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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 MARCH 31, 2004
[ ] 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 May 3, 2004
----- --------------------------
Common stock, $0.001 par value 9,423,809
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VALLEY NATIONAL GASES INCORPORATED
TABLE OF CONTENTS
Page
----
PART I FINANCIAL INFORMATION
ITEM 1 Condensed Consolidated Balance Sheets as of June 30, 2003
and March 31, 2004 (unaudited) 3
Condensed Consolidated Statements of Operations for the
Three Months Ended March 31, 2003 and 2004 (unaudited) 5
Condensed Consolidated Statements of Operations for the
Nine Months Ended March 31, 2003 and 2004 (unaudited) 6
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended March 31, 2003 and 2004 (unaudited) 7
Notes to Condensed Consolidated Financial Statements 8
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
ITEM 3 Quantitative and Qualitative Disclosures About Market Risk 23
ITEM 4 Controls and Procedures 24
PART II OTHER INFORMATION
ITEM 6 Exhibits and Reports on Form 8-K 25
SIGNATURES 26
- 2 -
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
VALLEY NATIONAL GASES INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, March 31,
2003 * 2004
------------- -------------
(Unaudited)
A S S E T S
CURRENT ASSETS:
Cash and cash equivalents $ 1,782,713 $ 2,779,030
Accounts receivable, net of allowance for
doubtful accounts of $814,846 and
$784,719, respectively 15,372,616 19,042,710
Inventory 10,013,709 8,418,252
Prepaids and other current assets 859,208 999,979
Deferred tax assets 3,458,887 2,788,729
Refundable taxes 1,587,681 396,117
------------- -------------
Total current assets 33,074,814 34,424,817
------------- -------------
PROPERTY, PLANT AND EQUIPMENT:
Land 55,000 2,680,485
Buildings and improvements 6,217,806 18,670,436
Equipment 87,045,075 89,746,088
Transportation equipment 14,306,183 17,037,717
Furniture and fixtures 7,414,897 7,911,225
------------- -------------
Total property, plant and equipment 115,038,961 136,045,951
Accumulated depreciation (45,380,867) (53,025,468)
------------- -------------
Net property, plant and equipment 69,658,094 83,020,483
------------- -------------
OTHER ASSETS:
Non-compete agreements, consulting agreements and customer lists,
net of accumulated amortization of $12,501,875 and $8,430,907,
respectively 3,885,170 3,077,155
Goodwill 41,209,615 40,870,615
Deposits and other assets 1,387,139 1,512,086
------------- -------------
Total other assets 46,481,924 45,459,856
------------- -------------
TOTAL ASSETS $ 149,214,832 $ 162,905,156
============= =============
* 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
June 30, March 31,
2003 * 2004
------------- -------------
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt $ 5,916,423 $ 5,149,058
Accounts payable 7,460,442 7,405,415
Accrued compensation and employee benefits 3,541,493 4,585,816
Interest rate derivatives 2,527,280 2,293,541
Other current liabilities 2,927,010 4,256,728
------------- -------------
Total current liabilities 22,372,648 23,690,558
LONG-TERM DEBT, less current maturities 67,641,782 65,557,194
DEFERRED TAX LIABILITIES 18,658,385 21,361,034
OTHER LONG-TERM LIABILITIES 1,797,102 1,764,537
INTEREST RATE DERIVATIVES 2,601,710 977,429
------------- -------------
Total liabilities 113,071,627 113,350,752
------------- -------------
COMMITMENTS AND CONTINGENCIES
MINORITY INTEREST IN VARIABLE INTEREST ENTITIES - 5,627,629
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, 9,356,834 and 9,363,970
shares, respectively 9,620 9,620
Paid-in-capital 19,221,378 18,977,575
Retained earnings 21,988,827 28,454,937
Accumulated other comprehensive loss (2,890,059) (1,829,474)
Treasury stock at cost, 263,250 and 203,000 shares, respectively (2,186,561) (1,685,883)
------------- -------------
Total stockholders' equity 36,143,205 43,926,775
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 149,214,832 $ 162,905,156
============= =============
* 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
March 31,
---------------------------
2003 2004
----------- -----------
NET SALES $45,818,882 $47,926,376
COST OF PRODUCTS SOLD, excluding depreciation and amortization 22,359,343 22,924,164
----------- -----------
Gross profit 23,459,539 25,002,212
----------- -----------
EXPENSES:
Operating and administrative, including expenses incurred with related
parties under lease and consulting agreements of $599,847 and
$619,789, respectively 16,082,461 15,549,074
Depreciation 1,441,700 1,444,944
Amortization of intangibles 604,093 398,378
----------- -----------
Total expenses 18,128,254 17,392,396
----------- -----------
Income from operations 5,331,285 7,609,816
----------- -----------
Interest expense 1,616,484 1,437,822
OTHER INCOME, NET 862 957
----------- -----------
EARNINGS BEFORE INCOME TAXES 3,715,663 6,172,951
PROVISION FOR INCOME TAXES 1,541,999 2,407,451
----------- -----------
NET EARNINGS $ 2,173,664 $ 3,765,500
=========== ===========
BASIC EARNINGS PER SHARE $ 0.23 $ 0.40
DILUTED EARNINGS PER SHARE $ 0.23 $ 0.40
WEIGHTED AVERAGE SHARES:
Basic 9,348,303 9,378,400
Diluted 9,383,813 9,462,985
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
- 5 -
VALLEY NATIONAL GASES INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Nine Months Ended
March 31,
-----------------------------
2003 2004
------------ ------------
NET SALES $117,947,274 $119,480,921
COST OF PRODUCTS SOLD, excluding depreciation and amortization 56,091,354 55,916,928
------------ ------------
Gross profit 61,855,920 63,563,993
------------ ------------
EXPENSES:
Operating and administrative, including expenses incurred with related
parties under lease and consulting agreements of $1,942,846 and
