

10.9 1998 Stock Option Plan, as amended (Incorporated by reference to Exhibit 10.2 of the Registrant’s Current Report on Form 8-K dated June 18, 2009 and filed with the Securities and Exchange Commission on June 18, 2009.)

*10.10 Lease Agreement, dated December 11, 2008, between Klement-Wes Partnership, LTD and Natural Gas Services Group, Inc. and commencing on January 1, 2009

14.0 Code of Ethics (Incorporated by reference to Exhibit 14.0 of the Registrant's Form 10-KSB for the fiscal year ended December 31, 2004, and filed with the Securities and Exchange Commission on March 30, 2005)

*23.1 Consent of Hein & Associates LLP

*31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

*31.2 Certification of Principal Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

*32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

*32.2 Certification of Principal Accounting Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 * Filed herewith.

E-2

EX-10.10

EXHIBIT 10.10

TENANT’S ESTOPPEL CERTIFICATE

The undersigned, Natural Gas Services Group, (“Tenant”), hereby warrants and represents to and agrees with Klement-Wes Partnership, LTD and its successors and/or assigns (“Purchaser”) as follows, with the understanding that Purchaser is relying on such warranties, representations and agreements in connection with its proposed acquisition of 4721 N. Highway 171 from Trennon Massengale dba Southwest Properties and Construction (‘Landlord”) as follows:

1.   Tenant is the tenant under that certain lease agreement (“Lease”) dated December 11, 2008, between Landlord (or Landlord’s predecessors in title), as landlord and Tenant, as tenant of approximately 5,000 square feet of net rentable area sited on approximately 2.568 acres of land, along with the site improvements thereon at 4721 N. Highway 171,  Cleburne, Johnson County, Texas.

2.   Attached hereto as EXHIBIT “A” is a true, correct and complete copy of the Lease and any and all amendments thereof.

3.   The lease has not been amended or modified and is in full force and effect as originally executed, except as other disclosed in EXHIBIT “A”, and to the best of Tenant’s knowledge and belief, neither Landlord nor Tenant is in default in any respect under the terms of the Lease

4.   The commencement date of the term of the Lease was January 1, 2009 and the term of said Lease will expire on December 31, 2013, unless sooner terminated as provided in said lease.

5.   Tenant is in possession of the premises leased to it (“Leased Premises”) and Landlord has complied fully and completely with all of its covenants, warranties and other undertakings and obligations under the Lease to this date including, without limitation, construction of all improvements and tenant finish and Tenant has received any and all tenant allowances due Tenant under the Lease, with the result that Tenant is fully obligated to perform, and is performing all of the other obligations of tenant under the Lease, without counterclaim, offset, defense or otherwise.

6.   Tenant has not made any prepayment of rent under said Lease and that there are no offsets, defenses, counterclaims or credit against the rentals due thereunder.

7.   A security deposit has been made with Landlord in the amount of $ 2,500.00.

8.   There are no side letters or other agreements, whether or not constituting amendments to the Lease, for tenant inducements such as rebates of or reductions in the rental provided for in the Lease.

9.   Except as specified in the Lease, Tenant has no options to Purchase or rights of first refusal in connection with the Leased Premises.  Tenant however reserves the option to renew for an additional period of time as specified in the Lease.

1

10.   To the best of Tenant’s knowledge, neither Landlord nor Tenant is in default under the Lease and no event has occurred which, with notice or the passage of time, will become a default under the Lease.

11.   This Certificate shall insure to the benefit of Purchaser, its successors and assigns, and shall be binding upon Tenant and Tenant’s heirs, legal representatives, successors and assigns.  This Certificate shall not be deemed to alter or modify any of the terms and conditions of the Lease or of any guaranty of the Lease

EFFECTIVE this 16th day of December, 2009.

TENANT:

Natural Gas Services Group

By: /s/ Stephen Taylor

Printed Name Stephen Taylor

Title: President / CEO

Address for Notices and Deliveries:

Natural Gas Services Group

Attn: Earl Wait

508 W. Wall Street, suite 550

Midland, TX  79701

STATE OF OKLAHOMA

}

COUNTY OF TULSA

This instrument was acknowledged before me on 16th day of December, 2009, by Christy Kitchen, (title) ___________________________

/s/: Christy Kitchen

Notary Public for State of Oklahoma

Christy Kitchen

Printed Name of Notary

(Seal) # 00005254

My Commission expires: 03/23/12

2

EXHIBIT A

STATE OF TEXAS                                                       }

LEASE AGREEMENT

COUNTY OF JOHNSON                                                       }

THIS LEASE made and entered into on the date last written below by and between Southwest Properties & Construction (“Lessor"), and Natural Gas Service Group ("Lessee"), is as follows:

1.  Premises.  Lessor hereby leases to Lessee, and Lessee hereby leases from Lessor those certain premises in Johnson County, Texas, being a 2.586 acre tract of land more or less with the improvements thereon more particularly described on Exhibit “A” attached hereto and incorporated herein by reference.

