Back to GetFilings.com
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NO. 000-29226
VALLEY NATIONAL GASES INCORPORATED
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2888240
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
200 WEST BEAU STREET, SUITE 200
WASHINGTON, PENNSYLVANIA 15301
(Address of principal executive offices)
(724) 228-3000
(Registrant's telephone number, including area code)
Indicate by checkmark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act.)
Yes No X
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 10, 2003
----- --------------------------------
Common stock, $0.001 par value 9,356,834
================================================================================
VALLEY NATIONAL GASES INCORPORATED
TABLE OF CONTENTS
-----------------
Page
PART I FINANCIAL INFORMATION
ITEM 1 Condensed Consolidated Balance Sheets as of June 30, 2003 and
September 30, 2003 (unaudited) 3
Condensed Consolidated Statements of Operations for the Three
Months Ended September 30, 2002 and 2003 (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the Three
Months Ended September 30, 2002 and 2003 (unaudited) 6
Notes to Condensed Consolidated Financial Statements 7
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
ITEM 3 Quantitative and Qualitative Disclosures About Market Risk 19
ITEM 4 Controls and Procedures 19
PART II OTHER INFORMATION
ITEM 6 Exhibits and Reports on Form 8-K 20
SIGNATURES 21
-2-
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
VALLEY NATIONAL GASES INCORPORATED
----------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
A S S E T S
-----------
June 30, September 30,
2003 * 2003
------------- -------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 1,782,713 $ 1,645,005
Accounts receivable, net of allowance for
doubtful accounts of $814,846 and
$708,508, respectively 15,372,616 14,408,676
Inventory 10,013,709 9,648,923
Prepaids and other 859,208 826,758
Deferred tax assets 3,458,887 3,411,734
Refundable taxes 1,587,681 1,580,899
------------- -------------
Total current assets 33,074,814 31,521,995
------------- -------------
PROPERTY, PLANT AND EQUIPMENT:
Land 55,000 55,000
Buildings and improvements 6,217,806 6,354,319
Equipment 87,045,075 87,760,083
Transportation equipment 14,306,183 14,714,584
Furniture and fixtures 7,414,897 7,514,841
------------- -------------
Total property, plant and equipment 115,038,961 116,398,827
Accumulated depreciation (45,380,867) (46,702,064)
------------- -------------
Net property, plant and equipment 69,658,094 69,696,763
------------- -------------
OTHER ASSETS:
Non-compete agreements, consulting
agreements and customer lists,
net of accumulated amortization of $12,501,875
and $7,604,648, respectively 3,885,170 3,753,414
Goodwill 41,209,615 40,870,615
Deposits and other assets 3,455,299 3,249,004
------------- -------------
Total other assets 48,550,084 47,873,033
------------- -------------
TOTAL ASSETS $ 151,282,992 $ 149,091,791
============= =============
* Amounts have been derived from audited financial statements.
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
-3-
VALLEY NATIONAL GASES INCORPORATED
----------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------ June 30, September 30,
2003 * 2003
------------- -------------
(Unaudited)
CURRENT LIABILITIES:
Current maturities of long-term debt $ 5,916,423 $ 5,481,665
Accounts payable 7,460,442 6,231,351
Accrued compensation and employee benefits 3,541,493 3,548,827
Interest rate derivatives 2,527,280 2,427,441
Other current liabilities 2,927,010 2,758,360
------------- -------------
Total current liabilities 22,372,648 20,447,644
LONG-TERM DEBT, less current maturities 67,641,782 66,970,498
DEFERRED TAX LIABILITIES 20,726,545 20,726,545
OTHER LONG-TERM LIABILITIES 1,797,102 1,816,085
INTEREST RATE DERIVATIVES 2,601,710 1,930,073
------------- -------------
Total liabilities 115,139,787 111,890,845
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, par value, $.01 per share--
Authorized, 5,000,000 shares, none Issued or
Outstanding - -
Common stock, par value, $.001 per share-
Authorized, 30,000,000 shares;
Issued, 9,620,084 shares, Outstanding, 9,347,584 shares and
9,356,834 shares, respectively 9,620 9,620
Paid-in-capital 19,221,378 19,221,378
Retained earnings 21,988,827 22,602,510
Accumulated other comprehensive loss (2,890,059) (2,446,001)
Treasury stock at cost, 263,250 shares (2,186,561) (2,186,561)
------------- -------------
Total stockholders' equity 36,143,205 37,200,946
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 151,282,992 $ 149,091,791
============= =============
* Amounts have been derived from audited financial statements.