$1,795,616, respectively 44,840,386 43,146,367
Depreciation 4,013,000 4,284,204
Amortization of intangibles 1,892,868 1,297,015
------------ ------------
Total expenses 50,746,254 48,727,586
------------ ------------
Income from operations 11,109,666 14,836,407
------------ ------------
INTEREST EXPENSE 4,960,501 4,365,396
OTHER INCOME, NET 116,239 129,170
------------ ------------
EARNINGS BEFORE INCOME TAXES 6,265,404 10,600,181
PROVISION FOR INCOME TAXES 2,600,143 4,134,071
------------ ------------
NET EARNINGS $ 3,665,261 $ 6,466,110
============ ============
BASIC EARNINGS PER SHARE $ 0.39 $ 0.69
DILUTED EARNINGS PER SHARE $ 0.39 $ 0.69
WEIGHTED AVERAGE SHARES:
Basic 9,347,820 9,363,970
Diluted 9,393,317 9,415,413
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
- 6 -
VALLEY NATIONAL GASES INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
March 31,
------------------------------
2003 2004
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 10,412,130 $ 15,324,983
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from disposal of assets 218,470 46,229
Cash from consolidation of variable interest
entities - 688,346
Purchases of property and equipment (4,802,968) (5,795,165)
Business acquisitions, net of cash acquired (1,054,112) -
------------ ------------
Net cash used in investing activities (5,638,610) (5,060,590)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings 38,442,686 32,464,315
Principal payments on loans (43,002,783) (41,989,266)
Redemption of stock options 28,906 256,875
------------ ------------
Net cash used in financing activities (4,531,191) (9,268,076)
------------ ------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 242,329 996,317
CASH AND CASH EQUIVALENTS, beginning of period 1,216,668 1,782,713
------------ ------------
CASH AND CASH EQUIVALENTS, end of period $ 1,458,997 $ 2,779,030
============ ============
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
- 7 -
VALLEY NATIONAL GASES INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION:
The accompanying condensed consolidated financial statements include the
accounts of Valley National Gases Incorporated and entities, as of March 31,
2004, required to be consolidated pursuant to Financial Accounting Standards
Board Interpretation No. 46R, "Consolidation of Variable Interest Entities,"
("FIN 46R"). The term "Valley" as used throughout this document is used to
indicate Valley National Gases Incorporated. The term "the Company" as used
throughout this document is used to indicate Valley as well as entities required
to be consolidated under FIN 46R.
The condensed consolidated financial statements of 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 normal recurring adjustments and adjustments required
upon adoption of FIN 46R, 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 Valley's audited consolidated financial statements
for the period ending June 30, 2003.
2. ORGANIZATION
Valley National Gases Incorporated, a Pennsylvania corporation, produces,
packages and resells industrial gases, specialty gases and propane; and resells
welding hard goods and equipment. Valley'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 Valley's 65 distribution or retail locations. In addition,
Valley 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 Valley was
founded, it has completed 70 acquisitions of smaller independent local
companies. Valley, 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-
- 8 -
out (FIFO) method. Valley estimates reserves for product loss and obsolete
inventory on a quarterly basis.
The components of inventory are as follows:
June 30, March 31,
2003 2004
----------- -----------
(Unaudited)
Hard goods $ 7,454,660 $ 6,716,229
Gases 2,559,049 1,702,023
----------- -----------
$10,013,709 $ 8,418,252
=========== ===========
ACCOUNTING FOR STOCK-BASED COMPENSATION
Valley has a stock-based compensation plan. Valley accounts for this plan
under the recognition and measurement provisions of APB Opinion No. 25,
"Accounting for Stock Issued to Employees". Under these provisions, the expense
related to stock-based employee compensation is not reflected in net earnings
for any year, as all options granted under the plan have an exercise price equal
to or greater than the market value of the underlying common stock on the grant
date.
If Valley had elected to recognize compensation expense for these stock
options based on the fair value method set forth in SFAS No. 123, "Accounting
for Stock Based Compensation" Valley's net earnings and earnings per share would
have been the pro forma amounts indicated below:
Three Months Ended Nine Months Ended
March 31, March 31,
--------------------------------- -------------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
Net income
As reported $ 2,173,663 $ 3,765,500 $ 3,665,261 $ 6,466,110
Deduct: Total stock-based
employee compensation
expense based on the fair
value method for all
awards, net of related
tax effects 16,180 20,514 48,198 63,940
----------- ----------- ----------- -----------
Pro forma 2,157,484 3,744,986 3,617,063 6,402,170
Earnings per share assuming
Dilution
As reported $ 0.23 $ 0.40 $ 0.39 $ 0.69
Pro forma $ 0.23 $ 0.40 $ 0.39 $ 0.68
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 nine months ending March
31:
Nine Months Ended
March 31,
---------------------------------
2003 2004
----------- -----------
Net earnings $ 3,665,261 $ 6,466,110
Unrealized gains, (losses) on
derivatives, net of tax (855,481) 1,060,585
----------- -----------
Comprehensive income (loss) $ 2,809,780 $ 7,526,695
=========== ===========
NEW ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). A variable interest entity ("VIE") is
one
- 9 -
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.
