ITEM 1. BUSINESS
OVERVIEW
Valley National Gases, Incorporated (the "Company") 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. The Company's net sales have grown at a compound annual rate of approximately 16% per year since the Company started business in 1958, increasing from $190,000 in that year to $144.5 million in fiscal 2002. In fiscal 2002, gases accounted for approximately 43% of net sales, welding equipment and supplies accounted for approximately 41% of net sales, and cylinder and tank rental accounted for approximately 16% of net sales. The Company is a Pennsylvania corporation.
The Company's gas operations consist primarily of packaging and mixing industrial, medical and specialty gases, such as oxygen, nitrogen and argon, in pressurized cylinders and transporting these cylinders to customers from one of the Company's 71 distribution or retail locations. The Company also distributes propane to industrial and residential customers. Customers pay a rental fee for use of Company cylinders. The Company owns approximately 527,000 cylinders, which require minimal maintenance and have useful lives that the Company expects will average 30 years or longer. The Company selectively participates in the small bulk gas market through the delivery of gases in cryogenic transports and the storage of gases in cryogenic and propane tanks that are also rented to customers. The Company owns approximately 27,000 bulk propane tanks and 414 bulk cryogenic tanks, which have useful lives generally less than those of cylinders. In connection with the distribution of gases, the Company sells welding equipment and supplies, including welding machines, wire, fluxes and electrodes and a wide variety of supporting equipment.
The Company's principal business strategy is to primarily pursue growth through the acquisition of other independent distributors and also through internally generated growth. Since the Company was founded, it has completed 69 acquisitions. Since July 1, 2001, the Company has acquired three independent distributors, adding approximately $6.0 million in annualized sales. Management believes there will continue to be numerous attractive acquisition candidates available to the Company as a result of the consolidation trend in the industry and that the Company will be able to successfully integrate acquired operations into its base business, generating growth and operational synergies. The Company expects that acquisitions will be financed primarily with internally generated funds, borrowings under the Company's credit facility and seller financing. While highly focused on external growth, management believes that the Company's competitive strengths will allow it to increase sales and improve market share in existing markets, while maintaining acceptable levels of profitability.
INDUSTRY OVERVIEW
GENERAL
Historically, the industrial gas distribution business had a base of customers engaged primarily in metal fabrication. In order to better serve these customers, industrial gas distributors have also traditionally sold welding equipment and supplies. As certain sectors of the economy have grown, such as the electronics and chemicals industries, and as new applications for gases have developed, the customer base of the industry has significantly broadened to include almost every major industry, including health care, electronics, chemicals, aerospace, beverages, environmental remediation, food processing, oil and gas, and primary metals, as well as metal fabrication.
The industrial, medical and specialty gas industry consists of two major segments, the bulk segment and the packaged gas segment. The bulk segment supplies gases to customers with large volume requirements, generally by truck or pipeline to a customer's facility, or in some cases by the actual construction of a gas production plant at a customer's facility. This segment is primarily supplied by the major gas producers in the United States, although some large distributors, such as the Company, selectively participate in the small bulk gas market.
The Company competes primarily in the packaged gas segment, which consists of the packaging, mixing and distribution of gases to customers with smaller volume needs or requirements for specially blended or purified gases.
This segment of the industry is estimated to have annual sales of $8 billion in the United States, including welding equipment and supplies. Participants in this segment can be further divided into two groups, large multi-state distributors with annual sales exceeding $25 million, and smaller, privately owned companies with few or single locations and annual sales below $25 million. Management believes that large, multi-state distributors, including the Company, account for approximately 50% of sales in the packaged gas segment. Management estimates that the remaining sales are generated by approximately 850 smaller distributors, many of which it believes are potential candidates for acquisition by larger distributors in the current wave of industry consolidation.
The Company believes that the following characteristics make distribution of packaged gases attractive and different from ordinary industrial distribution: (i) the production, packaging and mixing of gases, as well as the logistics of a large distribution network, require significant knowledge and expertise; (ii) customers expect technical support and assistance in a wide variety of gas applications; and (iii) the currently existing logistical framework is unlikely to change significantly because of the economics associated with the delivery and exchange of cylinders.
INDUSTRY CONSOLIDATION
The industry is undergoing significant consolidation, a trend which began in the early 1980's. The Company believes there are many reasons for this trend, including:
- Many owners are reaching retirement age without qualified succession.
- Small distributors are facing increasing competition from large distributors who sometimes operate with lower cost structures due to economies of scale.
- Changes in technology are providing opportunities for more efficient order entry, inventory and distribution management. Larger distributors are more likely to have the capital and human resources to take advantage of these opportunities, thereby creating greater cost and service reliability advantages.
- Larger customers are demanding additional services from their suppliers in such areas as automated order entry, automated restocking and applications technology support. These services require an investment in technology and equipment that many smaller distributors are incapable or unwilling to make.
- The number and complexity of government regulations is increasing, especially for distributors who produce or package gas products. Complying with new regulations requires expertise, which is difficult for the smaller distributor to access and maintain.
The Company believes this consolidation trend will continue, providing opportunities for those distributors, such as the Company, who have the financial and human resources to acquire and effectively assimilate acquisitions into their base business. The Company believes that distributors who fail to successfully participate in this consolidation trend and achieve a strong or leading position in their market areas will be at a cost disadvantage in the long term.
In recent years, the propane industry has also been undergoing consolidation for many of the same reasons as the industrial gas industry. The Company has been taking advantage of this consolidation trend through selective acquisitions. Except for a few large companies, the propane distribution industry is highly fragmented. Industry sources indicate there are approximately 7,000 retail propane companies operating 13,500 local distribution centers nationwide. The Company believes that the 50 largest propane distributors have less than a 50% share of the approximately nine billion gallon annual market.
ECONOMIC CHARACTERISTICS OF THE INDUSTRIAL GAS INDUSTRY
The industrial gas industry is mature with historical real growth consistent with growth in the overall economy. Gas sales tend to be less adversely impacted by a decline in general economic conditions than the sale of welding equipment and supplies. Management believes that the industrial gas distribution business is relatively resistant to downturns in the business cycle due to the following factors: (i) the industry has a broad and diverse customer base; (ii) gases frequently represent a fixed component of operating costs which does not decline with production levels; (iii) gases are required for maintenance and renovation activities, which tend to increase during economic downturns; (iv) industries less impacted by economic downturns are major purchasers of industrial gases; and (v) gas purchases represent a small portion of operating expenses and, therefore, are not a large cost cutting item. The total market for industrial gases has continued to expand due to strong growth in certain segments, such as electronics, food processing and health care, and significant growth from new applications for industrial gases. However, other activities which use industrial gases, such as metal fabrication, have declined in recent years.
BUSINESS STRATEGY
The Company has implemented a strategic plan designed to (i) sustain profitable growth through the acquisition of key distributors in selected markets, (ii) achieve and maintain a low-cost supplier position in each market segment where the Company participates and (iii) build a unified, cohesive organization, staffed by skilled employees who are responsive to changing customer requirements.
GROWTH THROUGH ACQUISITIONS
Prior Acquisitions. Since the formation of the Company in 1958, the Company has completed the acquisition of 69 distributors. The Company's acquisitions historically have been debt financed, and the Company expects that future acquisitions will be financed, primarily with internally generated funds supplemented with borrowings under the Company's credit facility and seller financing. The Company does not currently intend to issue shares of its common stock or other securities in order to consummate its acquisitions, but may in the future elect to do so.
Acquisition Strategy. The Company intends to continue to focus its acquisition efforts both on market areas where the Company has an existing presence and on new areas where it believes it can achieve a leading presence. However, in the next two (2) fiscal years, the Company will limit its acquisition expenditures and modify its focus to concentrate on the improvement in its operating performance and capital leverage. Over the next five (5) year period, the Company expects its expenditures for acquisitions to be at or near historical levels. The Company believes there are many potential acquisition candidates with operations in these market areas. The Company seeks to achieve operating efficiencies when it acquires a distributor in an overlapping or contiguous market area by closing redundant locations, eliminating a significant portion of the acquired distributor's overhead and consolidating distribution routes. Acquisitions in new markets allow the Company to achieve operating efficiencies through volume discounts on purchases, lower administrative and professional expenses and the purchase of new equipment to replace inefficient equipment and equipment previously leased at relatively expensive lease rates.
The Company believes that its principal competitive advantages in acquiring distributors are (i) its flexibility in structuring acquisitions to meet the concerns of sellers, (ii) its ability to offer sellers a continuing role in management and (iii) its methodology in assimilating acquisitions. The Company also believes it has a well organized acquisition program which utilizes individuals who are well respected in the industry and who have extensive experience in evaluating and negotiating transactions with distributor owners. Based upon the Company's experience, price is not always the primary determining factor in a selling distributor's choice of a buyer. Most owners of independent distributors are sensitive as to whom they sell their business and have concern for the well being of their employees after the acquisition. The Company has found that relationships, existing competitive rivalry and reputation are key elements in the success of acquiring most small, privately-owned distributors. The Company believes it has earned an excellent reputation for treating fairly the
employees of businesses it has acquired, providing them with competitive wages and benefits and opportunities for advancement within the scope of the Company's operations.
