UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2005


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File No. 000-15191

Valley National Gases Incorporated

(Exact name of registrant as specified in its charter)


	\
Pennsylvania		23-2888240
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

200 West Beau Street, Suite 200
Washington, Pennsylvania 15301
(Address of principal executive offices)

(724) 228-3000
(Registrant’s telephone number, including area code)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.


Yes þ		No o

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

Large accelerated filer o Accelerated filer o Non-accelerated filer þ

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


Yes o		No þ

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


Class		Outstanding at February 9, 2006
Common stock, $0.001 par value		9,641,999

VALLEY NATIONAL GASES INCORPORATED

TABLE OF CONTENTS


	Page
PART I FINANCIAL INFORMATION

Item 1 Financial Statements

Condensed Consolidated Balance Sheets as of June 30, 2005 and December 31, 2005 (unaudited)		3

Condensed Consolidated Statements of Operations for the Three Months Ended December 31, 2004 and 2005 (unaudited)		5

Condensed Consolidated Statements of Operations for the Six Months Ended December 31, 2004 and 2005 (unaudited)		6

Consolidated Statements of Changes in Stockholders’ Equity for the Periods Ended June 30, 2005 and December 31, 2005 (unaudited)		7

Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2004 and 2005 (unaudited)		8

Notes to Unaudited Condensed Consolidated Financial Statements		9

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		24

Item 3 Quantitative and Qualitative Disclosures About Market Risk		33

Item 4 Controls and Procedures		34

PART II OTHER INFORMATION

Item 6 Exhibits		35

Signatures		36
EX-10.1
EX-31.1
EX-31.2
EX-32.1
EX-32.2

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PART I. FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

VALLEY NATIONAL GASES INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS

ASSETS


	June 30,			December 31,
	2005			2005
				(unaudited)
CURRENT ASSETS:
Cash and cash equivalents	$	1,322,397		$	3,504,278
Accounts receivable, net of allowance for doubtful accounts of $672,822 and $962,213, respectively		16,956,510			27,742,640
Inventory		9,868,974			11,741,902
Prepaids and other		1,036,410			1,473,399
Current deferred tax asset		1,774,379			1,722,153
Prepaid and refundable taxes		1,471,519			—


Total current assets		32,430,189			46,184,372


PROPERTY, PLANT AND EQUIPMENT:
Land		2,099,915			2,197,415
Buildings and improvements		21,416,658			22,886,914
Equipment		100,332,506			116,212,516
Transportation equipment		19,249,082			21,269,917
Furniture and fixtures		8,756,310			9,261,143


Total property, plant and equipment		151,854,471			171,827,905

Accumulated depreciation		(57,737,096	)		(60,895,772	)


Net property, plant and equipment		94,117,375			110,932,133


OTHER ASSETS:
Intangible assets, net of accumulated amortization of $7,329,315 and $7,787,752, respectively		2,607,058			4,203,651
Goodwill		45,482,910			55,260,652
Deposits and other assets		448,429			550,989


Total other assets		48,538,397			60,015,292


TOTAL ASSETS	$	175,085,961		$	217,131,797

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

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VALLEY NATIONAL GASES INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS

LIABILITIES AND STOCKHOLDERS’ EQUITY


	June 30,			December 31,
	2005			2005
				(unaudited)
CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,674,444		$	4,197,702
Bank overdraft		—			100,992
Accounts payable		8,679,057			12,914,253
Accrued compensation and employee benefits		4,181,792			4,108,641
Interest rate derivatives		196,741			—
Other current liabilities		4,840,217			7,102,302


Total current liabilities		21,572,251			28,423,890

LONG-TERM DEBT, less current maturities		60,925,763			83,859,216
DEFERRED TAX LIABILITY		26,935,848			33,198,411
OTHER LONG-TERM LIABILITIES		670,615			731,381


Total liabilities		110,104,477			146,212,898


MINORITY INTEREST IN VARIABLE INTEREST ENTITIES		5,118,999			4,802,529

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS’ EQUITY:
Preferred stock, par value, $.01 per share— Authorized, 5,000,000 shares, none Issued or Outstanding		—			—
Common stock, par value, $.001 per share- Authorized, 30,000,000 shares; Issued, 9,620,084 shares, Outstanding, 9,574,999 and 9,617,674 shares, respectively		9,620			9,620
Paid-in-capital		19,160,327			19,302,562
Retained earnings		41,185,428			46,650,576
Accumulated other comprehensive (loss) income		(118,806	)		173,608
Treasury stock at cost, 45,085 and 2,410 shares, respectively		(374,084	)		(19,996	)