In December 2003, the FASB issued FIN 46R to further clarify the standard.
As required under the most recent deferral, Valley adopted FIN 46R in the
current quarter. Valley analyzed FIN 46R and it's impact to the financial
statements with regard to the put/call agreement as well as related party lease
agreements discussed in Note 7. Valley concluded that the put/call agreement
meets the scope exception requirements of FIN 46R for an entity deemed to be a
business. In addition, Valley concluded that the related party lease agreement
entities ("Variable Interest Entities") are required to be consolidated with
Valley's financial statements, as of March 31, 2004, pursuant to the common
control provisions under FIN 46R (see Note 8).
SUPPLEMENTAL CASH FLOW INFORMATION
For the Nine Months Ended
March 31,
--------------------------------
2003 2004
---------- ----------
Cash paid for certain items --
Cash payments for interest $4,936,938 $4,402,263
Cash payments for income taxes - -
Non-cash investing activity--
Purchases of property and equipment - 291,199
Non-cash financing activity--
Issuance of seller notes 855,000 -
Issuance of non-compete agreements 300,000 -
Adjustment of seller notes - (82,080)
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts to conform
with the current year presentation. These reclassifications had no effect on
reported net earnings.
4. INTANGIBLE ASSETS:
On July 1, 2001, Valley adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," under which goodwill and other intangible assets with
indefinite lives are not amortized. Each year, Valley evaluates the intangible
assets for impairment with any resulting impairment reflected as an operating
expense. Valley's intangibles, other than goodwill, are its noncompete
agreements, consulting agreements and customer lists, which Valley has assigned
definite lives equal to the terms of the agreements. As of June 30, 2003 and
March 31, 2004, Valley's noncompete agreements, consulting agreements and
customer lists are summarized as follows:
Gross Accumulated Gross Amount Accumulated Weighted
Amount Amortization as of Amortization Average
as of as of March 31, as of Amortization
June 30, 2003 June 30, 2003 2004 March 31, 2004 Period (years)
------------- ------------- ------------ -------------- --------------
Non-competition
agreements $15,223,274 $11,353,282 $10,811,651 $ 8,185,057 5.2
Consulting
agreements 1,163,771 1,148,593 357,411 211,950 3.0
Customer Lists - - 339,000 33,900 15.0
----------- ----------- ----------- -----------
Total $16,387,045 $12,501,875 $11,508,062 $ 8,430,907
=========== =========== =========== ===========
Amortization expense for the nine months ended March 31, 2004 totaled
$1,297,015. Estimated amortization expense for the remainder of fiscal 2004 as
of March 31, 2004 and the next five fiscal years is summarized as follows:
- 10 -
Fiscal year Ending
June 30,
- ------------------
Remainder of 2004 $ 365,817
2005 $ 1,111,743
2006 $ 588,568
2007 $ 351,068
2008 $ 309,818
2009 $ 117,437
The changes in the carrying amount of goodwill for the nine months ended
March 31, 2004, are as follows:
Balance as of June 30, 2003 $ 41,209,615
Final purchase price adjustments to
acquired goodwill (339,000)
-------------
Balance as of March 31, 2004 $ 40,870,615
-------------
5. LONG-TERM DEBT:
Long-term debt consists of the following:
June 30, March 31,
2003 2004
------------ ------------
(Unaudited)
Revolving note, interest at LIBOR plus 2.75% payable monthly through June 2005.
Collateralized by the assets of Valley. $ 55,770,000 $ 51,000,000
Term note, interest at LIBOR plus 2.75% payable monthly through June 2005.
Collateralized by the assets of Valley. 12,000,000 9,750,000
Note payable, interest at 6.6% payable annually through October 2003.
Collateralized by certain assets of Valley. 683,075 -
Individuals and corporations, mortgages and notes, interest at 3.75% to 10.00%,
payable at various dates through 2010. 5,180,189 3,263,405
------------ ------------
73,633,264 64,013,405
Original issue discount (75,059) (62,231)
Current maturities (5,916,423) (4,269,629)
------------ ------------
Total long-term debt before Variable Interest Entities 67,641,782 59,681,545
Total Variable Interest Entities debt - 6,755,078
Current maturities - (879,429)
------------ ------------
Total Variable Interest Entities long-term debt - 5,875,649
------------ ------------
Total long-term debt $ 67,641,782 $ 65,557,194
============ ============
The prime rate was 4.00% and LIBOR was 1.09% at March 31, 2004.
Valley was in compliance with the covenants under its credit facility for
the periods ended June 30, 2003 and March 31, 2004.
The weighted average interest rate for substantially all of the borrowings
under the Valley credit facility, excluding the effect of interest rate swap
agreements, was 3.47% as of March 31, 2004. As of March 31, 2004, availability
under the revolving loan was approximately $14.1 million, with outstanding
borrowings of approximately $51.0 million and outstanding letters of credit of
approximately $2.4 million. The credit facility is secured by all of the
Valley's assets. The revolving loan is used primarily to fund acquisitions.
Valley is not required to make principal payments on outstanding balances of the
revolving loan as long as
- 11 -
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
Valley's discretion, plus an applicable spread.
The loan agreement for the credit facility, as amended, contains various
financial covenants applicable to Valley, including covenants requiring minimum
fixed charge coverage, maximum funded debt to EBITDA, and minimum net worth. As
of March 31, 2004, Valley was in compliance with these covenants and believes
that it will continue to be in compliance through at least the next twelve
months. Valley believes that if and when the put/call option agreement described
in Note 7 is exercised it will have adequate capital resources available to fund
the acquisition and that it will continue to be in compliance with its debt
covenant requirements.