Competition for Acquisitions. In seeking to acquire distributors, the Company competes with the major industrial gas producers and national and regional gas distributors. The largest national distributor is Airgas, Inc. ("Airgas") which has been growing through acquisitions since the mid-1980's. The Company expects that Airgas will continue to selectively acquire distributors in the future, and in some situations will compete with the Company for acquisitions. The Company believes that the major industrial gas producers have self-imposed size and geographic constraints with respect to acquiring independent distributors. The Company also believes that some major industrial gas producers have eliminated or limited their acquisition efforts due primarily to the difficulty of resolving management differences, cultural differences and cost structure differences between the small, privately-held business and the large multinational corporation. The smaller, independent distributors with which the Company competes for acquisitions generally do not seek acquisitions beyond their immediate geographic region.
Acquisition Process. The Company has established formal procedures for locating, investigating and valuing potential distributor acquisitions. Criteria used by the Company in evaluating potential acquisitions include (i) a history of profitability, (ii) realistic projections of future performance, (iii) a sales mix which is or has the potential to become weighted towards the sale of gases, which generally have higher profit margins than welding equipment and supplies, (iv) a cylinder gas market which is serviced primarily by independent distributors, as opposed to industrial gas producers and (v) availability of qualified management and key personnel.
Assimilation of Acquired Businesses. The Company believes that the effective assimilation of acquired businesses into the Company's existing operations is critical to the success of the Company's acquisition strategy. The Company has established a transition team comprised of selected personnel with technical expertise in various areas, such as management, purchasing, accounting, operations and sales. This team has primary responsibility for converting the acquired business from its existing methods and practices to those used by the Company. A primary goal of the assimilation process is to instill the Company's culture into the new operations. The Company believes the ability to instill its culture provides a distinct and key advantage. This is partly accomplished by requiring the adoption of uniform policies and procedures which support the Company's operational strategies.
ACHIEVE AND MAINTAIN POSITION AS A LOW-COST SUPPLIER
The Company strives to produce, package and market its products and services at costs are lower than its local market competitors. This is achieved by optimizing branch size and location, requiring adherence to uniform policies and procedures, taking advantage of volume discount purchases not available to smaller competitors and utilizing the Company's management information systems. Where branch size is suboptimal, the Company has developed alternatives to increase size or profitability through growth or product diversification. The Company has implemented a "best practices" program involving identification of the most effective method of performing a specific activity, such as inventory control, and has adopted procedures and training to implement the practice as a standard throughout the Company's operations.
The Company has made significant investments in its management information system as part of its strategy to be a low cost supplier. The Company has installed an integrated company-wide point-of-sale system that provides current information on inventory levels and account status. The Company believes significant cost savings have resulted from the ability to efficiently manage inventory.
The Company believes the selective addition of complementary product offerings will enable it to better serve its diverse, expanding customer base, reach new customers, increase sales in existing locations and leverage its distribution system. The Company has focused in recent years on expanding its propane business. The addition of propane distribution at existing locations has proven advantageous by providing the opportunity to leverage fixed costs at existing locations, thereby creating economies of scale. Certain locations are more attractive for propane distribution, due primarily to residential growth potential, availability of competing sources of energy and existing branch size.
ENHANCE ORGANIZATIONAL STRENGTH
The Company believes that to attract and maintain customers it must have a skilled, responsive work force dedicated to providing excellent service. The Company works to instill a service culture through various operational policies. The Company places special emphasis on customer service, including the ability to quickly respond to technical questions on products and applications. The Company believes this is a key value provided to customers. The Company commits significant resources to training and educating employees through various programs.
The Company strives to fully utilize its existing management resources. In fiscal year 2002 the Company began restructuring certain reporting relationships and responsibilities to place operating and financial responsibility at the local market level, eliminating a layer of management and improving communication. These changes also allowed the Company to redirect the focus of certain key management to increasingly important operating issues, such as logistics, training, budgeting and overall operating performance, that are vital to the Company's growth.
PRODUCTS
Gases packaged and distributed by the Company include oxygen, nitrogen, hydrogen, argon, helium, acetylene, carbon dioxide, nitrous oxide, specialty gases and propane. Specialty gases include rare gases, high-purity gases and blended, multi-component gas mixtures. In connection with the distribution of gases, the Company sells welding equipment and supplies, including welding machines, wire, fluxes and electrodes and a wide variety of supporting equipment.
In fiscal 2002, the Company sold approximately twenty two million gallons of propane to approximately 37,000 residential, commercial and industrial users. The Company believes that it is now the twenty-fourth largest distributor of propane in an industry comprised of approximately 7,500 companies. Propane sales accounted for approximately 18% of net sales in fiscal 2002. Typical residential and commercial uses include conventional space heating, water heating and cooking. Typical industrial uses include engine fuel for forklifts and other vehicles, metal cutting, brazing and heat treating. The distribution of propane is seasonal in nature and sensitive to variations in weather with consumption as a heating fuel peaking sharply in winter months.
While primarily a packager and distributor of gases, the Company also manufactures a portion of its acetylene requirements at its facilities in West Mifflin, Pennsylvania, Canton, Ohio and Eddystone, Pennsylvania. Acetylene is produced through a combination of calcium carbide and water at relatively high temperatures. The reaction of these elements also produces lime as a by-product, which is sold in bulk to customers for a variety of applications. In fiscal 2002, acetylene accounted for approximately 2% of net sales.
The following table sets forth the percentage of the Company's net sales for the fiscal years ended June 30, 2000, 2001 and 2002 for each of the following products and services:
CUSTOMERS
The Company currently has more than 143,000 customers, none of which accounted for more than 1% of net sales in fiscal 2002. In fiscal 2002, approximately 10% of the Company's net sales were to metal production and fabrication customers. Other major industry categories served by the Company include manufacturing 14%, industrial 9%, construction 9%, services 7%, health care 5%, mining, oil and chemicals at 4% of net sales.
The customer base also includes smaller distributors in close proximity to one of the Company's larger facilities who find it economically advantageous to source certain products from the Company.
The Company believes the industry has been characterized by relatively high customer loyalty because of the importance of quality service and personal relationships. This characteristic has made it difficult for new entrants in a market to acquire existing customers. However, service requirements for certain large customers are becoming more demanding and sophisticated and the Company expects that this will result in more account turnover in the future.
For some larger volume customers, bulk cryogenic products are delivered in transports to cryogenic tanks at the customer location. The Company serves small bulk customers only where it can compete effectively with producers, primarily on the basis of service and the supply of other products, such as cylinder gases and hard goods.
SALES AND MARKETING
The distribution of most packaged gases is most economically performed within approximately a thirty-mile radius of the product packaging or inventory location due primarily to costs associated with delivery of cylinders. Therefore, the estimated national market of $8 billion consists of hundreds of regional markets with an estimated annual size of $5 million to $100 million. The Company believes the average market size is approximately $25 million. The Company solicits and maintains business primarily through a direct selling effort using an experienced sales force of approximately 106 sales representatives. Sales representatives receive continuous training so that they are knowledgeable about gas and product performance characteristics and current application technology. On average, the Company's sales representatives have more than ten years of industry experience. Sales representatives are paid a base salary and commissions based upon account profit margin. Efforts are focused on accounts generating sales of high margin products. Occasionally, sales representatives make joint sales calls with Company suppliers to address difficult or innovative application requirements. The Company has been testing both telemarketing and catalog solicitation at selected locations to attract new accounts. The Company believes that electronic commerce conducted through the internet, ("e-commerce"), will become an important method in attracting and maintaining some customers in the future. The Company plans to continue developments in this area.
Smaller accounts are usually served from "walk in" retail locations, where gases and hard goods are picked up rather than delivered. Each retail location contains a showroom to allow customer easy access to equipment and supplies. Branch locations are chosen on the basis of local market distribution logistics rather than suitability for "walk in" retail sales. The Company's advertising efforts are limited primarily to the residential propane market as management does not consider advertising to be a significant factor in generating sales.
COMPETITION
Competition is almost always on a regional market basis and is based primarily on customer loyalty, service and, to a lesser extent, price. Most regional markets have between three and six competitors, the majority of whom are small independent companies, with one or two competitors having a significantly higher market share than the others. The Company competes in many markets throughout West Virginia, Pennsylvania, Kentucky, Ohio, Virginia, Tennessee, Maryland, Delaware, New Jersey, Wisconsin and Florida. The Company believes it has a strong or leading position in most of the markets it serves.
While the Company competes with the distribution subsidiaries of the major industrial gas producers, the Company does not believe that the production of industrial gas provides these producers with a significant competitive advantage because in most cases, the cost for base gases represents a relatively minor component of the total selling price in comparison to the packaging and distribution expenses.
SUPPLIERS
The Company purchases industrial gases pursuant to short-term supply arrangements and open purchase orders with three of the five major gas producers in the United States. One such producer accounted for approximately 52% of the Company's gas purchases in fiscal 2002. If any of these arrangements were terminated, the Company believes it would be able to readily secure an alternate source of supply.
The Company purchases welding equipment and consumable supplies from approximately 67 primary vendors, of which purchases from the top five vendors represented approximately 63% of total purchases in fiscal 2002. Purchases from major vendors are made pursuant to purchase orders that are cancelable by the Company upon minimal notice. With supplier overcapacity in most product lines and high competitive rivalry for volume purchasers, large distributors such as the Company are generally able to purchase welding equipment and supplies from the vendor of their choice. This enables the Company to participate in vendor discount and rebate programs and obtain products at competitive costs.