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
-4-
VALLEY NATIONAL GASES INCORPORATED
----------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
-----------------------------------------------
(Unaudited)
Three Months Ended
September 30,
----------------------------
2002 2003
----------- -----------
NET SALES $33,452,736 $32,434,532
COST OF PRODUCTS SOLD, excluding depreciation
and amortization 15,394,603 14,678,461
----------- -----------
Gross profit 18,058,133 17,756,071
----------- -----------
EXPENSES:
Operating and administrative 13,903,532 13,501,971
Depreciation 1,260,600 1,377,974
Amortization of intangibles 701,054 470,756
----------- -----------
Total expenses 15,865,186 15,350,701
----------- -----------
Income from operations 2,192,947 2,405,370
----------- -----------
INTEREST EXPENSE 2,097,034 1,481,531
OTHER INCOME, NET 82,548 82,201
----------- -----------
EARNINGS BEFORE INCOME TAXES 178,461 1,006,040
PROVISION FOR INCOME TAXES 74,061 392,356
----------- -----------
NET EARNINGS $ 104,400 $ 613,684
=========== ===========
BASIC EARNINGS PER SHARE $ 0.01 $ 0.07
DILUTED EARNINGS PER SHARE $ 0.01 $ 0.07
WEIGHTED AVERAGE SHARES:
Basic 9,347,584 9,356,834
Diluted 9,403,829 9,387,864
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
-5-
VALLEY NATIONAL GASES INCORPORATED
----------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
(Unaudited)
Three Months Ended
September 30,
--------------------------------
2002 2003
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 3,036,700 $ 1,930,271
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from disposal of assets 49,257 7,550
Purchases of property and equipment (2,035,817) (1,051,567)
Business acquisitions, net of cash acquired (1,054,112) -
------------ ------------
Net cash used by investing activities (3,040,672) (1,044,017)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings 13,232,446 10,400,000
Principal payments on loans (13,406,353) (11,423,962)
------------ ------------
Net cash used by financing activities (173,907) (1,023,962)
------------ ------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (177,879) (137,708)
CASH AND CASH EQUIVALENTS, beginning of period 1,216,668 1,782,713
------------ ------------
CASH AND CASH EQUIVALENTS, end of period $ 1,038,789 $ 1,645,005
============ ============
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
-6-
VALLEY NATIONAL GASES INCORPORATED
----------------------------------
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------
1. BASIS OF PRESENTATION:
---------------------
The condensed consolidated financial statements of Valley National Gases
Incorporated (the Company) presented herein are unaudited. Certain information
and footnote disclosures normally prepared in accordance with generally accepted
accounting principles have been either condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission. Although the
Company believes that all adjustments, consisting of only normal recurring
adjustments, necessary for a fair presentation have been made, interim periods
are not necessarily indicative of the financial results of operations for a full
year. As such, these financial statements should be read in conjunction with the
financial statements and notes thereto included or incorporated by reference in
the Company's audited consolidated financial statements for the period ending
June 30, 2003.
2. ORGANIZATION
------------
Valley National Gases Incorporated, a Pennsylvania corporation (the
Company), produces, packages and resells industrial gases, specialty gases and
propane; and resells welding hard goods and equipment. The Company's gas
operations consist primarily of packaging and mixing industrial, medical and
specialty gases, such as oxygen, nitrogen and argon, in pressurized cylinders
and transporting these cylinders to customers from one of the Company's 65
distribution or retail locations. In addition, the Company distributes propane
to industrial and residential customers. Welding equipment and supplies sales
includes welding machines, wire, fluxes and electrodes, as well as a wide
variety of supporting equipment. Since the Company was founded, it has completed
70 acquisitions of smaller independent local companies. The Company, through its
consolidated subsidiary has been in operation since 1958 and currently operates
in 11 states.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary. All significant inter-company balances have
been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
INVENTORY
Inventory is carried at the lower of cost or market using the first-in,
first-out (FIFO) method. The Company estimates reserves for product loss and
obsolete inventory on a quarterly basis.
The components of inventory are as follows:
-7-
June 30, September 30,
2003 2003
-------------- --------------
(Unaudited)
Hard goods $ 7,454,660 $ 6,997,027
Gases 2,559,049 2,651,896
-------------- --------------
$ 10,013,709 $ 9,648,923
============== ==============
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company has a stock-based compensation plan. The Company accounts for
this plan under the recognition and measurement provisions of APB Opinion No.
25, "Accounting for Stock Issued to Employees". Under these provisions,
stock-based employee compensation cost is not reflected in net earnings for any
year, as all options granted under the plan had an exercise price equal to or
greater than the market value of the underlying common stock on the grant date.