The Variable Interest Entities debt, in the amount of $6.8 million,
consists primarily of asset-backed mortgages for real estate. This debt has
various interest rates ranging from 3.5% to 7.0% and various maturities from
2005 to 2016. Certain mortgages are personally guaranteed by the Chairman.
On April 30, 2004, Valley entered into an amended credit agreement
establishing a $75 million revolving note with a maturity of five years,
replacing the previous revolving and term notes. Covenant requirements under the
new agreement are not significantly different than under the previous agreement.
The schedule of maturities of the Company's debt for the next five years
and thereafter is as follows:
VARIABLE
INTEREST
FISCAL YEAR ENDING JUNE 30, VALLEY ENTITIES COMPANY
- --------------------------------- ----------- ----------- -----------
Remainder of 2004 $ 400,712 $ 361,671 $ 762,383
2005 753,723 858,817 1,612,540
2006 546,551 864,040 1,410,591
2007 189,580 851,994 1,041,574
2008 134,665 827,586 962,251
2009 60,811,708 736,429 61,548,137
Thereafter 1,114,235 2,254,541 3,368,776
----------- ----------- -----------
Total $63,951,174 $ 6,755,078 $70,706,252
=========== =========== ===========
6. EARNINGS PER SHARE
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.
- 12 -
Three Months Ended Nine Months Ended
March 31, March 31,
----------------------- -----------------------
2003 2004 2003 2004
---------- ---------- ---------- ----------
Net earnings available for common stock $2,173,664 $3,765,500 $3,665,261 $6,466,110
========== ========== ========== ==========
Basic earnings per common share:
Weighted average common shares 9,347,584 9,378,400 9,347,820 9,363,970
========== ========== ========== ==========
Basic earnings per common share $ 0.23 $ 0.40 $ 0.39 $ 0.69
========== ========== ========== ==========
Diluted earnings per common share:
Weighted average common shares 9,348,303 9,378,400 9,347,820 9,363,970
Shares issuable from assumed conversion of common
stock equivalents 35,510 84,585 45,497 51,443
---------- ---------- ---------- ----------
Weighted average common and common equivalent shares 9,383,813 9,462,985 9,393,317 9,415,413
========== ========== ========== ==========
Diluted earnings per common share $ 0.23 $ 0.40 $ 0.39 $ 0.69
========== ========== ========== ==========
Options to purchase 1,500 and 278,416 shares of common stock were
outstanding during the quarter and nine months ended March 31, 2004,
respectively, and 311,200 and 241,000 for the quarter and nine months ended
March 31, 2003, 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 their
transportation, storage, production or use. Valley, 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. Valley maintains liability
insurance policies with insurers in such amounts and with such coverages and
deductibles as Valley believes are reasonable and prudent. However, there can be
no assurance that such insurance will be adequate to protect Valley 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 Valley.
During fiscal year 2003, Valley incurred charges of $0.5 million related
to the severance payments for certain terminated employees as part of Valley's
organization strengthening program. As of June 30, 2003, Valley had $0.2 million
accrued for severance payments. Substantially all of these payments had been
made as of March 31, 2004.
Valley 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 independent distributor. Valley 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, Valley 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. Valley concluded that the put/call
agreement meets the scope exception requirements of FIN 46R for an entity deemed
to be a business.
- 13 -
Valley leases buildings and equipment and rents cylinders from related
parties, including the sole shareholder prior to Valley's initial public
offering and corporations owned by such sole shareholder and former officers of
Valley. Valley concluded that the related party lease agreement entities
("Variable Interest Entities") are required to be consolidated, as of March 31,
2004, pursuant to common control provisions under FIN 46R (see Note 8). These
lease agreements have various maturity dates through April 2013. For the nine
months ended March 31, 2004 and 2003, Valley incurred expenses under these
leases of $1,692,939 and $1,778,022, respectively. Valley entered into an
agreement, effective March 31, 2004, to cancel the lease obligation for one
particular property that Valley had discontinued use of. Under this agreement,
Valley paid $212,058 which was included in operating expenses for the quarter
ended March 31, 2004 to cancel the remaining term of lease and the remaining
obligation of $578,952.
In September 1991, in connection with the purchase by Valley of certain
assets of Praxair, Inc. (Praxair), Valley, 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 Valley's reorganization. Pursuant to this agreement, if at any
time during the term of the agreement Valley wishes to accept a third party
offer to purchase all or a material part of the assets of Valley, or Mr. West
and his affiliates wish to accept an offer to purchase shares of capital stock
of Valley (the Capital Stock) owned by them in a transaction that would result
in Mr. West and his affiliates collectively owning less than 51% of Valley'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 Valley, 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 Valley's issued and outstanding
shares of Common Stock, (b) Valley wishes to sell all or a material part of its
assets, or (c) Valley 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 Valley'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.
8. VARIABLE INTEREST ENTITIES
Valley leases buildings and equipment and rents cylinders under operating
leases from related parties, collectively referred to as "Variable Interest
Entities", primarily including West Rentals, Inc., GEW Real Estate LLC, Real
Equip-Lease LLC and Acetylene Products Corporation. The purpose of these
entities is to purchase, develop, sell and/or lease real estate. Valley has
historically entered into these leases to preserve its capital to support its
growth through acquisition strategy. Valley's Chairman, who is the beneficial
owner of 75% of Valley's common stock, beneficially owns greater than 50% of
each of these entities. These arrangements are supported by a master lease
agreement, as well as certain individual lease agreements, that do not contain a
bargain purchase option, fixed renewal option or residual value guarantee.