The Company purchases propane from pipeline sources at various supply points in its market areas, generally on a short-term basis at prevailing market prices. The Company historically has been able to adjust prices to customers to reflect changes in product cost, which varies with season and availability. The Company is not dependent upon any single supplier for propane and supplies have historically been readily available. A significant portion of the Company's propane sales are made to industrial customers. As a result, the Company's sales are less seasonal than those of many competitors who focus on the residential segment. Because of the Company's off-peak season demand, the Company believes that it would be less likely than other distributors to be placed on allocation by suppliers during a period of tight supply and accordingly would receive adequate supplies to meet customer demand.
EMPLOYEES
At June 30, 2002, the Company employed 699 people. Approximately 14% were covered by collective bargaining agreements. Historically, the Company has not been adversely affected by strikes or work stoppages. Approximately 62% of the Company's employees are hourly workers. The Company believes it has a skilled and motivated work force and that its relationship with employees is good. The Company believes that its wages and benefits, which reflect local conditions, are competitive with those provided by major competitors. All of the Company's hourly employees are currently paid wages at a rate that exceeds the current, and federally mandated increases in, the minimum wage. The Company believes it would not be materially impacted by future increases in the minimum wage.
The Company believes that continuing education is necessary for its employees to achieve and maintain the skills required to be effective in today's competitive environment. The Company provides a variety of training programs to its employees through modules maintained on the internet. This provides consistent, low-cost training across the entire organization. Key suppliers also provide employees product training relating primarily to welding and gas application technology at the Company's various locations.
REGULATORY MATTERS
The Company is subject to federal and state laws and regulations adopted for the protection of the environment, and the health and safety of employees and users of its products. In addition, the Company voluntarily complies with applicable industry safety standards. Management believes that the Company is in substantial compliance with all such laws, regulations and standards currently in effect and that the cost of compliance with such laws, regulations and standards will not have a material adverse effect on the Company.
PRODUCT LIABILITY AND INSURANCE
The Company maintains insurance coverage which it believes to be adequate. The nature of the Company's business may subject it to product liability lawsuits. To the extent that the Company is subject to claims which exceed or are outside of its liability insurance coverage, such suits could have a material adverse effect on the Company. The Company has not suffered any material losses from such lawsuits in the past.
ITEM 2.
ITEM 2. PROPERTIES
The Company owns approximately 527,000 cylinders, 27,000 bulk propane tanks and 414 bulk cryogenic tanks, generally ranging in size from 250 gallons to 11,000 gallons. Most cylinders and storage tanks are located at customer sites. Cylinders require minimal maintenance and have useful lives that the Company expects will extend on average for 30 years or longer. Bulk tanks have useful lives generally less than those of cylinders, however, if well maintained their useful life can be over 30 years.
The Company has 70 industrial gas and welding supply distribution locations in 11 states, 32 of which also package and distribute propane. A typical location has two acres of property, 5,000 square feet of space used to warehouse hard goods, 5,000 square feet of space used for gas filling and cylinder storage and 2,000 square feet of space used for a retail showroom. The Company's headquarters are located in 20,000 square feet of leased space in Wheeling, West Virginia.
Most of the specialty gas products sold by the Company are purified, packaged and mixed at the Company's facility in Cranberry Township, Pennsylvania. This facility processes approximately 25,000 cylinders per month, but has capacity to process approximately 100% more volume, which the Company believes would be sufficient to meet estimated future volume requirements.
All of the Company's facilities are leased on terms which the Company believes are consistent with commercial rental rates prevailing in the surrounding rental market. All of the Company's major facilities are leased under long-term arrangements. The Company believes that its facilities are adequate for its needs and that its properties are generally in good condition, well maintained and suitable for their intended use.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
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. The Company, in the ordinary course of business, is threatened with or is named as a defendant in various lawsuits which, among other items, seek actual and punitive damages for product liability, personal injury and property damage. The Company has not to date suffered any material loss as a result of any such lawsuit. The Company maintains liability insurance policies with insurers in such amounts and with such coverages and deductibles as the Company believes is reasonable and prudent. However, there can be no assurance that such insurance will be adequate to protect the Company from material expenses related to such personal injury or property damage or that such levels of insurance will continue to be available in the future at economical prices. There are no known claims or known contingent claims that management believes are likely to have a material adverse effect on the results of operations or financial condition of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended June 30, 2002.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the American Stock Exchange under the symbol "VLG".
The range of daily closing prices per share for the Company's common stock from July 1, 2000 to June 30, 2002 was:
The reported last sale price of the company's common stock on the American Stock Exchange on September 12, 2002 was $6.20.
On September 12, 2002, there were 97 record holders of the Company's common stock.
The Company has not paid any cash dividends since its initial public offering, and does not anticipate that it will pay dividends in the foreseeable future. The Company currently intends to retain future earnings, if any, to provide funds for the growth and development of the Company's business.
In addition, the Company's existing credit facilities prohibit the payment of cash or stock dividends on the Company's capital stock without the bank's prior written consent. See Item 7 -- "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and Note 6 of Notes to Consolidated Financial Statements contained in Item 14.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Selected consolidated financial data for the Company is presented in the table below and should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations included in Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a leading packager and distributor of industrial, medical and specialty gases, welding equipment and supplies, and propane in 11 states in the eastern United States. The Company's net sales have grown, primarily as a result of acquisitions, at a compound annual rate of approximately 16% per year since the Company started business in 1958, increasing from $190,000 in that year to $144.5 million in fiscal 2002. In fiscal 2002, gases accounted for approximately 43% of net sales, welding equipment and supplies accounted for approximately 41% of net sales, and cylinder and tank rental accounted for approximately 16% of net sales.
The Company believes it has been successful in executing its strategy of growth through acquisitions, having completed 53 acquisitions since 1990. Some acquisitions have had, and the Company expects some future acquisitions will have, a dilutive effect upon the Company's income from operations and income before tax for a short period following consummation. This temporary dilution occurs because some of the benefits of
acquisitions, such as leveraging of operating and administrative expenses, improved product gross margins and real sales growth, occur over a period ranging from two to eight quarters, depending upon the complexity of integrating each acquisition into the Company's existing operations. The consideration for most acquisitions includes a combination of a cash payment at closing, seller financing and payments under covenants not to compete and consulting agreements. In most cases, operating cash flow of an acquired business is positive in a relatively short period of time. For many acquisitions, the Company believes that projections of future cash flows justify payment of amounts in excess of the book or market value of the assets acquired, resulting in goodwill being recorded.
The Company's results are subject to moderate seasonality, primarily due to fluctuations in the demand for propane, which is highest during winter months falling in the Company's second and third fiscal quarters. Seasonality of total sales has increased as propane sales have increased as a percentage of total sales.
Operating and administrative expenses are comprised primarily of salaries, benefits, transportation equipment operating costs, facility lease expenses and general office expenses. These expenses are generally fixed on a quarter-to-quarter basis. The Company believes that changes in these expenses as a percentage of sales should be evaluated over the long term rather than on a quarter-to-quarter basis due to the moderate seasonality of sales mentioned above and the generally fixed nature of these expenses.
Historically, the Company's gross profit margins as a percentage of sales have been higher on the sale of gases than on the sale of welding equipment and supplies ("hard goods"). Future acquisitions may affect the Company's gross profit margins as a percentage of sales depending upon the product mix of the acquired businesses.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain items in the Company's consolidated statements of operations as a percentage of net sales. Results for any one or more periods are not necessarily indicative of continuing trends.
- --------------- (1) Effective July 1, 2000, the Company adopted Statement of Financial Accounting Standards No. 133.
(2) Effective July 1, 2001, the Company changed its estimate of the useful lives of its delivery vehicles from 3 to 7 years. This change was made to better reflect the estimated periods during which these assets will remain in service. See Note 2 to the financial statements.
Effective July 1, 2001, the Company changed its method of accounting for goodwill to comply with SFAS No. 142 whereby it discontinued amortization of goodwill. See Note 4 to the financial statements.
COMPARISON OF YEARS ENDED JUNE 30, 2002 AND 2001
Net sales increased 2.3%, or $3.2 million, to $144.5 million from $141.3 million for the years ended June 30, 2002 and 2001, respectively. Acquisitions made during the preceding twelve months contributed $13.8 million of the increase in net sales, while same store sales decreased $10.6 million or 7.5% (3.2% without propane). Same store sales for the fiscal year reflected a decrease of 5.0% for hard goods and a decline of 1.0% for industrial gases, cylinder rent and other. Propane sales declined $6.9 million, or 23.0%, on a same store basis, reflecting $5.1 million in price deflation and $1.8 million decrease in the volume due to warmer than normal temperatures during the past heating season. Gases and cylinder rent represented 59.0% of net sales for the year, with hard goods representing the remaining 41.0%. In comparison, net sales for the prior year reflected gases and cylinder rent as 59.7% and hard goods as 40.3%.
Gross profit, which excludes depreciation and amortization, increased 4.4%, or $3.2 million, to $76.6 million for the year, compared to $73.4 million for the prior year. Acquisitions made during the preceding twelve months contributed $7.7 million of the increase in gross profit, while same store gross profit decreased $4.5 million. Gross profit as a percentage of net sales was 53.0% for the year, compared to 51.9% for the prior year.