If the Company had elected to recognize compensation cost for these stock
options based on the fair value method set forth in SFAS No. 123, "Accounting
for Stock Based Compensation" the Company's net earnings and earnings per share
would have been the pro forma amounts indicated below:
Three Months Ended
September 30,
----------------------------
2002 2003
----- -----
Net income
As reported $ 104,400 $ 613,684
Deduct: Total stock-based employee
compensation expense based on the fair
value method for all awards, net of
related tax effects 14,256 21,713
---------- ---------
Pro forma 90,144 591,971
Earnings per share assuming dilution
As reported $ 0.01 $ 0.07
Pro forma $ 0.01 $ 0.06
COMPREHENSIVE INCOME
Comprehensive income includes net income and unrealized gains and losses on
derivatives designated and qualified as cash flow hedges. The components of
comprehensive income consist of the following for the fiscal years ending June
30:
Three Months Ended
September 30,
---------------------------
2002 2003
---- ----
Net earnings $ 104,400 $ 613,684
Unrealized gains, (losses) on
derivatives, net of tax (832,862) 444,058
---------- ----------
Comprehensive income (loss) $ (728,462) $1,057,742
========== ==========
NEW ACCOUNTING STANDARDS
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of the Indebtedness of Others" ("FIN 45"). This interpretation
changes the accounting recognition and disclosure requirements for certain
guarantees issued on behalf of other parties, which represent either a
contingent or a non-contingent obligation for the guarantor to make payments or
to perform specified activities. Effective
-8-
January 1, 2003, FIN 45 mandates the separate fair value recognition of
guarantees entered into on or after that date. As of September 30, 2003, the
Company has guarantees as defined in FIN 45 in the form of standby letters of
credit guaranteeing payments under the Company's obligations for certain
non-compete agreements and seller notes associated with acquisitions. The
outstanding letters of credit as of September 30, 2003 total $2.5 million and
approximate the total liabilities that they are associated with. The outstanding
amounts of these letters of credit decrement monthly through 2007. The Company
has adopted the provisions of FIN 45 as of January 1, 2003.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure" (SFAS No. 148), which amended SFAS No. 123 to allow multiple methods
of reporting the accounting transition for companies electing to adopt the
recognition provisions of SFAS 123 for fair valuing stock-based compensation. As
permitted by the accounting standards, the Company has elected to continue the
use of the intrinsic value method of accounting for stock-based compensation
under APB Opinion No. 25. The Company has adopted the disclosure provisions of
SFAS No. 148.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). A variable interest entity ("VIE") is
one where the contractual or ownership interests in an entity change with
changes in the entity's net asset value. This interpretation requires the
consolidation of a VIE by the primary beneficiary, and also requires disclosure
about VIEs where an enterprise has a significant variable interest but is not
the primary beneficiary. Under recent deferral issued, FIN 46 is effective in
the second quarter of fiscal year 2004 for VIEs existing prior to February 1,
2003. The required disclosure provisions of FIN 46 have been adopted in the
current year. The Company is currently analyzing FIN 46 and it's impact to the
financial statements with regard to the put/call agreement discussed in Note 7.
In April 2003, SFAS No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging" was issued. This statement amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities". This statement was effective for
the Company after April 30, 2003 and did not have a material impact on the
Company's results of operations or financial condition.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity". This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). This
statement was effective for the Company after May 31, 2003 and did not have a
material impact on the Company's results of operations or financial condition at
June 30, 2003. In November 2003, the FASB issued a deferral for an indefinite
period with the exception of the disclosure provisions.
-9-
SUPPLEMENTAL CASH FLOW INFORMATION
For the Three Months Ended
September 30,
------------------------------
2002 2003
---- ----
Cash paid for certain items--
Cash payments for interest $ 1,382,486 $ 1,490,455
Cash payments for income taxes -- --
Non-cash investing activity--
Purchases of property and equipment -- 451,163
Non-cash financing activity--
Issuance of seller notes 855,000 --
Issuance of non-compete agreements 300,000 --
Adjustment of seller notes -- (82,080)
4. INTANGIBLE ASSETS:
------------------
On July 1, 2001, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," under which goodwill and other intangible assets with
indefinite lives are not amortized. Such intangibles were evaluated for
impairment as of July 1, 2001 and no impairment existed. In addition, each year,
the Company will evaluate the intangible assets for impairment with any
resulting impairment reflected as an operating expense. The Company's
intangibles, other than goodwill, are its noncompete agreements, consulting
agreements and customer lists, which the Company has assigned definite lives
equal to the terms of the agreements. As of September 30, 2003, the Company's
noncompete agreements, consulting agreements and customer lists are summarized
as follows:
Weighted
Balance at Average
Original Accumulated September 30, Amortization Period
Cost Amortization 2003 (years)
----------------- -------------------- --------------------- -----------------------
Non-competition
Agreements $10,811,650 $7,386,021 $ 3,425,629 5.2
Consulting
Agreements 207,412 196,027 11,385 10.0
Customer Lists 339,000 22,600 316,400 15.0
----------------- -------------------- ---------------------
$11,358,062 $7,604,648 $3,753,414
================= ==================== =====================
Amortization expense for the three months ended September 30, 2003 totaled
$470,756. Estimated amortization expense for the remainder of fiscal 2004 and
the next five fiscal years is summarized as follows:
Fiscal year Ending
June 30,
-----------------------------
Remainder of 2004 $ 1,171,124
2005 $ 1,061,743
2006 $ 535,588
2007 $ 321,902
2008 $ 309,818
2009 $ 117,437
The changes in the carrying amount of goodwill for the three months ended
September 30, 2003, are as follows:
-10-
Balance as of June 30, 2003 $ 41,209,615
Final purchase price adjustments to
acquired goodwill (339,000)
----------------
Balance as of September 30, 2003 $ 40,870,615
----------------
5. LONG-TERM DEBT:
---------------
Long-term debt consists of the following:
June 30, September 30,
2003 2003
------------------- ---------------------
(Unaudited)
Revolving note, interest at LIBOR plus 2.75%
payable monthly through June 2005.