Valley has no equity interest in any of the entities included in the Variable
Interest Entities. Additionally, the creditors and beneficial interest holders
of the entities have no recourse to the general credit of the Company.
- 14 -
Based upon current interpretation of FIN 46R, in situations where no
contractual residual value guarantees exist, a related party lease is presumed
to contain an implied residual value guarantee. Therefore, Management concluded
that these entities collectively represent a variable interest entity under the
provisions of FIN 46R. The accounting policies of the Variable Interest Entities
are similar to those of Valley with the addition of the following:
Property, Plant and Equipment
Depreciation is computed, primarily, using declining balance methods as
well as straight line over the estimated useful lives of the properties as
follows:
Years
-----
Buildings and improvements 15-40
Equipment 5-10
Furniture and fixtures 7
Accordingly, as a result of the implied residual value guarantee, Valley
is considered the primary beneficiary, and has consolidated the historical
balance sheet of the entities as of March 31, 2004, the date of adoption of the
consolidation provision of FIN 46R. All intercompany balances have been
eliminated in consolidation.
- 15 -
The following table shows the consolidating balance sheet of the Company
at March 31, 2004:
A S S E T S As of March 31, 2004
----------- --------------------
Variable
Interest
Valley Entities Company
------------- ------------- -------------
CURRENT ASSETS:
Cash and cash equivalents $ 2,090,684 $ 688,346 $ 2,779,030
Accounts receivable, net of allowance
for doubtful accounts of $814,846
and $784,719, respectively 18,746,472 296,238 19,042,710
Inventory 8,418,252 - 8,418,252
Prepaids and other current assets 989,979 10,000 999,979
Deferred tax assets 2,788,729 - 2,788,729
Refundable taxes 396,117 - 396,117
------------- ------------- -------------
Total current assets 33,430,233 994,584 34,424,817
------------- ------------- -------------
PROPERTY, PLANT AND EQUIPMENT:
Land 55,000 2,625,485 2,680,485
Buildings and improvements 6,638,993 12,031,443 18,670,436
Equipment 89,106,962 639,126 89,746,088
Transportation equipment 16,892,168 145,549 17,037,717
Furniture and fixtures 7,794,308 116,917 7,911,225
------------- ------------- -------------
Total property, plant and equipment 120,487,431 15,558,520 136,045,951
Accumulated depreciation (49,211,658) (3,813,810) (53,025,468)
------------- ------------- -------------
Net property, plant and equipment 71,275,773 11,744,710 83,020,483
------------- ------------- -------------
OTHER ASSETS:
Non-compete agreements, consulting agreements and customer
lists, net of accumulated amortization of $12,501,875 and
$8,430,907, respectively 3,077,155 - 3,077,155
Goodwill 40,870,615 - 40,870,615
Deposits and other assets 1,499,818 12,268 1,512,086
------------- ------------- -------------
Total other assets 45,447,588 12,268 45,459,856
------------- ------------- -------------
TOTAL ASSETS $ 150,153,594 $ 12,751,562 $ 162,905,156
============= ============= =============
- 16 -
LIABILITIES AND STOCKHOLDERS' EQUITY As of March 31, 2004
------------------------------------ --------------------
Variable
Interest
Valley Entities Company
------------- ------------ -------------
CURRENT LIABILITIES:
Current maturities of long-term debt $ 4,269,629 $ 879,429 $ 5,149,058
Accounts payable 7,164,428 240,987 7,405,415
Accrued compensation and employee benefits 4,585,816 - 4,585,816
Interest rate derivatives 2,293,541 - 2,293,541
Other current liabilities 4,128,860 127,868 4,256,728
------------- ----------- -------------
Total current liabilities 22,442,274 1,248,284 23,690,558
LONG-TERM DEBT, less current maturities 59,681,545 5,875,649 65,557,194
DEFERRED TAX LIABILITIES 21,361,034 - 21,361,034
OTHER LONG-TERM LIABILITIES 1,764,537 - 1,764,537
INTEREST RATE DERIVATIVES 977,429 - 977,429
------------- ----------- -------------
Total liabilities 106,226,819 7,123,933 113,350,752
------------- ----------- -------------
COMMITMENTS AND CONTINGENCIES
Minority Interest In Variable Interest Entities - 5,627,629 5,627,629
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, 9,356,834 and 9,363,970
shares, respectively 9,620 - 9,620
Paid-in-capital 18,977,575 - 18,977,575
Retained earnings 28,454,937 - 28,454,937
Accumulated other comprehensive loss (1,829,474) - (1,829,474)
Treasury stock at cost, 263,250 and 203,000 shares, respectively (1,685,883) - (1,685,883)
------------- ----------- -------------
Total stockholders' equity 43,926,775 - 43,926,775
------------- ----------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 150,153,594 $12,751,562 $ 162,905,156
============= =========== =============
9. SEGMENT DATA
Effective with the adoption of FIN 46R in the third quarter of 2004 (See
Note 1), the Company now has two reportable operating segments: Valley and
Variable Interest Entities. Since these are two separate and distinct
businesses, the financial information for each company is maintained and managed
separately. The results of operations and assets for each of these segments are
derived from each company's financial reporting system. All intercompany
activity is eliminated in consolidation.
Identifiable assets by reporting segment are as follows at March 31, 2004:
Valley $150,153,594
Variable Interest Entities 12,751,562
------------
Total assets $162,905,156
- 17 -
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, 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.