Operating and administrative expenses increased 11.7%, or $5.9 million, to $56.2 million for the year, compared to $50.3 million for the prior year. Of this increase, $6.3 million was related to acquired businesses, with the balance of the change, or $(0.4) million, attributable to same store expenses. Expenses related to the search for a new Chief Executive Officer and settlement of litigation of $0.7 million were recorded in fiscal year 2002. Depreciation and amortization expense decreased $2.5 million for the fiscal year, compared to the prior year period. On July 1, 2001, the Company changed its method of accounting for goodwill to comply with SFAS No. 142 whereby it discontinued amortization of goodwill. In the prior year, goodwill amortization expense of $2.1 million was recorded. Under the new standard, pro forma diluted earnings per share for the prior year would have been $0.57. As a result of a study on the useful life of delivery vehicles, the Company changed its estimate of useful lives for delivery vehicles, effective July 1, 2001, from three years to seven years. Depreciation and amortization would have been $0.5 million higher for the year before this change. This change increased net earnings $0.3 million and earnings per diluted share $0.03 for the year.
Interest expense decreased 10.1%, or $0.7 million, to $5.9 million for the year, compared to $6.6 million for the prior year. Reflected in interest expense was a decrease of $0.7 million for the year to record changes in the fair market value of the Company's interest rate swap agreements under SFAS No. 133.
The Company's effective tax rate decreased from 44% for the prior year to 41.5% for the current year as a result of decreased nondeductible goodwill under SFAS No. 142.
Net earnings for the year were $4.2 million, compared to $3.9 million for the fiscal year ended June 30, 2001.
Earnings before interest, taxes, depreciation, amortization and other noncash charges decreased 12.1%, or $2.9 million, to $20.9 million for the year, compared to $23.8 million for the prior year. Earnings before interest, taxes, depreciation, amortization and other noncash charges is an important measurement of the Company's ability to repay debt through operations and provides the Company with the ability to pursue investment alternatives.
COMPARISON OF YEARS ENDED JUNE 30, 2001 AND 2000
Net sales increased 12.1%, or $15.2 million, to $141.3 million from $126.1 million for the years ended June 30, 2001 and 2000, respectively. Acquisitions made during the preceding twelve months contributed $8.4 million of the increase in net sales, while same store sales growth contributed $6.8 million of the increase. Same store sales increased 5.4% over the prior year, reflecting the increase in sale of propane products as a result of internal growth and higher demand, partially offset by reduced demand for hard goods. Gases and cylinder income represented 59.7% of net sales for the year, with hard goods representing the remaining 40.3%. In comparison, net sales for the prior year reflected gases and cylinder income as 54.9% and hard goods as 45.1%.
Gross profit, which excludes depreciation and amortization, increased 13.7%, or $8.9 million, to $73.4 million for the year, compared to $64.5 million for the prior year. Acquisitions made during the preceding twelve months contributed $4.5 million of the increase in gross profit, while same stores contributed $4.4 million of the increase. Gross profit as a percentage of net sales was 51.9% for the year, compared to 51.2% for the prior year.
Operating and administrative expenses increased 14.6%, or $6.4 million, to $50.3 million for the year, compared to $43.9 million for the prior year. Of this increase, $3.5 million was related to acquired businesses, with the balance of the change, or $2.9 million, attributable to same store expenses. Depreciation and amortization expense increased $0.8 million for the year, primarily as a result of acquisitions made during the last twelve months.
Interest expense increased 24.1%, or $1.3 million, to $6.6 million for the year, compared to $5.3 million for the prior year. This increase reflects the impact of additional borrowings related to acquisitions and the effect of adopting SFAS No. 133, which increased interest expense $0.5 million to record the changes in fair market value of the Company's interest rate swap agreements.
The Company's effective tax rate was 44% for both fiscal year 2001 and 2000.
Net earnings for the year were $3.9 million, compared to $3.6 million for the fiscal year ended June 30, 2000.
Earnings before interest, taxes, depreciation, amortization and other noncash charges increased 12.2%, or $2.6 million, to $23.7 million for the year, compared to $21.1 million for the prior year. Earnings before interest, taxes, depreciation, amortization and other noncash charges is an important measurement of the Company's ability to repay debt through operations and provides the Company with the ability to pursue investment alternatives.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has financed its operations, capital expenditures and debt service with funds provided from operating activities. Acquisitions have been financed by a combination of seller financing, bank borrowings and funds generated from operations.
At June 30, 2002, the Company had working capital of approximately $14.1 million. Funds provided by operations for the twelve months ended June 30, 2002 were approximately $16.7 million. Funds used for investing activities were approximately $12.7 million for the twelve months ended June 30, 2002, consisting primarily of capital spending and financing for acquisitions. Funds used for financing activities for the twelve months ended June 30, 2002 were approximately $3.4 million from net payments of debt. The Company's cash balance increased $0.7 million during the twelve months to $1.2 million.
On June 28, 2002, the Company entered into an amendment to the second amended and restated credit agreement with Bank One, as agent. This amendment decreased the maximum revolving note borrowings to $75.0 million, from the previous maximum borrowings level of $100.0 million, and extended the maturity of the revolving note to June 28, 2005. The agreement permits the Company, on an annual basis, to request that the maturity be extended one year. No significant changes were made to pricing and the covenant requirements when compared to the original agreement. The weighted average interest rate for substantially all of the borrowings under the credit facility was 4.6% as of June 30, 2002. As of June 30, 2002, availability under the revolving loan was approximately $13.1 million, with outstanding borrowings of approximately $58.0 million and outstanding letters of credit of approximately $3.9 million. The credit facility is secured by all of the Company's assets. The revolving loan is used primarily to fund acquisitions. The Company is not required to make principal payments on outstanding balances of the revolving loan as long as certain covenants are satisfied. Interest is charged on both the term loan and the revolving loan at either the lender's prime rate or various LIBOR rates, at the Company's discretion, plus an applicable spread.
The loan agreement for the credit facility contains various financial covenants applicable to the Company, including covenants requiring minimum fixed charge coverage, maximum funded debt to EBITDA, and
minimum net worth. As of June 30, 2002, the Company is in compliance with these covenants and believes that it will continue to be in compliance through at least the next twelve months.
The Company is obligated under various promissory notes related to the financing of acquisitions that have various rates of interest, ranging from 5.75% to 10.0% per annum, and maturities through 2010. The outstanding balance of these notes as of June 30, 2002 was $6.8 million. Some of these notes are secured by assets related to the applicable acquisition, some are unsecured, and some are backed by bank letters of credit issued under the Company's credit facility.
The Company enters into contractual agreements in the ordinary course of business to hedge its exposure to interest rate risks. Counterparties to these agreements are major financial institutions. Management believes the risk of incurring losses related to credit risk is remote and any losses would be immaterial.
Interest rate swap agreements are used to reduce interest rate risks and costs inherent in the Company's debt portfolio. The Company enters into these agreements to change the fixed/variable interest rate mix of the debt portfolio in order to maintain the percentage of fixed and variable debt within certain parameters set by management. Accordingly, the Company enters into agreements to effectively convert variable-rate debt to fixed-rate debt.
As of June 30, 2002, the Company had $60.0 million in notional amounts outstanding under interest rate swap agreements. These swaps have an average pay rate of 5.9% versus a receive rate of 1.8%.
The Company has previously entered into a put/call option agreement with an independent distributor for the purchase of its business. This option became exercisable in May 2002 and ends in the year 2008. The Company believes that it will have adequate capital resources available to fund this acquisition at such time that the option is exercised.
The Company believes that cash generated from operations, borrowing availability under its credit facility and the ability to obtain financing with sellers of businesses will be sufficient to satisfy the Company's requirements for operating funds, capital expenditures and future acquisitions for at least the next twelve months. The Company has no plans at this time to issue additional shares of common stock.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported in the consolidated financial statements and accompanying notes. Note 2 to the consolidated financial statements describes the significant accounting policies and methods used in the preparation of the consolidated financial statements. Estimates are used for, but not limited to, determining the net carrying value of trade receivables, inventories, goodwill, other intangible assets and employee health care benefit reserves. Actual results could differ from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the consolidated financial statements.
TRADE RECEIVABLES
The Company must make estimates of the collectability of its trade receivables. 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. Management believes that the allowances for doubtful accounts as of June 30, 2002 and 2001 are adequate.
INVENTORIES
The Company's inventories are stated at the lower of cost or market. The Company writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of
inventory and the estimated market value based upon its physical condition as well as assumptions about future demand and market conditions. If actual demand or market conditions in the future are less favorable than those estimated, additional inventory write-downs may be required.
GOODWILL AND OTHER INTANGIBLE ASSETS
The Company adopted SFAS 142, Goodwill and Other Intangible Assets, as of July 1, 2001. SFAS 142 requires goodwill and intangible assets with indefinite useful lives not to be amortized, but instead be tested for impairment at least annually. The Company has elected to perform its annual tests for indications of goodwill impairment as of June 30th of each year. The annual impairment test used by the Company includes a discounted cash flow analysis as well as other tests of the market value of its business entity. The discounted cash flow analysis requires the use of significant estimates, assumptions and judgments. Examples include, (i) projections on Company operating performance, (ii) assumptions as to the Company's cost of capital, and (iii) assumptions as to the availability of capital in the future.
EMPLOYEE HEALTH CARE BENEFITS PAYABLE
The Company has self-funded health care benefit programs in place whereby a third party administrator settles and pays incurred claims on an on-going basis. The Company estimates the level of outstanding claims, at any point in time, based upon historical payment patterns, knowledge of individual claims and estimates of health care costs. The Company has stop-loss insurance coverage in place to limit the extent of individual claims.