Collateralized by the assets of the Company. $55,770,000 $56,213,000
Termnote, interest at LIBOR plus 2.75% payable
monthly through June 2005. Collateralized by
the assets of the Company. 12,000,000 11,250,000
Note payable, interest at 6.6% payable annually
through October 2003. Collateralized by certain
assets of the Company. 683,075 683,075
Individuals and corporations, mortgages and
notes, interest at 3.75% to 10.00%,
payable at various dates through 2010. 5,180,189 4,376,769
------------------- ---------------------
73,633,264 72,522,844
Original issue discount (75,059) (70,681)
Current maturities (5,916,423) (5,481,665)
------------------- ---------------------
Total long-term debt $67,641,782 $66,970,498
=================== =====================
The prime rate was 4.00% and LIBOR was 1.12% at September 30, 2003.
On October 23, 2003, the Company entered into a fourth amendment to its
credit agreement to finalize prior non-recurring charges and their treatment for
covenant calculations. The Company was in compliance with the covenants under
its credit facility for the periods June 30 2003 and September 30, 2003.
The weighted average interest rate for substantially all of the borrowings
under the credit facility, excluding the effect of interest rate swap
agreements, was 3.78% as of September 30, 2003. As of September 30, 2003,
availability under the revolving loan was approximately $8.8 million, with
outstanding borrowings of approximately $56.2 million and outstanding letters of
credit of approximately $2.5 million. The credit facility is secured by all of
the Company's assets. The revolving loan is used primarily to fund acquisitions.
The Company is not required to make principal payments on outstanding balances
of the revolving loan as long as certain covenants are satisfied. Interest is
charged on both the term loan and the revolving loan at either the lender's
prime rate or various LIBOR rates, at the Company's discretion, plus an
applicable spread.
The loan agreement for the credit facility, as amended, contains various
financial covenants applicable to the Company, including covenants requiring
minimum fixed charge coverage, maximum funded debt to EBITDA, and minimum net
worth. As of September 30, 2003, the Company is in compliance with these
covenants and believes that it will continue to be in compliance through at
least the next twelve months. The Company believes that if and when the option
is exercised it will have adequate capital resources available to fund the
acquisition described in Note 7 and that it will continue to be in compliance
with its debt covenant requirements.
6. EARNINGS PER SHARE
------------------
-11-
Basic earnings per share were computed based on the weighted average number
of common shares issued and outstanding during the relevant periods. Diluted
earnings per share were computed based on the weighted average number of common
shares issued and outstanding plus additional shares assumed to be outstanding
to reflect the dilutive effect of common stock equivalents using the treasury
stock method.
Three Months Ended
September 30,
-------------------------------------------
2002 2003
------------------- -------------------
Net earnings available for common stock $ 104,400 $ 613,684
=================== ===================
Basic earnings per common share:
Weighted average common shares 9,347,584 9,356,834
=================== ===================
Basic earnings per common share $ 0.01 $ 0.07
=================== ===================
Diluted earnings per common share:
Weighted average common shares 9,347,584 9,356,834
Shares issuable from assumed conversion of
Common stock equivalents 56,245 30,850
------------------- -------------------
Weighted average common and common
equivalent shares 9,403,829 9,387,684
=================== ===================
Diluted earnings per common share $ 0.01 $ 0.07
=================== ===================
Options to purchase 391,200 and 189,500 shares of common stock were
outstanding during the quarter ended September 30, 2003 and 2002, respectively,
but were not included in the computation of diluted earnings per common share as
the options' exercise price was greater than the average market price of the
common stock for the respective periods.
7. COMMITMENTS AND CONTINGENCIES
-----------------------------
Some industrial gases and propane are flammable, explosive products. Serious
personal injury and property damage can occur in connection with its
transportation, storage, production or use. The Company, in the ordinary course
of business, is threatened with or is named as a defendant in various lawsuits
which, among other items, seek actual and punitive damages for product
liability, personal injury and property damage. The Company maintains liability
insurance policies with insurers in such amounts and with such coverages and
deductibles as the Company believes is reasonable and prudent. However, there
can be no assurance that such insurance will be adequate to protect the Company
from material expenses related to such personal injury or property damage or
that such levels of insurance will continue to be available in the future at
economical prices. Management is of the opinion that there are no known claims
or known contingent claims that are likely to have a material adverse effect on
the results of operations, financial condition or cash flows of the Company.
During fiscal year 2003 the Company incurred charges of $0.5 million related
to the severance payments for certain terminated employees as part of the
Company's organization strengthening program. As of June 30, 2003 the Company
had $0.2 million accrued for severance payments and anticipates that these
payments will be completed during fiscal year 2004.
The Company entered into a put/call option agreement in May 1998 with an
independent distributor for the purchase of its business. The put option became
-12-
exercisable in May 2002 and ends in May 2005. The call option becomes
exercisable upon expiration of the put option and ends in May 2008. The total
purchase price of this acquisition is currently estimated to be $10 million
based upon the purchase price calculation stipulated in the agreement, which
includes $1 million previously paid for this option. Management believes that
the carrying value of the option is not impaired, based upon its estimate of the
market value of such independent distributor. The Company could incur a loss
when the put option is exercised if the market value of the option at inception
is greater than the market value of the option at the date of purchase.
Management believes that a material loss is unlikely to occur based upon the
historical performance of the independent distributor. In addition, the Company
believes that if and when the option is exercised, it will have adequate capital
resources available to fund this acquisition and that it will continue to be in
compliance with its debt covenant requirements.