2.  Term.  The primary term of this lease shall be for a period of five (5) years, commencing on January 1, 2009 and ending on December 31, 2013, both dates inclusive, unless sooner terminated as herein provided.

3.  Rent.  Lessee agrees to pay to Lessor the following rent:

(a)  Base Rent:  The rent for the first three (3) years of the primary term of the lease shall be payable in advance in equal monthly installments of $5,450.00 each, without abatement, deduction, or offset. Each payment shall be due and payable on the first day of each month, beginning on the date the lease commences, and continuing on the first day of each month thereafter until the third year of the primary term of the lease at which time the rent for the remainder of the primary term of the lease shall be payable in advance in equal monthly installments of $5,600.00 each, without abatement, deduction, or offset. Each payment shall be due and payable on the first day of each month, beginning on the date the lease commences, and continuing each month thereafter until the end of the primary term of the lease. Payment shall be made to Lessor at the address identified in Paragraph 19.

(b)  Additional Rent:  Lessee shall pay, on demand and subject to documentation, to Lessor, the following as additional rent:

i)   taxes assessed against the Premises.

ii)   Casualty insurance premiums for the rebuild cost of the Premises as approved by Lessor.

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(c)  Interest: In the event basic rent or additional rent is not received by Lessor within twenty (20) days after it is due, Lessor may give Lessee ten (10) days written notice of such non-payment and upon expiration of such ten (10) days, interest will accrue, and be due and payable, on any unpaid amounts from the date such payments were due until the date paid at the Wall Street Journal Prime Rate Plus 2 percent.

4.  Use of Premises.  Lessee agrees that the demised premises shall be used and occupied only for the following purpose and for no other purpose(s) without the Lessor's written consent.

Comprehensive gas compression equipment and services company.

5.  Prohibited Use.  The Lessee shall not use or occupy or permit the leased premises or any part thereof to be used or occupied for any unlawful business, use, or purpose, nor for any business, use, or purpose deemed disreputable or extra hazardous, nor for any purpose or in any manner which is in violation of any present or future governmental laws or regulations.  The Lessee shall indemnify the Lessor against all costs, expenses, liabilities, losses, damages, injunctions, suits, fines, penalties, claims, and demands, including reasonable counsel fees arising out of any willful violation of or default in these covenants.

Lessee will not do or permit anything to be done in, upon, or about the leased premises that increases the fire hazard beyond that which exists by reason of the ordinary use or occupancy of the premises for the purposes specified above.  The Lessee agrees to pay to lessor, on demand, any increase in the fire insurance premiums on the building and improvements which Lessor may have to pay because of Lessee's use or occupancy of the premises.  Lessee will not do or permit to be done anything which will make uninsurable the leased premises or any part thereof.

6.  Repairs.  The Lessee, during the term of this lease or any extension or renewal thereof, shall at his expense make all repairs and perform all maintenance as shall reasonably be necessary to keep said leased premises in good condition and repair.  In particular, Lessee shall be responsible for the repair of any and all damage to the front glass and doors, and interior, including all plumbing, mechanical, electrical, air conditioning, ventilation and heating systems, including all repair and replacement thereof that are located within the interior walls of the building.  The Lessee further agrees that all damage or injury done to the premises by the Lessee or any person who may be in or upon the premises shall be repaired by the Lessee at its expense.  The Lessee agrees that at the expiration of this lease, or upon the earlier termination thereof, to quit and surrender said premises in good condition and repair, reasonable wear and tear, and damage by natural causes or fire, or other causes beyond the control of the Lessee, excepted. The Lessor, shall bear the cost of maintaining the roof, landscaping, grounds, signs, yard area  and  parking lot in compliance with all

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applicable laws, ordinances, and regulations and in accordance with the specified use of the premises during the term of this agreement.