Valley'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
Valley's 65 distribution or retail locations. Valley also distributes propane to
industrial and residential customers. Most customers pay a rental fee for use of
company cylinders. Valley owns approximately 546,000 cylinders, which require
minimal maintenance and have useful lives that Valley expects will average 30
years or longer. Valley 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. Valley 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, Valley sells welding equipment and supplies, including
welding machines, wire, fluxes and electrodes and a wide variety of supporting
equipment.
Effective with the adoption of FIN 46R in the third quarter of 2004
(See Note 1), the Company now has two reportable operating segments: Valley and
Variable Interest Entities. Since these are two separate and distinct
businesses, the financial information for each company is maintained and managed
separately. The results of operations and assets for each of these segments are
derived from each company's financial reporting system. All intercompany
activity is eliminated in consolidation.
The Valley reportable segment operates in both the industrial gas and
welding supply industry. Although this segment participates in both of these
markets, the financial information provided to the chief operating decision
maker for making critical decisions or allocating resources does not constitute
segment reporting.
Valley'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. Valley 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 Valley was founded, it has completed 70 acquisitions. Since July 1, 2002,
Valley has acquired one independent distributor, adding approximately $2 million
in annualized sales. Valley 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 Valley as a
result of the consolidation trend in the industry and that Valley will be able
to successfully integrate acquired operations into its base business, generating
growth and operational synergies. Valley expects that acquisitions will be
financed primarily with internally generated funds, and to a much lesser extent,
borrowings under Valley's credit facility and seller financing. While highly
focused on cost leveraging, management believes that Valley's competitive
strengths will allow it to increase sales.
- 18 -
RESULTS OF OPERATIONS
Comparison of Three Months Ended March 31, 2004 and 2003
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 increased 4.6%, or $2.1 million, to $47.9 million for the
three months ended March 31, 2004 from $45.8 million for the three months ended
March 31, 2003. Propane sales increased $0.9 million, reflecting $1.2 million in
price inflation and $0.3 million decrease due to decrease in the volume of
propane sold. The propane volume decline was primarily attributable to the
effect of average temperatures in Valley's market area being approximately 4.7%
higher in comparison to the prior year period, substantially offset by internal
growth. Hard good sales increased $0.9 million from the prior year quarter on a
same store basis, reflecting the effect of Valley's pricing initiatives. Gases
and cylinder revenue represented 70.5% of net sales for the three months ended
March 31, 2004, with hard goods representing 29.5%. In comparison, gases and
cylinder revenue represented 71.0% of net sales for the three months ended March
31, 2003, with hard goods representing 29.0%.
Gross profit, which excludes depreciation and amortization, increased
6.6%, or $1.5 million, to $25.0 million, for the three months ended March 31,
2004 compared to $23.5 million for the three months ended March 31, 2003. Gross
profit as a percentage of net sales was 52.2% for the three months ended March
31, 2004, compared to 51.2% for the three months ended March 31, 2003,
reflecting increases for hard goods, industrial gases and propane partially
offset by a reduction in gross profit percentage for cylinder rent and other.
Valley believes that these results reflect its efforts to implement a more
standardized pricing policy for its products and services.
Operating and administrative expenses decreased 3.3%, or $0.5 million,
to $15.5 million for the three months ended March 31, 2004. This reduction
reflected, primarily, the results of Valley's cost reduction initiatives and was
partially offset by the cancellation of a related party lease obligation of $0.2
million. The majority of these expense reductions were in the areas of wages,
benefits, legal, professional and other general expenses. Operating and
administrative expenses as a percentage of sales were 32.4% for the three months
ended March 31, 2004 compared to 35.1% for the three months ended March 31,
2003.
Depreciation and amortization expense decreased $0.2 million for the
three months ended March 31, 2004, compared to the three months ended March 31,
2003, primarily as a result of certain intangibles becoming fully amortized
during the last twelve months.
Interest expense decreased $0.2 million to $1.4 million for the three
months ended March 31, 2004 compared to $1.6 million for the three months ended
March 31, 2003. Reflected in interest expense was a decrease of $23,750 and an
increase of $14,634 for the three months ended March 31, 2004 and March 31, 2003
to record changes in the fair market value of Valley's interest rate swap
agreements under SFAS No. 133. The increase related to the changes in market
value of the swap agreements was more than offset by the effect of the declining
debt balances.
Valley's effective tax rate for the three months ended March 31, 2004
was 39.0% and was consistent with the rate realized for the year ended June 30,
2003.
Net earnings increased to $3.8 million for the three months ended March
31, 2004 compared to $2.2 million for the prior year quarter reflecting,
primarily, the effect of increased gross profit and reduced expenses.
- 19 -
Comparison of Nine months Ended March 31, 2004 and 2003
Net sales increased 1.3%, or $1.5 million, to $119.5 million for the
nine months ended March 31, 2004 from $118.0 million for the nine months ended
March 31, 2003. Acquisitions made since the prior year quarter contributed $0.1
million of increase in net sales for the nine months ended March 31, 2004, while
same store sales increased $1.4 million or 1.2% for such nine month period.