In September 1991, in connection with the purchase by the Company of certain
assets of Praxair, Inc. (Praxair), the Company, Gary E. West and certain of his
affiliates entered into a Right of First Refusal Agreement with Praxair. In
March 1997, the parties to such agreement entered into an Amended and Restated
Right of First Refusal Agreement (the Right of First Refusal Agreement) in
connection with the Company's reorganization. Pursuant to this agreement, if at
any time during the term of the agreement the Company wishes to accept a third
party offer to purchase all or a material part of the assets of the Company, or
Mr. West and his affiliates wish to accept an offer to purchase shares of
capital stock of the Company (the Capital Stock) owned by them in a transaction
that would result in Mr. West and his affiliates collectively owning less than
51% of the Company's issued and outstanding shares of Capital Stock on a fully
diluted basis or owning less than 51% of the combined voting power of all
outstanding voting securities of the Company, Praxair will have a right of first
refusal to match the offer. In addition, in the absence of a third party offer,
if (a) Mr. West and his affiliates wish to sell shares of Common Stock which
would result in their owning collectively less than 51% or more of the Company's
issued and outstanding shares of Common Stock, (b) the Company wishes to sell
all or a material part of its assets, or (c) the Company wishes to issue
additional shares or options or securities exercisable or convertible into
shares of Common Stock, pursuant to employee stock options, a public offering,
private placement, merger, share exchange or otherwise, which in the aggregate
on a fully diluted basis would result in Mr. West and his affiliates
collectively owning less than 51% of all the issued outstanding shares of Common
Stock, then Praxair will have the right to purchase from Mr. West and his
affiliates up to all of the issued and outstanding shares of Common Stock held
by them (but not less than 51% of all of the issued and outstanding shares of
the Company's Common Stock on a fully diluted basis) at the then prevailing
market price. If Praxair does purchase shares of Capital Stock from Mr. West and
his affiliates as described in this paragraph, then Mr. West and his affiliates
will be bound by certain non-compete provisions, as described in the Right of
First Refusal Agreement, for a period of three years from such purchase.
-13-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with, and is
qualified in its entirety by, the Financial Statements and the Notes thereto
included in item 1 herein.
OVERVIEW
Valley National Gases, Incorporated (the "Company"), a Pennsylvania
corporation, is a leading packager and distributor of cylinder and bulk
industrial, medical and specialty gases, welding equipment and supplies, propane
and fire protection equipment in 11 states in the eastern United States. In
fiscal 2003, gases accounted for approximately 48% of net sales, welding
equipment and supplies (generally referred to in the industry as "hard goods")
accounted for approximately 36% of net sales, and cylinder and tank rental
accounted for approximately 16% of net sales.
The Company's gas operations consist primarily of packaging and mixing
industrial, medical and specialty gases, such as oxygen, nitrogen and argon, in
pressurized cylinders and transporting these cylinders to customers from one of
the Company's 65 distribution or retail locations. The Company also distributes
propane to industrial and residential customers. Most customers pay a rental fee
for use of Company cylinders. The Company owns approximately 546,000 cylinders,
which require minimal maintenance and have useful lives that the Company expects
will average 30 years or longer. The Company selectively participates in the
small bulk gas market through the supply of gases in cryogenic transports and
the storage of gases in cryogenic and propane tanks that are also rented to
customers. The Company owns approximately 30,000 bulk propane tanks and 390 bulk
cryogenic tanks, which have useful lives generally less than those of cylinders.
In connection with the distribution of gases, the Company sells welding
equipment and supplies, including welding machines, wire, fluxes and electrodes
and a wide variety of supporting equipment.
The Company has determined that its business has one reportable segment in
the industrial gas and welding supply industry. Although the Company
participates in both of these markets, the financial information provided to the
chief operating decision maker for making critical decisions or allocate
resources does not constitute segment reporting.
The Company's current business strategy is to grow earnings through cost
leveraging its operations, and grow sales through the selective acquisition of
other independent distributors; and, to a lesser degree, through internally
generated growth. The Company believes that the proper implementation of certain
key operating procedures and staffing based upon "best practices" standards will
facilitate the reduction of total operating expenses and higher product margins.
Since the Company was founded, it has completed 70 acquisitions. Since July 1,
2002, the Company has acquired one independent distributor, adding approximately
$2 million in annualized sales. The Company believes that the current activity
regarding the sale and purchase of independent distributors has been slow,
relative to historical levels. However, management believes that, over the long
term, there will continue to be attractive acquisition candidates available to
the Company as a result of the consolidation trend in the industry and that the
Company will be able to successfully integrate acquired operations into its base
business, generating growth and operational synergies. The Company expects that
acquisitions will be financed primarily with internally generated funds, and to
a much lesser extent, borrowings under the Company's credit facility and seller
financing. While highly focused on cost leveraging, management believes that the
Company's competitive strengths will allow it to increase sales.
RESULTS OF OPERATIONS
Comparison of Three Months Ended September 30, 2003 and 2002
The following discussion of the results of operations and financial
condition of the Company should be read in conjunction with the financial
statements included in response to Part 1, Item 1 of this report.