The Lessor shall, at all times during the term of this lease, or any extension or renewal thereof, be responsible to put and maintain in repair and good and safe condition the exterior walls of the building and the roof thereof.

Lessee will not permit any mechanics, materialmens, or other liens to stand against the leased premises for work or material furnished to the Lessee.  The Lessee shall indemnify the Lessor against any loss out of the making of any alteration, repair, addition, or other improvement by the Lessee.

Lessee hereby covenants and agrees that the Lessor shall have the reserved right, with reasonable advance notice to Lessee, to enter the leased premises at any and all reasonable times in order to examine or repair said premises.

7.  Assignment and Subletting.  The Lessee shall not assign the lease, or any interest therein, nor sublet the premises, or any part thereof or any right or privilege appurtenant thereto, without the prior written consent of the Lessor first had and obtained, such consent to not be unreasonably withheld. In the event, under any circumstances, of assignment or subletting, the Lessee shall remain primarily liable for the payment of the rent herein described and for the performance of all other terms of this lease required to be performed by the Lessee.

          The transfer of a majority of the issued and outstanding stock of any corporate Lessee or of a majority of the total interest in any partnership Lessee, however, accomplished, shall be deemed an assignment of this lease.

8.  Insolvency.  If any proceeding in bankruptcy or insolvency be filed against Lessee, or if any Writ of Attachment or Writ of Execution be levied upon the interest herein of the Lessee, or if any sale of the leasehold interest hereby created or any part thereof shall be made under any extension or other judicial process, or if the Lessee shall make any assignment for the benefit of creditors or shall voluntarily institute bankruptcy or insolvency proceedings, the Lessor, at the Lessor's election, may re-enter and take possession of the premises, and  remove all persons therefrom, and may, at Lessor's option,  terminate this lease.

9.  Attorney's Fees.  The Lessee shall pay and indemnify the Lessor against all legal costs and charges, including counsel fees, lawfully and reasonably incurred in obtaining possession of the leased premises after a default of the Lessee, including the proceedings set forth in paragraph 8 above, or after the Lessee's default in surrendering possession upon the expiration or earlier

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termination of the term of the lease, or enforcing any covenant of the Lessee herein contained, or collecting from any guarantor any sums due Lessor under this  lease.

The Lessor shall pay and indemnify Lessee against all legal costs and charges, including counsel fees, lawfully and reasonably incurred in effecting performance of Lessor’s duties and responsibilities.

10.  Default.  This lease is made upon the express condition that if the Lessee fails to pay the rental reserved hereunder, or any part thereof, after the same shall become due, and such failure shall continue for a period of ten (10) days after written notice thereof, from the Lessor to the Lessee, or if the Lessee fails or neglects to perform, meet or observe any of the Lessee's other obligations hereunder, and such failure or neglect shall continue for a period of ten (10) days, then the Lessor at any time thereafter, by written notice to the Lessee,  may lawfully declare the termination hereof, including  acceleration of maturity of the rent for the remainder of the lease term whether primary or secondary, and re-enter  said premises, or any part thereof, and by due process of law,  expel, remove and put out the Lessee, or any person or persons  occupying said premises, and may remove all personal property  therefrom, without prejudice to any remedies which might  otherwise be used for the collection of arrears of rent or for  any breach of covenant or conditions.

If the Lessor fails or neglects to perform, meet or observe any of the Lessor's obligations hereunder, and such failure or neglect shall continue for a period of twenty (20) days after written notice from Lessee of such deficiency, then the Lessee at any time thereafter, by written notice to the Lessor, may remedy such deficiency in a manner of Lessee’s choosing. Costs incurred for said remedy may, at Lessee’s option, be offset through deductions from rentals due.

If Lessor re-enters the Premises or takes possession of them before normal expiration of this Lease, in accordance with the terms herein, Lessor shall have the right, but not the obligation, to remove from the Premises all of Lessee's personal property located therein and place it in storage in a public warehouse at Lessee's expense and risk.

Lessor’s pursuit of any remedy specified in this Lease will not constitute an election to pursue that remedy only, nor preclude Lessor from pursuing any other remedy available at law or in equity, nor constitute a forfeiture or a waiver of any rent or other amount due Lessor under this Lease.

11.  Non-waiver of Default.  The subsequent acceptance of rent hereunder by the Lessor shall not be deemed as waiver of any preceding breach of any obligation hereunder by the Lessee, other than the failure to pay the particular rental so accepted, and the waiver of any breach of any covenant or condition by the Lessor shall not constitute a waiver of any other breach regardless of knowledge thereof.