Propane sales increased $3.2 million on a same store basis compared to the prior
year period, reflecting $3.1 million in price inflation and $0.1 million
increase due to increase in the volume of propane sold. Same store bulk propane
gallons sold were down 0.4% for the nine months reflecting reduced demand due to
warmer average temperatures than experienced in the prior period more than
offsetting growth in Valley's customer base. Hard good sales decreased $1.9
million from the prior year nine months on a same store basis, reflecting the
effect of the softness in the economy during the period and Valley's decision to
reduce activity with selective low margin accounts. Gases and cylinder revenue
represented 66.9% of net sales for the nine months ended March 31, 2004, with
hard goods representing 33.1%. In comparison, gases and cylinder revenue
represented 64.7% of net sales for the nine months ended March 31, 2003, with
hard goods representing 35.3%.
Gross profit, which excludes depreciation and amortization, increased
2.8%, or $1.7 million, to $63.6 million, for the nine months ended March 31,
2004 compared to $61.9 for the nine months ended March 31, 2003. Acquisitions
made since the prior year quarter contributed $0.1 million of increase in gross
profit while same store gross profit increased $1.6 million. Gross profit as a
percentage of net sales was 53.2% for the nine months ended March 31, 2004,
compared to 52.4% for the nine months ended March 31, 2003, reflecting,
primarily, improvements in gross profits for hard goods as average price
realization increased. Valley believes that these results reflect its efforts to
implement a more standardized pricing policy for its products and services.
Operating and administrative expenses decreased 3.8%, or $1.7 million,
to $43.1 million for the nine months ended March 31, 2004. This reduction
reflected, primarily, the results of Valley's cost reduction initiatives and was
partially offset by the cancellation of a related party lease obligation of $0.2
million. The majority of these expense reductions were in the areas of wages,
benefits, legal, professional and other general expenses. Operating and
administrative expenses as a percentage of sales were 36.1% for the nine months
ended March 31, 2004 and compared to 38.0% for the nine months ended March 31,
2003.
Depreciation and amortization expense decreased $0.3 million for the
nine months ended March 31, 2004, compared to the nine months ended March 31,
2003, primarily as a result of certain intangibles becoming fully amortized.
Interest expense decreased $0.6 million to $4.4 million for the nine
months ended March 31, 2004 compared to $5.0 million for the nine months ended
March 31, 2003, reflecting primarily the effect of reduced debt balances.
Included in interest expense was a decrease of $90,378 and $23,962 for the nine
months ended March 31, 2004 and March 31, 2003, respectively, to record changes
in the fair market value of Valley's interest rate swap agreements under SFAS
No. 133.
Valley's effective tax rate for the nine months ended March 31, 2004
was 39.0% and was consistent with the rate realized for the year ended June 30,
2003.
Net earnings increased to $6.5 million for the nine months ended March
31, 2004 compared to $3.7 million for the nine months ended March 31, 2003,
reflecting, primarily, the effect of increased gross profit and reduced
operating and interest expense.
LIQUIDITY AND CAPITAL RESOURCES
Historically, Valley 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.
- 20 -
At March 31, 2004, the Company had working capital of approximately
$10.7 million, compared to $12.3 million as of March 31, 2003, reflecting
primarily the reduction in inventory of $1.6 million. Funds provided by
operations for the nine months ended March 31, 2004 were approximately $15.3
million, compared to $10.4 million for the nine months ended March 31, 2003.
This increase of $5.0 million is primarily attributable to the $2.8 million
increase of net earnings and receipt of an income tax refund of $1.2 million.
Funds used for investing activities were approximately $5.1 million for the nine
months ended March 31, 2004, consisting primarily of capital spending, compared
to $5.6 million for the nine months ended March 31, 2003. Valley anticipates
capital spending for fiscal year 2004 to be approximately $6.5 million. Funds
used for financing activities for the nine months ended March 31, 2004 were
approximately $9.3 million from net payments of debt, compared to $4.5 million
for the nine months ended March 31, 2003. The Company's cash balance increased
$1.0 million during the nine months ended March 31, 2004 to $2.8 million.
The weighted average interest rate for substantially all of the
borrowings under the credit facility was 3.47% as of March 31, 2004. As of March
31, 2004, availability under the revolving loan was approximately $14.1 million,
with outstanding borrowings of approximately $51.0 million and outstanding
letters of credit of approximately $2.4 million. The credit facility is secured
by all of Valley's assets. The revolving loan is used primarily to fund
acquisitions. Valley 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 Valley's discretion, plus an
applicable spread.
The loan agreement for the credit facility, as amended, contains
various financial covenants applicable to Valley, including covenants requiring
minimum fixed charge coverage, maximum funded debt to EBITDA, and minimum net
worth. As of March 31, 2004, Valley was in compliance with these covenants and
believes that it will continue to be in compliance through at least the next
twelve months.
The Variable Interest Entities debt, in the amount of $6.8 million,
consists primarily of asset-backed mortgages for real estate. This debt has
various interest rates ranging from 3.5% to 7.0% and various maturities from
2005 to 2016. Certain mortgages are personally guaranteed by the Chairman.
On April 30, 2004, Valley entered into an amended credit agreement
establishing a $75 million revolving note with a maturity of five years,
replacing the previous revolving and term notes. Covenant requirements under the
new agreement are not significantly different than under the previous agreement.
Valley 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 March 31, 2004 was $3.3 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 Valley's credit facility.
Valley 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 Valley's debt portfolio. Valley 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, Valley enters into agreements to
effectively convert variable-rate debt to fixed-rate debt. As of March 31, 2004,
Valley 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%.
- 21 -
Valley 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 independent distributor. Valley 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, Valley 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. Valley concluded that the put/call
agreement meets the scope exception requirements of FIN 46R for an entity deemed
to be a business.