FLUCTUATIONS IN QUARTERLY RESULTS
The Company generally has experienced higher sales activity during its second and third quarters as a result of seasonal sales of propane, with corresponding lower sales for the first and fourth quarters. As a result, income from operations and net income typically are higher for the second and third quarters than for the first and fourth quarters of the fiscal year. The timing of acquisitions may also have an appreciable effect on quarter to quarter earnings.
INFLATION
The impact of inflation on the Company's operating results has been moderate in recent years, reflecting generally low rates of inflation in the economy and the Company's historical ability to pass purchase price increases to its customers in the form of sales price increases. While inflation has not had, and the Company does not expect that it will have, a material impact upon operating results, there is no assurance that the Company's business will not be affected by inflation in the future.
SUBSEQUENT EVENTS
Subsequent to June 30, 2002, the Company acquired substantially all of the assets of Gerber's Propane, Inc. a propane distributor having approximately $2.0 million in annualized sales. This transaction was financed through the Company's credit facility.
NEW ACCOUNTING STANDARDS
In August 2001, SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), was issued. This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121"), Accounting Principles Board ("APB") No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB 30") and APB No. 51, "Consolidated Financial Statements" ("APB 51"). This statement is effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The Company has adopted SFAS 144 effective July 1, 2002. The Company is currently evaluating the impact of
this statement but does not anticipate that the adoption of SFAS 144 will have a material impact on the Company's financial position and results of operations.
In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections", was issued. The Statement updates, clarifies and simplifies existing accounting pronouncements. While the technical corrections to existing pronouncements are not substantive in nature, in some instances, they may change accounting practice. The provisions of this standard related to SFAS No. 13 are effective for transactions occurring after May 15, 2002. All other provisions of this standard must be applied for financial statements issued on or after May 15, 2002, with early application encouraged. The Company is currently evaluating the effects of SFAS No. 145 and does not anticipate that the adoption of SFAS 145 will have a material impact on the Company's financial position and results of operations.
In June 2002, SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146") was issued. This Statement addresses financial accounting an reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early adoption encouraged. The Company is currently evaluating the effects of SFAS No. 146 and does not anticipate that the adoption of SFAS 146 will have a material impact on the Company's financial position and results of operations.
FORWARD LOOKING STATEMENTS AND RISK FACTORS
This report includes statements that are forward-looking as that term is defined by the Private Securities Litigation and Reform Act of 1995 or by the Securities and Exchange Commission in its rules, regulations and releases, including statements regarding the Company's ability to 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 plans to develop e-commerce capabilities, its ability to secure alternative sources of supply if needed, its ability to maintain its supply of propane, its ability to meet increased demand for specialty gas products, the effect of product liability or other claims on the Company's results of operations or financial condition and the trend towards consolidation in the industry. The Company intends that such forward-looking statements be afforded the protections provided by the safe harbor created by the Private Securities Litigation and Reform Act of 1995.
All forward-looking statements are based upon current expectations regarding important factors. Accordingly, actual results may differ materially from those expressed in the forward-looking statements and the making of such statements should not be regarded as a representation by the Company or any other person that the results expressed will be achieved. Important risk factors that may affect the Company's ability to achieve the results expressed in the forward-looking statements include, but are not limited to, the Company's ability to (i) accurately identify attractive acquisition targets and make accurate predictions regarding the performance of those business if integrated into the Company's operations, (ii) successfully negotiate agreements for the acquisition of those businesses, (iii) integrate the operations of the acquired businesses as anticipated, (iv) secure financing necessary to make acquisitions, including maintaining and/or expanding its line of credit, negotiating seller financing, or securing other financing methods, (v) manage rapid growth, (vi) effectively compete, (vii) attract and retain key personnel and (viii) maintain good relationships with suppliers and locate alternative suppliers if needed. In addition, the Company's ability to achieve the results expressed by the forward-looking statements may be affected by litigation or other claims arising out of accidents involving the Company's products, changes in the economy, monetary or fiscal policies, changes in laws and regulations affecting the Company's business, inflation and fluctuations in interest rates.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The table below provides information about the Company's derivative financial instruments and other financial instruments that are sensitive to changes in interest rates, including interest rate swaps and debt
obligations. For debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. For interest rate swaps, the table presents notional amounts and weighted average interest rates by expected (contractual) maturity dates. Notional amounts are used to calculate the contractual payments to be exchanged under the contract. Weighted average variable rates are based on the one month LIBOR rate in effect at the reporting date. No assumptions have been made for future changes in the one month LIBOR rate.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company and the Report of Independent Public Accountants listed in the accompanying Index to Consolidated Financial Statements are incorporated herein by reference.
Summarized quarterly financial data for fiscal 2002 and 2001 is as follows:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
Previously reported.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The directors and executive officers of the Company are as follows:
GARY E. WEST, CHAIRMAN OF THE BOARD. Mr. West has served as Chairman of the Board of Directors of the Company since 1984. From 1970, when he purchased the Company, to March 1995, Mr. West served as President of the Company. Mr. West has also served as President of West Rentals, Inc. and Equip Lease Corp. and Vice President of Acetylene Products Corp. since 1992, 1988 and 1985, respectively. Since June 1993, he has served as a director of WesBanco Wheeling, and since June 1990 he has served as a director of H.E. Neumann Co., a plumbing, heating and mechanical contracting company. Mr. West received his Bachelor of Science degree in Business Administration from West Liberty State College.
WILLIAM A. INDELICATO, VICE CHAIRMAN, ACTING CHIEF EXECUTIVE OFFICER AND DIRECTOR. Mr. Indelicato was elected a director of the Company in January 1997 and was appointed as the Company's Vice Chairman and Acting Chief Executive Officer in February 2002. Mr. Indelicato has been President of ADE Vantage, Inc., a business consulting firm which provides certain services to the Company, since July 1992. From 1988 to 1991, Mr. Indelicato served as General Business Director of Union Carbide Industrial Gases Inc. Mr. Indelicato has also been an associate professor of strategic management at Pace University in New York. Mr. Indelicato received his Bachelor of Science degree in Electrical Engineering from the University of Notre Dame and his Masters in Business Administration degree from Pace University.
AUGUST E. MAIER, ACTING PRESIDENT AND DIRECTOR. Mr. Maier was elected a Director of the Company in January 1997 and was appointed as the Company's Acting President in February 2002. In September 1997, Mr. Maier became an employee of the Company and served as Corporate Director of Field Operations until his retirement in July 1999. He served as Chief Executive Officer of Houston Fearless 76, a manufacturer of digital imaging and film processing equipment, from May 1995 to August 1997. From October 1987 to May 1995, Mr. Maier was Chief Executive Officer of Holox, Inc., a large distributor of industrial gases and welding equipment. Mr. Maier received his Bachelor of Science degree in Mechanical Engineering from the Indiana Institute of Technology and his Masters in Business Administration degree from the Harvard Business School.
JOHN R. BUSHWACK, EXECUTIVE VICE PRESIDENT, SECRETARY AND DIRECTOR. Mr. Bushwack has served as the Executive Vice President, Secretary and a director of the Company since January 1997. From 1991 to 1996, Mr. Bushwack served in various positions with the Company, including Executive Vice President of Sales and Acquisitions, Vice President of Sales and Acquisitions, Vice President of Sales and General Manager. From 1987 to 1990, Mr. Bushwack served as President of the Harvey Company, a gas distributor, and from 1990 to 1991 he served as Vice President and director of Linde Gases of the Great Lakes, also a gas distributor. In addition, Mr. Bushwack has been a director of Convenient Care
Products Group, Ltd., a division of Westmoreland Health System, since 1991 and Westmoreland Holding Company, Inc., since 1999.
ROBERT D. SCHERICH, CHIEF FINANCIAL OFFICER. Mr. Scherich has served as the Company's Chief Financial Officer since May 1996. From January 1993 to April 1996, he served as Controller and General Manager of Wheeling Pittsburgh Steel Corporation, a subsidiary of WHX Corporation, and from January 1988 to December 1993 he served as Division Controller of such corporation. Mr. Scherich was an accountant with Ernst & Whinney from 1981 to 1984. Mr. Scherich received his Bachelor of Science degree in Accounting from The Pennsylvania State University and is a Certified Public Accountant.
BEN EXLEY, IV, DIRECTOR. Mr. Exley was elected a Director of the Company in January 1997. He served as a Marketing Specialist for the Ohio Valley Industrial and Business Development Corporation from April 1998 to May 2000 and served as Interim Executive Director during 1999. He served as the President of Ohio Valley Clarksburg, Inc. from 1987 through 1997 and Bailey Drug Company from 1993 through 1997, both of which are pharmaceutical distributors and wholly-owned subsidiaries of Cardinal Health Inc. Mr. Exley has also served on the board of directors of several companies, including BankOne West Virginia N.A. from 1994 through 2000, BankOne Wheeling-Steubenville N.A. from 1991 through 2000 and Stone & Thomas, a chain of clothing department stores, from 1991 through 1997. Mr. Exley is a graduate of West Virginia Wesleyan College with a Bachelor of Science degree in Business Administration. He also holds a Masters in Business Administration degree from Northern Illinois University.
JAMES P. HART, DIRECTOR. Mr. Hart was elected a director of the Company in January 1997. He served as Vice President and Chief Financial Officer of Industrial Scientific Corporation ("ISC"), a manufacturer of portable instruments used for detecting and monitoring a variety of gases, from August 1994 through September 2002. From March 1984 to August 1994, Mr. Hart was Treasurer and Controller of ISC. Mr. Hart holds a Bachelor of Science degree in Accounting from the University of Scranton.