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12.  Indemnity and Insurance.

The Lessee shall keep the leased property insured at  its sole costs and expense against claims for personal injury or property damage under a policy of general public liability  insurance, with limits of at least $2,000,000.00 for bodily  injury and/or death, and $500,000.00 for property damage.  Such policy or policies shall name the Lessor and the Lessee as the insureds.   Within ten (10) days of the date hereof the Lessee shall deliver to the Lessor certificates of insurance certifying that such insurance is in full force and effect.  The Lessee hereby agrees to indmenify the Lessor against and to hold the Lessor harmless from any and all claims or demands for loss of or damage to personal property or for injury or death to any person or persons from any cause whatsoever while in, upon or about said demised premises, or on any adjacent sidewalks or driveways, during the term of this lease or any extension(s) or renewal(s) hereof, as long as said claims, demands, loss or damages are not attributable to Lessor.  Lessee shall deliver to Lessor copies of all policies which shall specify that ten (10) days notice to Lessor shall be required before any cancellation of said policies.

The Lessee shall be responsible for the insurance coverage of its principal property and business insurance.

13.  Utilities and Services.  The Lessee agrees to pay for all water, fuel, gas, oil, heat, electricity, power, materials, trash removal and services which may be furnished to it or used by it in or about the demised premises and to keep said demised premises free and clear of any lien or encumbrance of any kind whatsoever created by Lessee's act or omission.

14.  Entry and Inspection.  The Lessee shall permit the Lessor and his agent to enter the demised premises at all reasonable times, subject to advance reasonable notice to Lessee, for any of the following purposes:  to inspect same; to maintain the building in which the said premises are located; to make such repairs to the demised premises as the Lessor is obligated or may elect to make; to post notices of non-responsibility for alteration or additions or repairs.  The Lessor shall have such right of entry and the right to fulfill the purposes thereof without any rebate of rent to the Lessee for any loss of occupancy or quiet enjoyment of the demised premises thereby occasioned.

15.  Destruction of Premises.  In the event of a total or partial destruction of the said premises during said term from any cause, the Lessor shall forthwith repair the same, provided such repairs can be made within ninety (90) days under the laws and regulations of state, federal, county or municipal authorities, but such partial destruction shall in no way annul or void this lease, except that the rent reserved to be paid hereunder shall be equitably adjusted according to the amount and value of the undamaged space.

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Should the total or partial destruction result from causes covered by the fire and extended coverage insurance furnished by the Lessee, the insurance proceeds shall be made available to the Lessor to effect the required repairs.

If such repairs cannot be made within ninety (90) days, this lease may be terminated at the option of either party.

16.  Condemnation.  If the whole of the premises hereby demised shall be taken or condemned by any competent authority for any public use or purpose, then the term hereby granted shall cease on the day prior to the taking of possession by such authority, and rent hereunder shall be paid to and adjusted as of that day.

If a portion of said demised premises shall be condemned or taken, and, as a result thereof, there shall be such a major change in the character of the premises as to prevent Lessee from using the same in substantially the same manner as theretofore used, then and in that event, the Lessee may either cancel and terminate this lease, as of the date when the part of the premises so taken or condemned shall be required for public purposes, or said Lessee may continue to occupy the remaining portion, provided, however, the Lessee shall give written notice  to the Lessor, within fifteen (15) days after the date of any  taking or vesting of title, of its election.  In the event the Lessee shall remain in possession and occupation of the remaining portion, all the terms and conditions of this lease shall remain in full force and effect with respect to such remaining portion,  except that the rent reserved to be paid hereunder shall be  reduced in the proportion which the space taken bears to the  space originally leased; and provided, further, that Lessor  shall, at Lessor's own expense, promptly and with all reasonable  diligence (subject to strikes, lockouts, inability to procure  material and labor in the free market, governmental restrictions,  fire, the elements, and other extraordinary conditions beyond  Lessor's reasonable control) do such work as to make a complete  architectural unit of the remainder of the building on the  demised premises and this lease shall continue for the balance of  its term, subject to the terms and conditions herein stated and  provided further that the cost of said work shall not exceed the  lesser of the proceeds for the condemnation award less related  fees and expenses. The entire award of damages or compensation for the premises taken, or the amount paid pursuant to private purchase in lieu thereof, whether such condemnation or sale be total or partial, shall belong to and be the property of the Lessor, and the Lessee hereby assigns to Lessor any and all such award or purchase price.  Nothing herein contained shall be deemed or construed to prevent Lessee from interposing and prosecuting in any condemnation proceeding a claim for the value of any trade fixtures installed in the demised premises, the cost, loss or damage sustained by Lessee as the result of any alterations, modifications, or repairs which may be reasonably required of the Lessee in order to place the remaining portion of the demised premises not so condemned in a suitable condition for Lessee's

further occupancy.

