UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission File No. 000-29226

Valley National Gases Incorporated

200 West Beau Street, Suite 200
Washington, Pennsylvania 15301

(724) 228-3000

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  þ          No  o

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.)

Yes  o          No  þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

VALLEY NATIONAL GASES INCORPORATED

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

VALLEY NATIONAL GASES INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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VALLEY NATIONAL GASES INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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VALLEY NATIONAL GASES INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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VALLEY NATIONAL GASES INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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VALLEY NATIONAL GASES INCORPORATED

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(unaudited)

For the periods ended June 30, 2004 and March 31, 2005

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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VALLEY NATIONAL GASES INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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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 wholly-owned subsidiaries and entities required to be consolidated pursuant to Financial Accounting Standards Board Interpretation No. 46R, “Consolidation of Variable Interest Entities,” (“FIN 46R”) effective March 31, 2004. The term “Valley” as used throughout this document is used to indicate Valley National Gases Incorporated and wholly-owned subsidiaries. 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. Effective with this adoption, the Company has two reportable segments: Valley and Variable Interests Entities.

     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 (the “SEC”). 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 the Company’s audited consolidated financial statements for the year ended June 30, 2004.

2. ORGANIZATION

     Valley 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 63 distribution or retail locations. In addition, Valley distributes propane to industrial and residential customers. Welding equipment and supplies sales include welding machines, wire, fluxes and electrodes, as well as a wide variety of supporting equipment. Valley, through its consolidated subsidiaries, has been in operation since 1958 and currently operates in 11 states.

3. SUMMARY OF SIGNIFICANT 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 2004 Annual Report on Form 10-K filed on September 29, 2004. There have been no significant changes in these policies or the application thereof during the first nine months of fiscal 2005.

TRADE RECEIVABLES

     Valley makes estimates of the collectability of its trade receivables on a monthly basis. Management has established an allowance for doubtful accounts to adjust the carrying value of trade receivables to fair value based on an estimate of the amount of trade receivables that are deemed uncollectible. The allowance for doubtful accounts is determined based on historical experience, economic trends and management’s knowledge of significant accounts.

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     The roll-forward of the allowance for doubtful accounts as of March 31 is as follows:

INVENTORY

     Inventory is carried at the lower of cost or market, cost being determined by the first-in, first-out method. Valley estimates reserves for product loss and obsolete inventory on a quarterly basis. Inventory amounts are removed from inventory on a first in first out basis.

     The components of inventory are as follows:

COST OF PRODUCTS SOLD, EXCLUDING DEPRECIATION

     Cost of products sold principally consists of direct material costs and freight-in for bulk gas purchases and hardgoods (welding supplies and equipment, safety products and industrial tools and supplies).

OPERATING, DISTRIBUTION AND ADMINISTRATIVE EXPENSES

     Operating, distribution and administrative expenses consist of labor and overhead associated with the purchasing, marketing and distribution of the Company’s products, as well as costs associated with a variety of administrative functions such as legal, treasury, accounting and tax, and facility-related expenses.

DEPRECIATION

     The Company recognizes depreciation expense on all its property, plant and equipment in the consolidated statement of earnings line item “Depreciation”.

SHIPPING AND HANDLING FEES AND DISTRIBUTION COSTS

     The Company recognizes delivery and freight charges to customers as elements of net sales. Costs of third-party freight are recognized as cost of products sold. The majority of the costs associated with the distribution of the Company’s products, which include direct labor and overhead associated with filling, warehousing and delivery by Company vehicles, is reflected in operating, distribution and administrative expenses and amounted to $16,271,000 and $15,614,000 for the nine months ended March 31, 2005 and 2004, respectively. The Company conducts multiple operations out of the same facilities and does not allocate facility-related expenses to each operational function. Accordingly, there is no facility-related expense in the distribution costs disclosed above. Depreciation expense associated with the Company’s delivery fleet amounted to $1,092,000 and $720,000 for the nine months ended March 31, 2005 and 2004, respectively, and is included in depreciation expense.

     Third party freight costs relating to the delivery of products to customers totaled $422,391 and $529,389 for the nine months ended March 31, 2005 and 2004,

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respectively, and were classified as operating, distribution and administrative expenses.

     The Company has classified cost of deliveries by its employees and vehicles as operating, distribution and administrative expense which amounted to $11,829,000 and $11,088,000 for the nine months ended March 2005 and 2004, respectively.

ACCOUNTING FOR STOCK-BASED COMPENSATION

     Valley has a stock-based compensation plan. Valley accounts for this plan under the recognition and measurement provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”. Under these provisions, stock-based employee compensation cost is not reflected in net income 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.