F. WALTER RIEBENACK, DIRECTOR. Mr. Riebenack was elected a Director of the Company in January 1999. He has served as the Chief Financial Officer, General Counsel and as a member of the Board of Site-Blauvelt Engineers, Inc. since 1990, a multi-disciplinary consulting engineering firm offering transportation design, geotechnical engineering, subsurface exploration, construction inspection and materials testing services to a wide range of clients in both the public and private sectors of the marketplace, with offices in New Jersey, Pennsylvania, New York, Delaware, Virginia, Ohio, Maryland, South Carolina and West Virginia. Mr. Riebenack received his law degree along with his Bachelor of Business Administration degree in Finance and Accounting from the University of Notre Dame. Mr. Riebenack has served as an instructor of Business Law at Indiana University in Fort Wayne, Indiana and has also served as an instructor of Business Law, Principles of Insurance and Seminars in Business at the University of St. Francis in Fort Wayne, Indiana.
The information called for by item 405 of Regulation S-K is contained in the Company's definitive proxy statement relating to the annual meeting of shareholders to be held October 29, 2002, in the section titled "Section 16(a) Beneficial Ownership Reporting Compliance" and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this item is contained in the Company's definitive proxy statement relating to the annual meeting of shareholders to be held October 29, 2002, in the section titled "Executive Compensation" and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this item is contained in the Company's definitive proxy statement relating to the annual meeting of shareholders to be held October 29, 2002, in the section titled "Common Stock Ownership of Directors, Nominees and Officers" and is incorporated herein by reference.
Following is the equity compensation plan information for the Company as of June 30, 2002:
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this item is contained in the Company's definitive proxy statement relating to the annual meeting of shareholders to be held October 29, 2002, in the section titled "Certain Relationships and Related Transactions" and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
The consolidated financial statements of the Company required by this item are listed in the Index to Consolidated Financial Statements set forth on page.
(a)(2) Financial Statements Schedules
The financial statement schedules required by this item are set forth beginning on page S-1. Schedules not filed herewith have been omitted as inapplicable, or not required, or the information is included in the Company's consolidated financial statements or the notes thereto.
(a)(3) Exhibits
The exhibits required by this item are listed in the Index to Exhibits set forth on page E-1.
(b) Reports on Form 8-K
The Company filed a Form 8-K on June 4, 2002 reporting under Item 4 Changes in Registrant's Accountant.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
VALLEY NATIONAL GASES INCORPORATED September 24, 2002 /s/ WILLIAM A. INDELICATO -------------------------------------- William A. Indelicato Acting Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
CERTIFICATIONS
CHIEF EXECUTIVE OFFICER
I, William A. Indelicato, certify that:
1. I have reviewed this annual report on Form 10-K of Valley National Gases Incorporated;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; and
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operation and cash flows of the registrant as of, and for, the periods presented in this annual report.
Date: 9/24/02 -------------------- /s/ WILLIAM A. INDELICATO -------------------------------------- Chief Executive Officer
CHIEF FINANCIAL OFFICER
I, Robert D. Scherich, certify that:
1. I have reviewed this annual report on Form 10-K of Valley National Gases Incorporated;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; and
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operation and cash flows of the registrant as of, and for, the periods presented in this annual report.
Date: 9/24/02 -------------------- /s/ ROBERT D. SCHERICH -------------------------------------- Chief Financial Officer
VALLEY NATIONAL GASES INCORPORATED
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors, Valley National Gases Incorporated:
We have audited the accompanying consolidated balance sheet of Valley National Gases Incorporated (a Pennsylvania corporation) and subsidiary as of June 30, 2002, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements of Valley National Gases Incorporated as of June 30, 2001 and for the two year period then ended, were audited by other auditors who have ceased operations and whose report dated July 31, 2001, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Valley National Gases Incorporated and subsidiary at June 30, 2002, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States.
As discussed in Notes 2 and 4 to the financial statements, in 2001 the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" and, in 2002 the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets."
/s/ ERNST & YOUNG LLP Pittsburgh, Pennsylvania, July 30, 2002
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors, Valley National Gases Incorporated:
We have audited the accompanying consolidated balance sheets of Valley National Gases Incorporated (a Pennsylvania corporation) and subsidiary as of June 30, 2000 and 2001, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended June 30, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Valley National Gases Incorporated and subsidiary as of June 30, 2000 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2001, in conformity with accounting principles generally accepted in the United States.
As explained in Note 2 to the financial statements, effective July 1, 2000, the Company changed its method of accounting for derivative instruments and hedging activities.
/s/ Arthur Andersen LLP Pittsburgh, Pennsylvania July 31, 2001
THIS IS A COPY OF THE AUDIT REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP IN CONJUNCTION WITH VALLEY NATIONAL GASES INCORPORATED'S FILING ON FORM 10-K FOR THE YEAR ENDED JUNE 30, 2001. THIS AUDIT REPORT HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP IN CONJUNCTION WITH THIS FILING ON FORM 10-K.
VALLEY NATIONAL GASES INCORPORATED
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2001 AND 2002
The accompanying notes are an integral part of these financial statements.
VALLEY NATIONAL GASES INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30, 2000, 2001 AND 2002
The accompanying notes are an integral part of these financial statements.
VALLEY NATIONAL GASES INCORPORATED
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30, 2000, 2001 AND 2002
The accompanying notes are an integral part of these financial statements.
VALLEY NATIONAL GASES INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 2000, 2001 AND 2002
The accompanying notes are an integral part of these financial statements.
VALLEY NATIONAL GASES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001 AND 2002
1. ORGANIZATION:
Valley National Gases Incorporated, a Pennsylvania corporation (the Company), produces, packages and resells industrial gases, specialty gases and propane; and resells welding hard goods and equipment. The Company, through its consolidated subsidiaries has been in operation since 1958 and currently operates in 11 states.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
CASH EQUIVALENTS
For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
INVENTORY
Inventory is carried at the lower of cost or market using the first-in, first-out (FIFO) method.
The components of inventory for the year ended June 30 were as follows:
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are carried at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the properties while leasehold improvements are amortized over the shorter of their useful life or the term of the lease as follows:
The cost of maintenance and repairs is charged to operations as incurred. Major renewals and betterments are capitalized.
Effective July 1, 2001, the Company changed its estimate of the useful lives of its delivery vehicles from 3 to 7 years. This change was made to better reflect the estimated periods during which these assets will remain in service. The change had the effect of reducing depreciation expense for the year ended June 30, 2002 by approximately $495,000 and increasing net earnings by $290,000 or $0.03 per diluted share.
The Company changed the estimated useful life of delivery vehicles as a result of thorough studies and analyses. The studies considered empirical data obtained from truck manufacturers and other industry experts and experience gained from the Company's maintenance of a delivery vehicle population of approximately 200 delivery vehicles.
INTANGIBLES
Intangibles consist of non-competition agreements, goodwill, consulting agreements and deferred loan origination costs. Costs pursuant to non-competition agreements entered into in connection with business acquisitions are amortized over the terms of the arrangements. Annually, or more frequently if needed, goodwill is evaluated for impairment, with any resulting impairment charge reflected as an operating expense. Consulting agreements are entered into with the owners of various businesses acquired by the Company and require such owners to be available to perform services upon the Company's request. Consulting payments are made regardless of the number of hours of service performed and are payable to the consultant's successor upon death. Consulting costs are amortized over the term of the agreement. Deferred loan origination costs are amortized over the term of the related debt.
INCOME TAXES
Income taxes are accounted for in accordance with the liability method, 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 enacted marginal tax rate. 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.
EARNINGS PER SHARE
Basic earnings per share is computed by dividing net earnings by the number of weighted-average common shares outstanding during the year. Diluted earnings per share is computed by dividing net earnings by the number of weighted-average common and common equivalent shares outstanding during the year (See Note 8).
COMPREHENSIVE INCOME
Comprehensive income includes net income and unrealized gains and losses on derivatives designated and qualified as cash flow hedges. The components of comprehensive income consist of the following for the fiscal years ending June 30:
MAJOR CUSTOMERS AND CONCENTRATIONS OF CREDIT RISK:
The Company markets its products to a diverse customer base in unrelated industries and, as such, does not have any significant concentrations of credit risk. No one customer accounted for greater than 10% of revenues in 2000, 2001 and 2002.
REVENUE RECOGNITION
Revenues are recognized for product sales when such goods are received by the customer. Additionally, revenues from cylinder leases are reported ratably over the terms of the leases.
SHIPPING AND HANDLING FEES AND COSTS
The Company recognizes delivery and freight charges to customers as elements of net sales. Costs of third-party freight and costs of deliveries by company vehicles and personnel are recognized as elements of operating and administrative expenses and depreciation expense.
DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate fair value of each class of financial instrument for which it is practicable to estimate that value:
Cash and Cash Equivalents -- The carrying amount approximates fair value because of the short maturity of those instruments.
Long-Term Debt -- The fair value of long-term debt bearing interest at floating rates is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The fair value of the notes payable are not practical to estimate due to a lack of a ready market and certain restrictions associated with these instruments.
The estimated fair values of the Company's financial instruments as of June 30, 2002 are as follows:
The fair values and carrying amounts of the Company's term notes and revolving note are deemed to be approximately equivalent as they bear interest at floating rates which are based upon current market rates.