Net sales decreased 3.0%, or $1.0 million, to $32.4 million for the three
months ended September 30, 2003 from $33.4 million for the three months ended
September 30, 2002. Acquisitions made since the prior year quarter contributed
$0.1 million
-14-
of increase in net sales for the three months ended September 30, 2003, while
same store sales decreased $1.1 million or 3.4% for such three month period.
Propane sales increased $1.1 million on a same store basis, reflecting $0.6
million in price inflation and $0.5 million increase due to increase in the
volume of propane sold. Same store bulk propane gallons sold were up 15.1% for
the quarter reflecting increased demand and the growth in the Company's customer
base. Hard good sales decreased $1.8 million from the prior year quarter on a
same store basis, reflecting the effect of the softness in the economy during
the quarter. Gases and cylinder revenue represented 61.5% of net sales for the
three months ended September 30, 2003, with hard goods representing 38.5%. In
comparison, gases and cylinder revenue represented 57.4% of net sales for the
three months ended September 30, 2002, with hard goods representing 42.6%.
Gross profit, which excludes depreciation and amortization, decreased 1.7%,
or $0.3 million, to $17.8 million, for the three months ended September 30, 2003
compared to $18.1 for the three months ended September 30, 2002. Acquisitions
made since the prior year quarter contributed $0.1 million of increase in gross
profit while same store gross profit decreased $0.4 million. Gross profit as a
percentage of net sales was 54.7% for the three months ended September 30, 2003,
compared to 54.0% for the three months ended September 30, 2002, reflecting,
primarily, the change in sales mix.
Operating and administrative expenses decreased 2.9%, or $0.4 million, to
$13.5 million for the three months ended September 30, 2003. Included in
operating expense was an insurance recovery for legal expenses incurred in prior
periods of $0.1 million. Operating and administrative expenses as a percentage
of sales were 41.6% for the three months ended September 30, 2003 and 2002.
Depreciation and amortization expense decreased $0.1 million for the three
months ended September 30, 2003, compared to the three months ended September
30, 2002, of $2.0 million primarily as a result of certain intangibles becoming
fully amortized.
Interest expense decreased $0.6 million to $1.5 million for the three months
ended September 30, 2003 compared to $2.1 million for the three months ended
September 30, 2002. Reflected in interest expense was a decrease of $31,379 for
the three months ended September 30, 2003 and an increase of $350,161 for the
three months ended September 30, 2002 to record changes in the fair market value
of the Company's interest rate swap agreements under SFAS No. 133.
The Company's effective tax rate for the three months ended September 30,
2003 was 39.0%, compared to 41.5% for the three months ended September 30, 2002.
This change was primarily the result of changes in estimates for federal and
state accrued taxes.
Net earnings increased to $0.6 million for the three months ended September
30, 2003 compared to $0.1 million for the prior year quarter.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has financed its operations, capital expenditures
and debt service with funds provided from operating activities. Acquisitions
have been financed by a combination of seller financing, bank borrowings and
funds generated from operations.
At September 30, 2003, the Company had working capital of approximately
$11.1 million, compared to $12.5 million as of September 30, 2002, reflecting
primarily the reduction in inventory levels. Funds provided by operations for
the three months ended September 30, 2003 were approximately $1.9 million,
compared to $3.0 million for the three months ended September 30, 2002. Funds
used for investing
-15-
activities were approximately $1.0 million for the three months ended September
30, 2003, consisting primarily of capital spending, compared to $3.0 million for
the three months ended September 30, 2003. Funds used for financing activities
for the three months ended September 30, 2003 were approximately $1.0 million
from net payments of debt, compared to $0.2 million for the three months ended
September 30, 2002. The Company's cash balance decreased $0.1 million during the
three months ended September 30, 2003 to $1.6 million.
On October 23, 2003, the Company entered into a fourth amendment to its
credit agreement to finalize prior non-recurring charges and their treatment for
covenant calculations. The Company was in compliance with the covenants under
its credit facility for the periods June 30, 2003 and September 30, 2003.
The weighted average interest rate for substantially all of the borrowings
under the credit facility was 3.78% as of September 30, 2003. As of September
30, 2003, availability under the revolving loan was approximately $8.8 million,
with outstanding borrowings of approximately $56.2 million and outstanding
letters of credit of approximately $2.5 million. The credit facility is secured
by all of the Company's assets. The revolving loan is used primarily to fund
acquisitions. The Company is not required to make principal payments on
outstanding balances of the revolving loan as long as certain covenants are
satisfied. Interest is charged on both the term loan and the revolving loan at
either the lender's prime rate or various LIBOR rates, at the Company's
discretion, plus an applicable spread.
The loan agreement for the credit facility, as amended, contains various
financial covenants applicable to the Company, including covenants requiring
minimum fixed charge coverage, maximum funded debt to EBITDA, and minimum net
worth. As of September 30, 2003, the Company is in compliance with these
covenants and believes that it will continue to be in compliance through at
least the next twelve months.
The Company is obligated under various promissory notes related to the
financing of acquisitions that have various rates of interest, ranging from
3.75% to 10.0% per annum, and maturities through 2010. The outstanding balance
of these notes as of September 30, 2003 was $4.4 million. Some of these notes
are secured by assets related to the applicable acquisition, some are unsecured
and some are backed by bank letters of credit issued under the Company's credit
facility.