Valley leases buildings and equipment and rents cylinders from related
parties, including the sole shareholder prior to Valley's initial public
offering and corporations owned by such sole shareholder and former officers of
Valley. Valley concluded that the related party lease agreement entities
("Variable Interest Entities") are required to be consolidated, as of March 31,
2004, pursuant to common control provisions under FIN 46R (see Note 8). These
lease agreements have various maturity dates through April 2013. For the nine
months ended March 31, 2004 and 2003, Valley incurred expenses under these
leases of $1,692,939 and $1,778,022, respectively. Valley entered into an
agreement, effective March 31, 2004, to cancel the lease obligation for one
particular property that Valley had discontinued use of. Under this agreement,
Valley paid $212,058 which was included in operating expenses for the quarter
ended March 31, 2004 to cancel the remaining term of lease and the remaining
obligation of $578,952.
Valley 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 Valley's requirements for
operating funds, capital expenditures and future acquisitions for at least the
next twelve months. Valley has no plans at this time to issue additional shares
of common stock.
The schedule of maturities of the Company's debt for the next five
years and thereafter is as follows:
VARIABLE
INTEREST
FISCAL YEAR ENDING JUNE 30, VALLEY ENTITIES COMPANY
- --------------------------- ------------ -------------- -----------
Remainder of 2004 $ 400,712 $ 361,671 $ 762,383
2005 753,723 858,817 1,612,540
2006 546,551 864,040 1,410,591
2007 189,580 851,994 1,041,574
2008 134,665 827,586 962,251
2009 60,811,708 736,429 61,548,137
Thereafter 1,114,235 2,254,541 3,368,776
----------- ---------- -----------
Total $63,951,174 $6,755,078 $70,706,252
=========== ========== ===========
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 Valley'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 nine months of fiscal 2004.
- 22 -
New Accounting Standards
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.
In December 2003, the FASB issued FIN 46R to further clarify the
standard. As required under the most recent deferral, Valley adopted FIN 46R in
the current quarter. Valley analyzed FIN 46R and it's impact to the financial
statements with regard to the put/call agreement as well as related party lease
agreements discussed in Note 7. Valley concluded that the put/call agreement
meets the scope exception requirements of FIN 46R for an entity deemed to be a
business. In addition, Valley concluded that the related party lease agreement
entities ("Variable Interest Entities") are required to be consolidated with
Valley's financial statements, as of March 31, 2004, pursuant to the common
control provisions under FIN 46R (see Note 8).
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 Valley's ability to grow sales and 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, its ability to meet its
covenant requirements under its credit facility and its anticipated capital
spending during fiscal year 2004. Valley 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 Valley or any other
person that the results expressed will be achieved. Important risk factors that
may affect Valley'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 Valley's 10-K for the fiscal year ended June 30, 2003 and
Valley's ability to (i) accurately identify attractive acquisition targets and
make accurate predictions regarding the performance of those businesses if
integrated into Valley'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, Valley'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
Valley's products, changes in the economy, monetary or fiscal policies, changes
in laws and regulations affecting Valley's business, inflation and fluctuations
in interest rates.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The table below provides information about Valley'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
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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.
The information set forth in the table below reflects the effect of
Valley's new credit facility, the inclusion of the Variable Interest Entities
debt maturities, the elimination of intercompany operating lease commitments and
the change in the fair value of the swap agreements. This change in fair value
is primarily attributable to the decrease in time to expiration of the
agreements. There was no significant change to the composition of Valley's fixed
and variable rate long-term debt or interest rate swaps during the nine months
ended March 31, 2004. As of March 31, 2004, Valley'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 Fair
2004 2005 2006 2007 2008 After Total Value
----------- ----------- ---------- ----------- ----------- ------- ------- ----------
(In Thousands)
Liabilities
Long term debt
Fixed rate $ 3,278 $2,006 $ 1,625 $ 1,399 $ 1,018 $ 3,218 $12,544 $ 11,043
Average interest rate 4.03% 5.30% 6.15% 6.11% 5.75% 5.93%
Variable rate $ 2,250 - - - - $60,750 $63,000 $ 63,000
Average interest rate 3.75% - - - - 3.75%
Interest rate swaps
Variable to fixed $ 55,000 $25,000 - - - - $ (3,271)
Average pay rate 5.99% 5.58% - - - -
Average receive rate 1.20% 1.20% - - - -
Commitments
Operating leases $ 3,185 $ 3,007 $ 2,678 $ 2,445 $ 2,314
Intercompany elimination (2,230) (2,158) (2,150) (2,150) (2,089)
------- ------- ------- ------- -------
Company total 956 849 528 295 224
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 Valley 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 Valley'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.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
3.1 Articles of Amendment (1)
3.2 Bylaws (1)
4.1 Form of Certificate for Common Stock (1)
10.1 Third Amended and Restated Credit Agreement dated April 30,
2004
10.2 Amendment dated March 31, 2004 to Lease Agreement dated as of
November 5, 1997 between Valley and West Rentals, Inc.
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
(1) Incorporated by reference to Valley's Registration Statement
on Form S-1, Reg. No. 333-19973
(b) Reports on Form 8-K
Valley furnished a Form 8-K on February 4, 2004 reporting under Item 7
and Item 12 its financial results for the quarter ended December 31,
2003.
Valley furnished a Form 8-K on April 28, 2004 reporting under Item 7
and Item 12 its financial results for the quarter ended March 31, 2004.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
VALLEY NATIONAL GASES INCORPORATED
May 24, 2004 /s/ Robert D. Scherich
-----------------------------------
Robert D. Scherich
Chief Financial Officer and Duly
Authorized Officer
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