     The Company continues to account for stock option grants under APB Opinion No. 25, and has not elected to expense these options. If Valley had elected to recognize compensation cost for these stock options based on the fair value method set forth in Statement of Financial Accounting Standards (“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:

INCOME TAXES

     Income taxes are accounted for in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes”, under which deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the estimated tax rate at the date of reversal. These differences are classified as current or non-current based upon the classification of the related asset or liability. For temporary differences that are not related to an asset or liability, classification is based upon the expected reversal date of the temporary difference. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. No valuation allowances were required for the deferred tax assets as of March 31, 2005 and June 30, 2004. The Company estimates and records additional tax expense based on uncertain tax positions taken by the Company within statutory limitations. This estimate is adjusted when tax audits are completed or when the statute of limitations expires on those recorded tax positions.

VARIABLE INTEREST ENTITIES

     The Company leases buildings and equipment and rents cylinders from West Rentals, Inc., G.E.W. Real Estate LLC, RealEquip-Lease LLC, Equip-Lease Co. and Acetylene Products Corp., entities that are engaged primarily in the purchase, development, sale and/or lease of real estate and that are controlled by Gary West, our

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Chairman and principal shareholder. Under Financial Accounting Standards Board Interpretation No. 46R, “Consolidation of Variable Interest Entities,” (“FIN 46R”) effective March 31, 2004, we consolidated the financial statements of these related entities.

SUPPLEMENTAL CASH FLOW INFORMATION

4. GOODWILL AND 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, at June 30, Valley evaluates the intangible assets for impairment with any resulting impairment reflected as an operating expense. Valley’s intangibles, other than goodwill, consist of noncompete agreements, consulting agreements and customer lists for which Valley has assigned definite lives equal to the terms of the agreements. As of June 30, 2004 and March 31, 2005, Valley’s noncompete agreements, consulting agreements and customer lists are summarized as follows:

     Amortization expense for the three months ended March 31, 2005 and 2004 totaled $243,003 and $398,378, respectively and the nine months ended March 31, 2005 and 2004 totaled $865,280 and $1,297,015, respectively. Estimated amortization expense for the remainder of fiscal 2005 as of March 31, 2005 and the next five fiscal years is summarized as follows:

5. 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.

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Stock options to purchase 12,920 shares of common stock for the nine months ended March 31, 2005 were excluded from the diluted net income per share calculation because their effect would be anti-dilutive. No such shares were excluded for the three months ended March 31, 2005. For the quarter and nine months ended March 31, 2004, options to purchase 1,500 and 278,416 shares, respectfully, were excluded because their effect would have been anti-dilutive.

6. LEASE OBLIGATIONS

     Valley leases real estate at several locations for use as branch stores and warehouses. Certain equipment is also leased. All of the leases, which are with related and unrelated parties, are classified as operating leases. The lease terms expire at various dates through April 2013, with options to renew for periods of three to five years.

     Certain lease agreements contain rent escalation clauses that are generally based on changes in the consumer price index over the escalation term. These leases are accounted for in accordance SFAS No. 29, “Contingent Rentals”. During the three and nine months ended March 31, 2005, we evaluated these leases and recorded an expense of $31,000 in the consolidated financial statements to straight-line estimated total lease expense including escalation clauses. Our lease arrangements do not include any step rent provisions, capital improvement funding or significant lease concessions. Leasehold improvements are depreciated over the life of the lease or the useful life of the asset, whichever is shorter, which is consistent with the lease term used to recognize rent expense.

     The Company renewed certain lease arrangements during the first nine months of fiscal year 2005. Minimum future rental payments under non-cancelable operating leases, including consideration of expected renewals at estimated payment amounts based on average increases over the last three years, for the remainder of fiscal year 2005 and each of the next five fiscal years are as follows:

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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 and its subsidiaries, in the ordinary course of business, are threatened with and are subject to claims and are named as defendants in various lawsuits typical of those filed against employers, commercial property owners, welding equipment and supply distributors, manufacturers of specialty gases and distributors of specialty gases and propane which, among other items, seek actual and punitive damages for product liability, personal injury and property damage. In some cases, claimants seek attorney fees in addition to actual and punitive damages. Valley always incurs costs in the handling of claims. Management and employees time is taken up and frequently there are out-of-pocket expenses which are not recoverable or reimbursed by insurance. Valley maintains liability and other insurance coverage against such claims in such amounts 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 liability and claims or that such levels of insurance will continue to be available in the future at economical prices. The Company accrues for estimated losses in accordance with SFAS No. 5, “Contingencies”. Management is of the opinion that the resolution of these claims and lawsuits will not have a material adverse effect on the results of operations, financial condition or cash flows of Valley.