The Company enters into contractual agreements in the ordinary course of
business to hedge its exposure to interest rate risks. Counterparties to these
agreements are major financial institutions. Management believes the risk of
incurring losses related to credit risk is remote and any losses would be
immaterial.
Interest rate swap agreements are used to reduce interest rate risks and
costs inherent in the Company's debt portfolio. The Company enters into these
agreements to change the variable/ fixed interest rate mix of the debt portfolio
in order to maintain the percentage of fixed and variable debt within certain
parameters set by management. Accordingly, the Company enters into agreements to
effectively convert variable-rate debt to fixed-rate debt. As of September 30,
2003, the Company had $55.0 million in notional amounts outstanding under
interest rate swap agreements. These swaps have an average pay rate of 6.1%
versus a receive rate of 1.1%.
The Company entered into a put/call option agreement in May 1998 with an
independent distributor for the purchase of its business. The put option became
exercisable in May 2002 and ends in May 2005. The call option becomes
exercisable upon expiration of the put option and ends in May 2008. The total
purchase price of this acquisition is currently estimated to be $10 million
based upon the purchase price calculation stipulated in the agreement, which
includes $1 million previously paid for this option. Management believes that
the carrying value of the option is not impaired, based upon its estimate of the
market value of such
-16-
independent distributor. The Company could incur a loss when the put option is
exercised if the market value of the option at inception is greater than the
market value of the option at the date of purchase. Management believes that a
material loss is unlikely to occur based upon the historical performance of the
independent distributor. In addition, the Company believes that if and when the
option is exercised, it will have adequate capital resources available to fund
this acquisition and that it will continue to be in compliance with its debt
covenant requirements.
The Company believes that cash generated from operations, borrowing
availability under its credit facility and the ability to obtain financing with
sellers of businesses will be sufficient to satisfy the Company's requirements
for operating funds, capital expenditures and future acquisitions for at least
the next twelve months. The Company has no plans at this time to issue
additional shares of common stock.
CRITICAL ACCOUNTING POLICIES
The Company's financial statements are prepared in conformity with
accounting principles generally accepted in the United States of America.
Certain of these accounting principles are more critical than others in gaining
an understanding of the basis upon which the Company's financial statements have
been prepared. A comprehensive review of these policies is contained in the
Company's 2003 Annual Report on Form 10-K filed on September 29, 2003. There
have been no significant changes in these policies or the application thereof
during the first quarter of 2004.
NEW ACCOUNTING STANDARDS
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of the Indebtedness of Others" ("FIN 45"). This interpretation
changes the accounting recognition and disclosure requirements for certain
guarantees issued on behalf of other parties, which represent either a
contingent or a non-contingent obligation for the guarantor to make payments or
to perform specified activities. Effective January 1, 2003, FIN 45 mandates the
separate fair value recognition of guarantees entered into on or after that
date. As of September 30, 2003, the Company has guarantees as defined in FIN 45
in the form of standby letters of credit guaranteeing payments under the
Company's obligations for certain non-compete agreements and seller notes
associated with acquisitions. The outstanding letters of credit as of September
30, 2003 total $2.5 million and approximate the total liabilities that they are
associated with. The outstanding amounts of these letters of credit decrement
monthly through 2007. The Company has adopted the provisions of FIN 45 as of
January 1, 2003.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure" (SFAS No. 148), which amended SFAS No. 123 to allow multiple methods
of reporting the accounting transition for companies electing to adopt the
recognition provisions of SFAS 123 for fair valuing stock-based compensation. As
permitted by the accounting standards, the Company has elected to continue the
use of the intrinsic value method of accounting for stock-based compensation
under APB Opinion No. 25. The Company has adopted the disclosure provisions of
SFAS No. 148.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). A variable interest entity ("VIE") is
one where the contractual or ownership interests in an entity change with
changes in the entity's net asset value. This interpretation requires the
consolidation of a VIE by the primary beneficiary, and also requires disclosure
about VIEs where an enterprise has a significant variable interest but is not
the primary beneficiary. Under recent deferral issued, FIN 46 is effective in
the second quarter of fiscal year 2004 for VIEs existing prior to February 1,
2003. The required disclosure
-17-
provisions of FIN 46 have been adopted in the current year. The Company is
currently analyzing FIN 46 and it's impact to the financial statements with
regard to the put/call agreement discussed in Note 7.
In April 2003, SFAS No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging" was issued. This statement amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities". This statement was effective for
the Company after April 30, 2003 and did not have a material impact on the
Company's results of operations or financial condition.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity". This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). This
statement was effective for the Company after May 31, 2003 and did not have a
material impact on the Company's results of operations or financial condition at
June 30, 2003. In November 2003, the FASB issued a deferral for an indefinite
period with the exception of the disclosure provisions.