The Company utilizes interest rate swap agreements to reduce the potential impact of increases in interest rates on floating-rate long-term debt. Counterparties to these contracts are major financial institutions. The company has established counterparty credit guidelines and only enters into transactions with financial institutions of investment grade or better. Management believes the risk of incurring losses related to credit risk is remote, and any losses would be immaterial to financial results.
In accordance with the provisions of SFAS No. 133, as amended, the Company recognizes all derivatives on the balance sheet at fair value. On the date the derivative instrument is entered into, the Company generally designates the derivative as a hedge of the variability of cash flows to be paid related to a recognized liability (cash flow hedge). Changes in the fair value of a derivative that is designated as and meets all the required criteria for a cash flow hedge are recorded in accumulated other comprehensive income and reclassified into earnings as the underlying hedged item affects earnings. Changes in the fair value of a derivative that is not designated as a hedge are recorded immediately in earnings. At June 30, 2002 and 2001 the Company had interest rate swap agreements outstanding that effectively convert a notional amount of $60.0 million from floating rates to fixed rates. The agreements outstanding at June 30, 2002 mature at various times between December 2002 and January 2006. The Company would have paid $3,874,204 and $2,095,366 to settle its interest rate swap agreements at June 30, 2002 and 2001, respectively, which represents the fair value of these agreements. The carrying value equals the fair value for these contracts at June 30, 2002 and 2001. Fair value was estimated based on the mark-to market value of the contracts which closely approximates the amount the Company could receive or pay to terminate the agreements at year end.
Based upon interest rates at June 30, 2002, the Company expects to recognize into earnings in the next 12 months net current liabilities of $242,198 related to outstanding derivative instruments and net losses of $185,852 recorded in accumulated other comprehensive loss, related to the classification of unrealized losses on derivatives that were not designated as cash flow hedges upon the adoption of SFAS No. 133.
It is not practicable to estimate the fair value of the notes payable of the Company as no ready market exists for these instruments and comparable instruments available from outside the Company are not available.
NEW ACCOUNTING STANDARDS
In August 2001, SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), was issued. This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121"), Accounting Principles Board ("APB") No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB 30") and APB No. 51, "Consolidated Financial Statements" ("APB 51"). This statement is effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The Company has adopted SFAS 144 effective July 1, 2002. The Company is currently evaluating the impact of this statement but does not anticipate that the adoption of SFAS 144 will have a material impact on the Company's financial position and results of operations.
In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections", was issued. The Statement updates, clarifies and simplifies existing accounting pronouncements. While the technical corrections to existing pronouncements are not substantive in nature, in some instances, they may change accounting practice. The provisions of this standard related to SFAS No. 13 are effective for transactions occurring after May 15, 2002. All other provisions of this standard must be applied for financial statements issued on or after May 15, 2002, with early application encouraged. The Company is currently evaluating the effects of SAFS No. 145 and does not anticipate that the adoption of SFAS 145 will have a material impact on the Company's financial position and results of operations.
In June 2002, SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146") was issued. This Statement addresses financial accounting an reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early adoption encouraged. The Company is currently evaluating the effects of SAFS No. 146 and does not anticipate that the adoption of SFAS 146 will have a material impact on the Company's financial position and results of operations.
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.
SUPPLEMENTAL CASH FLOW INFORMATION
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.
3. ACQUISITIONS:
The Company acquires businesses engaged in the distribution of industrial, medical and specialty gases and related welding supplies and accessories. Acquisitions have been recorded using the purchase method of accounting and, accordingly, results of their operations have been included in the Company's financial statements since the effective dates of the respective acquisitions.
During fiscal 2002, the Company purchased three businesses. These acquisitions and their effective dates were Buckeye Corporation (August 2001), Mansfield Oxygen Corp. (August 2001) and Gas Arc, Inc. (December 2001).
During fiscal 2001, the Company purchased four businesses. The largest of these acquisitions was Air Liquide America Corporation which was effective May 2001.
During fiscal 2000, the Company purchased four businesses. The largest of these acquisitions was Lee's Gas Supply, Inc. which was effective December 1999.
In connection with these acquisitions, the total purchase price, fair value of assets acquired, cash paid and liabilities assumed for the year ended June 30 were as follows:
As part of the acquisitions completed during fiscal 2002, the Company recorded $684,000 for goodwill and $850,000 for non-compete agreements having an amortization period of 3 years.
The following summarized unaudited pro forma results of operations for the fiscal years ended June 30, 2000, 2001 and 2002, illustrate the estimated effects of the 2000, 2001 and 2002 acquisitions, as if the transactions were consummated as of the beginning of each fiscal year presented. These pro forma results have been prepared for comparable purposes only and do not purport to be indicative of what would have occurred had the acquisitions been made as of the beginning of each fiscal year, or of results which may occur in the future.
4. INTANGIBLE ASSETS:
On July 1, 2001, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," under which goodwill and other intangible assets with indefinite lives are not amortized. Such intangibles were evaluated for impairment as of July 1, 2001 and no impairment existed. In addition, each year, the Company will evaluate the intangible assets for impairment with any resulting impairment reflected as an operating expense. The Company's only intangibles, other than goodwill, are its noncompete agreements and consulting
agreements, which the Company currently believes have finite lives. The Company entered into an agreement with a former officer of the Company in connection with his separation from the Company in February 2002. The agreement requires payments of $16,667 per month from April 2002 through March 2005 and has been accounted for in the same manner as the Company's other non-compete agreements. As of June 30, 2002, the Company's noncompete agreements and consulting agreements are summarized as follows:
Amortization expense for the years ended June 30, 2000,2001 and 2002 totaled $4,495,818, 4,890,261 and $2,631,213 respectively. Estimated amortization expense for the next five fiscal years is summarized as follows:
The changes in the carrying amount of goodwill for the year ended June 30, 2002, are as follows:
The following table reports pro forma information as if SFAS No. 142 had been adopted for all periods presented:
5. LONG-TERM DEBT:
Long-term debt consists of the following as of June 30:
The prime rate was 6.75% and 4.75% at June 30, 2001 and 2002, respectively. The LIBOR rate was 1.83% and 1.84% at June 30, 2001 and 2002, respectively.
On June 28, 2002 the Company entered into an amendment to the second amended and restated credit facility with Bank One, as agent. The amendment decreased the maximum revolving note borrowings from $100.0 million to $75.0 million, including a letter of credit sublimit of $15.0 million. The term note has a new balance of $15.0 million. The scheduled maturity date of both the term and revolving note is June 28, 2005. The Company pays a fee for the unused portion of the revolving loan. The revolving loan is used primarily to fund acquisitions. The Company is not required to make principal payments on outstanding balances of the revolving loan as long as certain covenants are satisfied. Interest is charged on both the term loan and the revolving loan at either the lender's prime rate or various LIBOR rates, at the Company's discretion, plus an applicable spread. The weighted average interest rate for substantially all of the borrowings under the credit facility was 4.6% as of June 30, 2002. As of June 30, 2002, availability under the revolving loan was approximately $13.1 million, with outstanding borrowings of approximately $58.0 million and outstanding letters of credit of approximately $3.9 million. The credit facility is secured by all of the Company's assets.
The loan agreement for the credit facility contains various financial covenants applicable to the Company, including covenants requiring minimum fixed charge coverage, maximum funded debt to EBITDA, and minimum net worth. As of April 30, 2001, the Company was not in compliance with the capital spending covenant and obtained a waiver for the non-compliance.
The schedule of maturities as amended for the credit agreements for the next five years and thereafter is as follows as of June 30, 2002:
6. PENSION PLANS:
The Company sponsors a defined contribution pension plan ("401-k") for employees. All employees are eligible to participate in the 401-k plan after meeting the age and service requirements. Cash contributions to the plan are based on a percentage of employees' compensation. Pension expense for this plan was $719,126, $892,849 and $1,049,497 respectively, in fiscal years 2000, 2001 and 2002.
The Company also maintains a profit sharing plan for its employees. Profit sharing payments are based on a discretionary amount determined annually by the Board of Directors and are paid as additional cash contributions to the pension plan. In 2000, 2001 and 2002, the amount of additional cash contributions distributed to the employees' pension plan amounted to $149,888, $142,604 and $54,000 respectively.
Certain management employees are provided supplemental retirement benefits. The cost of these contracts is being accrued over the period of active employment of the covered employees. The costs of the supplemental retirement benefits plans charged to expense were $67,583, $44,304 and $7,085 respectively, in fiscal years 2000, 2001 and 2002.
7. 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.
Options to purchase 222,750, 221,375 and 154,500 shares of common stock were outstanding during fiscal years 2000, 2001 and 2002, respectively, but were not included in the computation of diluted earnings per common share as the options' exercise price was greater than the average market price of the common stock for the respective periods.
8. LEASE OBLIGATIONS:
The Company 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 the year 2010, with options to renew for periods of three to five years. Lease expenses charged to operations were $3,844,848, $4,047,918 and 4,722,281 respectively, in fiscal years 2000, 2001 and 2002.
Minimum future rental payments under noncancelable operating leases for each of the next five years are as follows:
9. RELATED PARTY TRANSACTIONS:
The Company leases buildings and equipment, rents cylinders and has sales and purchase transactions with related parties, including the sole shareholder prior to the initial public offering and corporations owned by such sole shareholder and officers of the Company. These transactions and balances for the year ended June 30 are summarized as follows:
The Company has entered into a master lease agreement for virtually all of its operating properties with a related party. The term of this master lease agreement is ten years with annual minimum lease payments of $1,955,484 with renewal options and have been accounted for as operating leases in the accompanying financial statements.