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17.  (A)  Abandonment.  The Lessee agrees not to vacate or abandon the premises at any time during the demised term.   Should the Lessee vacate or abandon said premises or be dispossessed by process of law or otherwise, such abandonment, vacation, or dispossession shall be a breach of this lease and, in addition to any other rights which the Lessor may have, the Lessor may remove any personal property belonging to the Lessee which remains on the demised premises and store the same, such removal and storage to be for the account of the Lessee.

                  (B)  Continuous Operation.  Lessee hereby covenants and agrees that it will continuously throughout the term of this lease and extensions thereof operate the business above described.

18.  Laws and Regulations.  The Lessee, at his own cost and expense, shall comply promptly with all laws, rules, and orders of all federal, state and municipal governments, shall procure all permits and licenses required for the transaction of business on the leased premises and shall likewise promptly comply with the requirements of the Board of Fire Undewriters concerning the premise.

19.  Notices.  All notices to be given to the Lessee shall be in writing, deposited in the United States mail, certified or registered, with postage prepaid, and addressed to  the Lessee at the following address, to-wit:

Natural Gas Service Group

Attn: Earl Wait

508 W. Wall Street, Suite 550

Midland, TX 79701

Notices by the Lessee to Lessor shall be in writing, deposited in the United States mail, certified or registered, with postage prepaid, and addressed to the Lessor as follows, to-wit:

Southwest Properties & Construction

Attn: Trennon L. Massengale

108 S. Main

P.O. Box 689

Godley, Texas 76044

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20.  Taxes.  The Lessee shall pay all taxes and assessments upon the demised premises and upon the buildings and improvements thereon which are assessed during the term of the lease.

21.  DEPOSIT.  AS SECURITY FOR THE PERFORMANCE OF THE CONDITIONS AND COVENANTS OF THIS LEASE, LESSEE AGREES TO DEPOSIT WITH LESSOR THE SUM OF $2,500.00, AND SHOULD CHARGES BE MADE AGAINST SUCH DEPOSIT DURING THE TERM OF LESSEE'S OCCUPANCY, BECAUSE OF BREAKAGE OR OTHER DAMAGES TO THE LEASED PREMISES, LESSEE AGREES, AFTER NOTICE, TO DEPOSIT SUCH ADDITIONAL AMOUNT AS MAY BE REQUIRED TO RESTORE SUCH DEPOSIT TO THE ORIGINAL AMOUNT.  WHEN THE LEASED PREMISES ARE VACATED AND AFTER INSPECTION BY LESSOR, THE DEPOSIT SHALL BE REFUNDED TO LESSEE, LESS ANY REASONABLE CHARGES FOR CLEANING AND DAMAGES TO THE LEASED PREMISES (BEYOND REASONABLE WEAR AND TEAR), PROVIDED THAT LESSEE HAS FULFILLED ALL OTHER PROVISIONS OF THIS LEASE, INCLUDING THE COVENANT TO OCCUPY AND PAY RENTAL FOR THE FULL TERM OF THIS LEASE.  DEFAULT BY LESSEE IN THE PERFORMANCE OF ANY OF THE CONDITIONS AND COVENANTS HEREOF SHALL AUTHORIZE THE RETENTION OF LESSEE'S DEPOSIT FOR CREDIT AGAINST DAMAGES ACCRUING TO LESSOR BECAUSE OF LESSEE'S BREACH OF THIS LEASE.  IN NO CASE SHALL THE DEPOSIT BE CREDITED OR USED AS RENTAL EXCEPT WITH THE WRITTEN PERMISSION OF LESSOR.  THE WRITTEN NOTICE TO VACATE REQUIRED OF LESSEE SHALL BE GIVEN TO THE LESSOR ON THE PREMISES OR IN SUCH OTHER MANNER AS LESSOR SHALL DIRECT.