FORWARD LOOKING STATEMENTS AND RISK FACTORS
This report includes statements that are forward-looking as that term is
defined by the Private Securities Litigation and Reform Act of 1995 or by the
Securities and Exchange Commission in its rules, regulations and releases,
including statements regarding the Company's ability to grow earnings, cost
leverage its operations, reduce operating expenses, increase product margins,
identify attractive acquisition targets and to successfully acquire new
businesses and assimilate the operations of those businesses into its
operations, its ability to finance such acquisitions and its ability to meet its
covenant requirements under its credit facility . The Company intends that such
forward-looking statements be afforded the protections provided by the safe
harbor created by the Private Securities Litigation and Reform Act of 1995.
All forward-looking statements are based upon current expectations regarding
important factors. Accordingly, actual results may differ materially from those
expressed in the forward-looking statements and the making of such statements
should not be regarded as a representation by the Company or any other person
that the results expressed will be achieved. Important risk factors that may
affect the Company's ability to achieve the results expressed in the
forward-looking statements include, but are not limited to, the risks discussed
in Exhibit 99.1 to the Company's 10-K for the fiscal year ended June 30, 2003
and the Company's ability to (i) accurately identify attractive acquisition
targets and make accurate predictions regarding the performance of those
businesses if integrated into the Company's operations, (ii) successfully
negotiate agreements for the acquisition of those businesses, (iii) integrate
the operations of the acquired businesses as anticipated, (iv) secure financing
necessary to make acquisitions, including maintaining and/or expanding its line
of credit, maintaining compliance with covenants, negotiating seller financing,
or securing other financing methods, (v) manage rapid growth, (vi) effectively
compete, (vii) attract and retain key personnel and (viii) maintain good
relationships with suppliers and locate alternative suppliers if needed. In
addition, the Company's ability to achieve the results expressed by the
forward-looking statements may be affected by litigation or other claims arising
out of accidents involving the Company's products, changes in the economy,
monetary or fiscal policies, changes in laws and regulations affecting the
Company's business, inflation and fluctuations in interest rates.
-18-
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The table below provides information about the Company's derivative
financial instruments and other financial instruments that are sensitive to
changes in interest rates, including interest rate swaps and debt obligations.
For debt obligations, the table presents principal cash flows and related
weighted average interest rates by expected maturity dates. For interest rate
swaps, the table presents notional amounts and weighted average interest rates
by expected (contractual) maturity dates. Notional amounts are used to calculate
the contractual payments to be exchanged under the contract. Weighted average
variable rates are based on the one month LIBOR rate in effect at the reporting
date. No assumptions have been made for future changes in the one month LIBOR
rate.
No material change to the information set forth in the table below has
occurred since June 30, 2003. There was no significant change to the composition
of the Company's fixed and variable rate long-term debt or interest rate swaps
during the three months ended September 30, 2003. As of September 30, 2003, the
Company's average pay rate for these swaps was 6.1% compared to its average
receive rate of 1.1%.
Expected Maturity Date
For periods ending June 30,
------------------------------------------------------------------------- ----------------------------
There Total Fair
2004 2005 2006 2007 2008 After Value
------------------------------------------------------------------------------------------------------
(In Thousands)
Liabilities
Long term debt
Fixed rate $ 2,916 $ 1,147 $ 761 $ 547 $ 190 $ 228 $ 5,789 $ 5,360
Average interest rate 3.79% 4.78% 6.31% 6.28% 4.65% 4.97%
Variable rate $ 3,000 $ 64,770 -- -- -- -- $67,770 $ 67,770
Average interest rate 3.75% 3.75% -- -- -- --
Interest rate swaps
Variable to fixed $ 55,000 $ 25,000 -- -- -- -- $ (5,129)
Average pay rate 5.99% 5.58% -- -- -- --
Average receive rate 1.20% 1.20% -- -- -- --
Commitments
Operating leases $3,205,511 $3,088,217 $2,758,983 $2,525,484 $2,394,443
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including
our Chief Executive Officer, William A. Indelicato, and our Chief Financial
Officer, Robert D. Scherich, we evaluated the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Rule
13a-15(e) under the Exchange Act) as of the end of the period covered by this
report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this
report, our disclosure controls and procedures were adequately designed to
ensure that information required to be disclosed by the Company in the reports
that it files or submits under the Securities Exchange Act of 1934, as amended,
is recorded, processed, summarized and reported within the time periods
specified in applicable rules and forms.
(b) Changes in Internal Controls
During the fiscal quarter covered by this report, there have not been any
significant changes in the Company's internal control over financial reporting
(as defined in Rule 13a-15(f) under Securities Exchange Act) that have
materially affected or are reasonably likely to materially affect, our internal
control over financial reporting.
-19-
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1 Fourth Amendment to Second Amended and Restated Credit Agreement
dated October 23, 2003.
31.1 Certification of the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of the Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
The Company filed a Form 8-K on July 24, 2003 reporting under
Item 9 disclosing guidance for its expected earnings per share
for the fiscal year ended June 30, 2003.
The Company filed a Form 8-K on August 12, 2003 reporting under
Item 7 and Item 12 the Company's financial results for the fiscal
year ended June 30, 2003.
The Company filed a Form 8-K on October 29, 2003 reporting under
Item 7 and Item 12 the Company's financial results for the
quarter ended September 30, 2003.
-20-
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VALLEY NATIONAL GASES INCORPORATED
November 14, 2003 /s/ Robert D. Scherich
-----------------------------------
Robert D. Scherich
Chief Financial Officer
-21-