Pursuant to a Consulting Agreement, the Company retained ADE Vantage, Inc. ("ADE"), a consulting company wholly-owned by Mr. Indelicato, Acting CEO, Vice Chairman and director of the Company, to provide consulting services, including appraisal valuation services used in connection with the adoption of SFAS No. 142. The Company pays Mr. Indelicato a monthly retainer fee of $4,500, reimburses for out-of-pocket expenses, retains ADE for related acquisition services and provides a variable payment for each acquisition completed based on the purchase price and the annual sales of the acquired business. Payments to Mr. Indelicato and ADE during fiscal year 2000, 2001 and 2002 totaled $181,607, $226,270 and $168,982 respectively.
10. STOCK OPTIONS:
The Company adopted a stock option plan during fiscal year 1997 (the 1997 Plan). A total of 650,000 shares are authorized and have been reserved for issuance under the 1997 Plan. These options are incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended. The 1997 Plan is administered by the Nominating and Compensation Committee of the Board of Directors who determines, among other things, those individuals who shall receive options, the time period during which the options may be exercised, the number of shares of common stock that may be purchased under each option, and the option price.
The following summarizes the activity under the 1997 Plan:
The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123) in October 1995. This statement establishes a fair value based method of financial accounting and related reporting standards for stock-based employee compensation plans. SFAS No. 123 became effective for fiscal year 1997 and provides for adoption in the income statement or through footnote disclosure only. The Company has continued to account for the 1997 Plan under APB No. 25, "Accounting for Stock Issued to Employees", as permitted by SFAS No. 123.
Had compensation cost of the 1997 Plan been determined based on the fair value at the grant dates for awards consistent with the method of SFAS No. 123, the Company's net income and earnings per share would have been the pro forma amounts indicated below:
The fair value of each option grant was estimated on the date of grant using an option pricing model with the following assumptions:
11. INCOME TAXES:
The Company accounts for income taxes in accordance with the provisions of SFAS No. 109. Although there can be no assurance that the Company will generate any earnings or specific level of continuing earnings in future periods, management believes that it is more likely than not that the net deductible differences will reverse during periods when the Company generates sufficient net taxable income.
The reconciliation of income taxes computed using the statutory U.S. income tax rate and the provision for income taxes follows:
The provision for income taxes as shown in the accompanying consolidated statement of operations, includes the following components for the year ended June 30:
The components of the deferred tax assets and liabilities recorded in the accompanying consolidated balance sheets at June 30, 2000, 2001 and 2002 were as follows:
12. CONTINGENCIES, COMMITMENTS AND OTHER
Some industrial gases and propane are flammable, explosive products. Serious personal injury and property damage can occur in connection with its transportation, storage, production or use. The Company, in the ordinary course of business, is threatened with or is named as a defendant in various lawsuits which, among other items, seek actual and punitive damages for product liability, personal injury and property damage. The Company maintains liability insurance policies with insurers in such amounts and with such coverages and deductibles as the Company believes is reasonable and prudent. However, there can be no assurance that such insurance will be adequate to protect the Company from material expenses related to such personal injury or property damage or that such levels of insurance will continue to be available in the future at economical prices. Management is of the opinion that there are no known claims or known contingent claims that are likely to have a material adverse effect on the results of operations, financial condition or cash flows of the Company.
During the fourth quarter of fiscal year 2002 the Company incurred non-recurring charges of $0.4 million, net of taxes, related to its search for a new Chief Executive Officer and settlement of litigation.
The Company has previously entered into a put/call option agreement with an independent distributor for the purchase of its business. This option became exercisable in May 2002 and ends in the year 2008. The
Company believes that it will have adequate capital resources available to fund this acquisition at such time that the option is exercised.
In September 1991, in connection with the purchase by the Company of certain assets of Praxair, Inc. (Praxair), the Company, Gary E. West and certain of his affiliates entered into a Right of First Refusal Agreement with Praxair. In March 1997, the parties to such agreement entered into an Amended and Restated Right of First Refusal Agreement (the Right of First Refusal Agreement) in connection with the Company's reorganization. Pursuant to this agreement, if at any time during the term of the agreement the Company wishes to accept a third party offer to purchase all or a material part of the assets of the Company, or Mr. West and his affiliates wish to accept an offer to purchase shares of capital stock of the Company (the Capital Stock) owned by them in a transaction that would result in Mr. West and his affiliates collectively owning less than 51% of the Company's issued and outstanding shares of Capital Stock on a fully diluted basis or owning less than 51% of the combined voting power of all outstanding voting securities of the Company, Praxair will have a right of first refusal to match the offer. In addition, in the absence of a third party offer, if (a) Mr. West and his affiliates wish to sell shares of Common Stock which would result in their owning collectively less than 51% or more of the Company's issued and outstanding shares of Common Stock, (b) the Company wishes to sell all or a material part of its assets, or (c) the Company wishes to issue additional shares or options or securities exercisable or convertible into shares of Common Stock, pursuant to employee stock options, a public offering, private placement, merger, share exchange or otherwise, which in the aggregate on a fully diluted basis would result in Mr. West and his affiliates collectively owning less than 51% of all the issued outstanding shares of Common Stock, then Praxair will have the right to purchase from Mr. West and his affiliates up to all of the issued and outstanding shares of Common Stock held by them (but not less than 51% of all of the issued and outstanding shares of the Company's Common Stock on a fully diluted basis) at the then prevailing market price. If Praxair does purchase shares of Capital Stock from Mr. West and his affiliates as described in this paragraph, then Mr. West and his affiliates will be bound by certain non-compete provisions, as described in the Right of First Refusal Agreement, for a period of three years from such purchase.
13. SUBSEQUENT EVENTS:
Subsequent to June 30, 2002, the Company acquired substantially all of the assets of Gerber's Propane, Inc. a propane distributor having approximately $2.0 million in annualized sales. This transaction was financed through the Company's credit facility.
14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
- --------------- (1) Includes the effect of non-recurring charges related to the search for a new Chief Executive Officer and settlement of litigation which totaled $0.4 million, net of taxes.
(This page left blank intentionally)
INDEX TO EXHIBITS
- ------------------------------------------------------------------------------- 3.1 Articles of Amendment (a)
3.2 Bylaws (a)
4.1 Form of Certificate for Common Stock (a)
10.2 Master Lease Agreement dated as of May 1, 2001 between the Company and West Rentals, Inc. (d)
10.3 Amended and Restated Right of First Refusal Agreement dated March 12, 1997 among the Company, Valley National Gases Delaware, Inc., Valley National Gases, Inc., West Rentals, Inc., Gary E. West, Phyllis J. West, The Gary E. West Grantor Retained Annuity Trust #1, The Gary E. West Grantor Retained Annuity Trust #2, The Gary E. West Grantor Retained Annuity Trust #3, The Gary E. West Grantor Retained Annuity Trust #4, The Gary E. West Grantor Retained Annuity Trust #5, The Gary E. West Grantor Retained Annuity Trust #6 and Praxair, Inc. (a)
10.6 Agreement dated October 5, 1992 between the Company and Lawrence E. Bandi providing for death, disability and retirement benefits (a)+
10.7 Agreement dated October 5, 1992 between the Company and John R. Bushwack providing for death, disability and retirement benefits (a)+
10.10 Lease Agreement dated as of April 1, 1998 between the Company and Acetylene Products, Inc. (d)
10.11 1997 Stock Option Plan as amended (d)
10.18 Second Amended and Restated Credit Agreement dated May 1, 2000 between the Company and Bank One, Indiana NA, as agent (c)
10.19 Agreement dated July 1, 2001 between the Company and William A. Indelicato providing for certain consulting payments (d)+
10.20 Lease Agreement dated as of April 1, 2000 between the Company and Real Equip-Lease, LLC (d)
10.21 Agreement dated February 22, 2002 between the Company and Lawrence E. Bandi (e)+
10.22 Amendment dated June 28, 2002 to Second Amended and Restated Credit Agreement dated May 1, 2000 between the Company and Bank One, Indiana NA, as agent (filed herewith)
10.23 Agreement dated July 1, 2002 between the Company and William A. Indelicato providing for certain consulting payments (filed herewith)+
10.24 Agreement dated February 11, 2002 between the Company and August E. Maier providing for certain consulting payments (filed herewith)+
10.25 Agreement dated June 30, 2002 between the Company and John R. Bushwack relating to assignment of life insurance policy (filed herewith)+
10.26 Agreement dated June 30, 2002 between the Company and Robert D. Scherich relating to assignment of life insurance policy (filed herewith)+
10.27 Lease Agreement dated as of November 5, 1997 between the Company and EquipLease Corp (filed herewith)
10.28 Lease Agreement dated as of September 24, 2001 between the Company and GEW Realty LLC (filed herewith)
21.1 Subsidiaries of Registrant (a)
99.1 Certification of Chief Executive Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
99.2 Certification of Chief Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
- ------------------------------------------------------------------------------- (a) Incorporated by reference to the Company's Registration Statement on Form S-1, Reg. No. 333-19973.
(b) Incorporated by reference to the Company's Annual Report on Form 10-K filed September 28, 1999.
(c) Incorporated by reference to the Company's Quarterly Report on Form 10-Q filed May 15, 2000.
(d) Incorporated by reference to the Company's Annual Report on Form 10-K filed September 28, 2001.
(e) Incorporated by reference to the Company's Quarterly Report on Form 10-Q filed May 15, 2002.
+ A management or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
E-1