22.  Alterations to Leased Property.  No alterations, additions, or improvements to the leased property shall be made by the Lessee without the written consent of the Lessor.  Any alteration, addition, or improvement made by the Lessee after such consent shall have been given, and any fixtures installed as  a part thereof, shall, at the Lessor's option, become the property of the Lessor upon the expiration or sooner termination  of this lease, provided, however, that the Lessor shall have the  right to require the Lessee to remove such fixtures at the  Lessee's cost upon such termination of this lease.  All movable trade fixtures and personal property, exclusive of heating and/or air conditioning, shall remain the property of the Lessee.

23.  Lessee's Acceptance.  Lessee agrees, in the event that the improvements on the demised premises are complete, that it has inspected said premises and accepts same and agrees that same are suitable for the use herein stated.

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24.  No Business Association.  Nothing herein contained shall be deemed or construed by the parties hereto, nor by any third party, as creating the relationship of principal and agent or of partnership or of joint venture between the parties hereto, it being understood and agreed that neither the method of computation of rent, nor any other provision contained herein, nor any acts of the parties hereto, shall be deemed to create any relationship of landlord and tenant.  Whenever herein the singular number is used, the same shall include the plural, and words of any gender shall include the other gender.

26.  Environmental Provisions

A.  Lessee shall not place, store, dispose or keep any Hazardous Substances on the Premises, except those used in the normal course of Lessee’s business.

B.  If Lessee becomes aware of the presence of any Hazardous Substance in, on or under the Premises (except for those Hazardous Substances or other toxic material or waste brought, kept or used in the Premises by Lessee in the course of their business  and which are used and kept in compliance with applicable public health, safety and environmental laws) or if Lessee, or the Premises become subject to any order of any federal, state or local agency to repair, close, detoxify, decontaminate or otherwise cleanup the Premises, Lessee shall, at its own cost and expense, but only to the extent of Lessee’s contamination, carry out and complete any repair, closure, detoxification, decontamination or other cleanup of the Premises; provided that Lessee shall not be responsible for any of the foregoing relating to any Hazardous Substance, or other toxic materials or waste located on, in or under the Premises on the date of this Lease, all of which shall be the responsibility of Lessor. If Lessee fails to implement and diligently pursue any such repair, closure, detoxification, decontamination, or other cleanup of the Premises, Lessor shall have the right, but not the obligation, to carry out such action and to recover all of the costs and expenses of same from Lessee, but only to the extent that Lessee’s responsibility within this clause is limited to any contamination or clean-up that is directly attributable to Lessee.

C.  "Hazardous Substances" as such term is used in this Lease means any hazardous or toxic substance, material or waste, regulated or listed pursuant to any federal, state or local environmental law, including without limitation, the Clean Air Act, The Clean Water Act, the Toxic Substances Control Act, the Comprehensive Environmental Response Compensation and Liability Act, the Resource Conservation and Recovery Act, the Federal Insecticide, Fungicide, Rodenticide Act, the Safe Drinking Water Act and the Occupational Safety and Health Act.

D.  Lessee agrees to return the Premises to Lessor in the same order and condition as received, ordinary wear and tear excepted, and in the event of environmental contamination which

arises during the term of this Lease and/or Lessee’s occupancy which ever is longer.  Lessee agrees to restore the Premises to the same order and condition as received, ordinary wear and tear excepted.

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E.           Lessee shall promptly comply with all laws and all lawful orders, ordinances and regulations affecting the cleanliness, safety, occupation and use of the Premises.  While Lessee cannot guarantee the Lessor will never be considered by the governmental agencies enforcing environmental regulations to be a "Potentially Responsible Party" or PRP for environmental pollution, Lessee does agree to indemnify and hold Lessor harmless from any and all damages, costs and expenses which Lessor may suffer as a result of environmental damage or pollution or claims of such damage or pollution which are directly attributable to Lessee's use of the Premises.

27.  Holdover Term - In the event Lessee remains in possession of the Premises after the expiration of this Lease and without the execution of a new lease, Lessee shall be deemed to be occupying said premises as a Lessee from month to month, subject to all of the conditions, provisions and obligations of monthly tenancy.  Any holding over beyond the expiration of the term of this Lease shall be construed to be a tenancy from month to month at 100% of the monthly rental rate that was paid during the last month of the Lease term.

28.  Miscellaneous.

(a)  This lease shall be governed by, construed and enforced in accordance with, the laws of the State of Texas.