     Valley entered into an option agreement in May 1998 with an independent distributor for the purchase of its business. The agreement provides the distributor the option to sell its business to Valley commencing in May 2002 and ending in May 2005 and provides Valley the option to purchase the business from the distributor commencing in June 2005 and ending in May 2008. Valley estimates the purchase price for the distributor’s business at $11.4 million based upon the purchase price calculation stipulated in the agreement. Of this purchase price, Valley paid $1 million for the option when the agreement was signed, and has recorded this payment in its consolidated balance sheet at March 31, 2005 and June 30, 2004, as a long-term asset. Management believes that the carrying value of the option is not impaired, based upon its estimate of the market value of the independent distributor and that the purchase price formula per the agreement has resulted in a purchase price that approximates fair value when the agreement was executed as well as over the term of the agreement. As a result, no fair market value adjustments have been required. Management estimates it is more likely than not that the put or the call option will be exercised. Management will continue to assess the valuation of this long-term asset as facts and circumstances change, or at least on an interim basis. Valley could incur a loss if the market value of the put option declines or if it is determined that the acquisition will not be completed. 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 and therefore was not consolidated at March 31, 2004 upon

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adoption of the new standard.

     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”) were required to be consolidated, as of March 31, 2004, pursuant to implied variable interest guidance under FSP FIN 46R-5 (see Note 8). These lease agreements have various maturity dates through April 2013.

     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.” These entities include West Rentals, Inc., G.E.W. Real Estate LLC, RealEquip-Lease LLC, Equip-Lease Co. and Acetylene Products Corp. The primary activity of these entities is to purchase, develop, sell and/or lease real estate. Valley has historically entered into these leases with these related parties to preserve its capital to support its strategy of growing through acquisitions. 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 Valley.

     Based upon current interpretation of FSP FIN 46R-5, in situations where no contractual residual value guarantees exist, a related party lease arrangement with these characteristics is presumed to contain an implied residual value guarantee. Therefore, as a result of the implied residual value guarantee, Valley is considered the primary beneficiary of the related party lease agreements, and management concluded that these entities collectively represent a variable

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interest entity under the provisions of FIN 46R. Accordingly, Valley 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.

     The Variable Interest Entities’ debt, in the amount of $8.3 million at March 31, 2005, consists primarily of asset-backed mortgages for real estate. The assets that are collateral for the variable interest entity’s obligations are classified as land and buildings and improvements upon adoption of FIN 46R beginning March 31, 2004. The carrying value of these assets totaled $5,477,000 as of March 31, 2005. This debt has various interest rates ranging from 3.5% to 6.0% and various maturities from 2005 to 2016. Certain mortgages are personally guaranteed by the Chairman of Valley.

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     The following table shows the consolidating balance sheet of the Company at March 31, 2005:

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     The following table shows the consolidating balance sheet of the Company at June 30, 2004:

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     The following table shows the consolidating statement of operations of the Company for the nine months ended March 31, 2005:

     The following table shows the consolidating statement of operations of the Company for the three months ended March 31, 2005:

     No tables are provided to present the consolidating income statement of the Company for the three and nine month periods ended March 31, 2004, because no consolidation was required until the adoption of FIN46R at March 31, 2004.

9. SEGMENT DATA

     Effective with the adoption of FIN 46R and the required consolidation of certain variable interest entities in the third quarter of fiscal year 2004 (See Note 1), the Company has two reportable segments: Valley and Variable Interest Entities. Since these

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are two separate and distinct businesses, the financial information for each business is maintained and managed separately. The results of operations and assets for each of these segments are derived from each business’ financial reporting system. All intercompany activity is eliminated in consolidation.

     The Variable Interest Entities reportable segment, including West Rentals, Inc., G.E.W. Real Estate LLC, RealEquip-Lease LLC, Equip-Lease Co. and Acetylene Products Corp., primarily purchases, develops, sells and leases real estate.

     The Valley reportable segment operates 63 retail and distribution locations in 11 states. All locations offer the same core products of packaged gases, welding equipment and supplies. All locations generally sell to customers in the metal fabrication, construction, general industrial, research and laboratory, hospital and other medical, commercial, agricultural and residential industries. Management considers each of the locations to be an operating segment as defined in SFAS No. 131, however, none of these locations individually meet the quantitative thresholds stated in SFAS No. 131 of 10% of revenue (or profits or assets) to be deemed a reportable segment. Since these operating segments are similar in economic characteristics, long-term gross margin averages, products sold, types of customers, methods of distribution and regulatory environment, management concluded that these operating segments should be aggregated into one reporting segment.

     In February 2005, the Financial Accounting Standards Board (FASB) issued Emerging Issues Task Force (EITF) No. 04-10 “Determining Whether to Aggregate Segments That Do Not Meet the Quantitative Thresholds.” This statement clarifies the aggregation criteria of operating segments as defined in SFAS No. 131. The effective date of this statement is not yet determined, but likely to be effective in late 2005. The Company believes its current segment reporting complies with EITF No. 04-10 and anticipates no significant changes upon adoption.

     Identifiable assets by reporting segment are as follows (See Note 8):