(b)  If there is more than one party Lessee, the covenants of the Lessee shall be the joint and several obligation of each party, and if the Lessee is a partnership, the covenants of the Lessee shall be the joint and several obligations of each of the partners and the obligations of the firm.

(c)  The covenants, terms, conditions, provisions and  undertakings in this lease or in any renewals thereof shall  extend to and be binding upon the heirs, executors,  administrators, successors, and assigns of the respective parties  hereto, as if they were in every case named and expressed, and  shall be construed as covenants running with the land; and  wherever reference is made to either of the parties hereto, it  shall be held to include and apply also to the heirs, executors,  administrators, successors and assigns of such party, as if in  each and every case so expressed.

(d)  The specified remedies to which the either party may resort under the terms of this lease are cumulative and are not intended to be exclusive of any other remedies or

means of redress to which either party may be lawfully entitled in case of any breach or threatened breach by the Lessee of any provision or  provisions of this lease.

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(e)  This lease, together with any written agreements which shall have been executed simultaneously herewith, contains the entire agreement and understanding between the parties. There are no oral understandings, terms, or conditions, and neither party has relied upon any representation, express or implied, not contained in this lease or the simultaneous writings heretofore referred to.  All prior understandings, terms, or conditions are deemed merged in this lease.  This lease cannot be changed or supplemented orally.

(f)  This lease may not be changed orally, but only by an agreement in writing and signed by the party against whom enforcement of any waiver, change, modification, or discharge is sought.

(g)  If any provision of this lease shall be declared invalid or unenforceable, the remainder of the lease shall continue in full force and effect.

IN WITNESS WHEREOF, Lessor and Lessee have executed this lease on this the 11th day of December, 2008.

LESSOR:

Southwest Properties & Construction
By:	/s/ Trennon L. Massengale - Owner
	Trennon L. Massengale - Owner

LESSEE:

Natural Gas Service Group
By:	/s/ Stephen C. Taylor
	President, Chairman & CEO

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EX-23.1

EXHIBIT 23.1

Consent of Independent Registered Public Accounting Firm

The Board of Directors

Natural Gas Services Group, Inc.

Midland, Texas

We consent to the incorporation by reference in the registration statements on Form S-8 (No. 333-147311, No. 333-110954, No. 333-160068, No. 333-160063 and No. 333-153874) and the registration statements (No. 333-119502, No. 333-122687 and No. 333-161346) on Form S-3, of Natural Gas Services Group, Inc. of our report dated March 4, 2010, relating to our audits of the financial statements and internal control over financial reporting, which appear in this Annual Report on Form 10-K of Natural Gas Services Group, Inc for the year ended December 31, 2009.

/s/ HEIN & ASSOCIATES LLP

Dallas, Texas

March 4, 2010

EX-31.1

EXHIBIT 31.1

Certifications

I, Stephen C. Taylor, certify that:

1. I have reviewed this Annual Report on Form 10-K of Natural Gas Services Group, Inc;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)       Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  March 4, 2010		Natural Gas Services Group, Inc.
	By:	/s/ Stephen C. Taylor
		Stephen C. Taylor
		Chairman of the Board of Directors, President and Chief Executive Officer (Principal  Executive Officer)

EX-31.2

EXHIBIT 31.2

Certifications

I, Earl R. Wait, certify that:

1. I have reviewed this Annual Report on Form 10-K of Natural Gas Services Group, Inc;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)      Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  March 4, 2010		Natural Gas Services Group, Inc.
	By:	/s/ Earl R. Wait
		Earl R. Wait
		Vice President of Accounting (Principal Accounting Officer) and Treasurer

EX-32.1

EXHIBIT 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. §1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Natural Gas Services Group, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2009 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Stephen C. Taylor, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date:  March 4, 2010		Natural Gas Services Group, Inc.
	By:	/s/ Stephen C. Taylor
		Stephen C. Taylor
		Chairman of the Board of Directors, President and Chief Executive Officer (Principal  Executive Officer)

EX-32.2

EXHIBIT 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. §1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Natural Gas Services Group, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2009, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Earl R. Wait, Vice President - Accounting (Principal Accounting Officer) of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date:  March 4, 2010		Natural Gas Services Group, Inc.
	By:	/s/ Earl R. Wait
		Earl R. Wait
		Vice President of Accounting (Principal Accounting Officer) and Treasurer