Total stockholders’ equity		59,862,485			66,116,370


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	175,085,961		$	217,131,797

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

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VALLEY NATIONAL GASES INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three Months Ended
	December 31,
	2004		2005
NET SALES	$	43,203,376	$	56,418,116
COSTS AND EXPENSES
Cost of products sold, excluding depreciation		20,635,179		28,426,906
Operating, distribution and administrative		13,672,585		17,443,236
Depreciation		1,751,240		2,005,534
Amortization of intangibles		278,559		219,580
Loss (gain) on disposal of assets		43,113		(27,557	)

Total costs and expenses		36,380,676		48,067,699

INCOME FROM OPERATIONS		6,822,700		8,350,417


INTEREST EXPENSE		1,148,207		1,181,615
OTHER INCOME, NET		138,364		115,348

EARNINGS BEFORE MINORITY INTEREST		5,812,857		7,284,150
MINORITY INTEREST		178,895		187,338

NET EARNINGS BEFORE TAXES		5,633,962		7,096,812
PROVISION FOR INCOME TAXES		2,140,905		2,706,102

NET EARNINGS	$	3,493,057	$	4,390,710


BASIC EARNINGS PER SHARE	$	0.37	$	0.46
DILUTED EARNINGS PER SHARE	$	0.36	$	0.45
WEIGHTED AVERAGE SHARES:
Basic		9,492,746		9,596,067
Diluted		9,655,223		9,752,787

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

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VALLEY NATIONAL GASES INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Six Months Ended
	December 31,
	2004		2005
NET SALES	$	79,403,892	$	98,081,347
COSTS AND EXPENSES
Cost of products sold, excluding depreciation		37,549,164		48,378,808
Operating, distribution and administrative		27,208,373		32,880,477
Depreciation		3,323,367		3,797,916
Amortization of intangibles		622,277		458,437
Loss (gain) on disposal of assets		61,272		(65,015	)

Total costs and expenses		68,764,453		85,450,623

INCOME FROM OPERATIONS		10,639,439		12,630,724


INTEREST EXPENSE		2,348,198		2,072,571
OTHER INCOME, NET		241,136		320,541

EARNINGS BEFORE MINORITY INTEREST		8,532,377		10,878,694
MINORITY INTEREST		376,844		444,479

NET EARNINGS BEFORE TAXES		8,155,533		10,434,215
PROVISION FOR INCOME TAXES		3,099,102		4,007,690

NET EARNINGS	$	5,056,431	$	6,426,525


BASIC EARNINGS PER SHARE	$	0.53	$	0.67
DILUTED EARNINGS PER SHARE	$	0.53	$	0.66
WEIGHTED AVERAGE SHARES:
Basic		9,489,221		9,586,274
Diluted		9,631,073		9,737,515

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

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VALLEY NATIONAL GASES INCORPORATED

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

For the periods ended June 30, 2005 and December 31, 2005


														Accumulated
														Other						Total
	Common Stock				Treasury Stock						Paid-in-			Comprehensive			Retained			Stockholders’			Comprehensive
	Shares		Amount		Shares			Amount			Capital			Income (Loss)			Earnings			Equity			Income
BALANCE, June 30, 2004		9,620,084		9,620		155,500			(1,291,633	)		18,905,761			(1,184,309	)		29,668,686			46,108,125			—
Net earnings		—		—		—			—			—			—			12,370,670			12,370,670		$	12,370,670
Dividend paid, per share $0.09		—		—		—			—			—			—			(853,928	)		(853,928	)		—
Exercise of stock options		—		—		(110,415	)		917,549			(142,575	)		—			—			774,974			—
Tax benefit from exercise of stock options		—		—		—			—			397,141			—			—			397,141			—
Unrealized gains on derivatives designated and qualified as cash flow hedges, net of tax provision of $665,159		—		—		—			—			—			997,739			—			997,739			997,739
Reclassification of unrealized gains on derivatives, net of tax provision of $45,176		—		—		—			—			—			67,764			—			67,764			67,764

BALANCE, June 30, 2005		9,620,084		9,620		45,085			(374,084	)		19,160,327			(118,806	)	$	41,185,428		$	59,862,485			13,436,173

Net earnings		—		—		—			—			—			—			6,426,525			6,426,525			6,426,525
Dividend paid, per share $0.10		—		—		—			—			—			—			(961,377	)		(961,377	)		—
Exercise of stock options		—		—		(42,675	)		354,088			(80,111	)		—			—			273,977			—
Tax benefit from exercise of stock options		—		—		—			—			124,098			—			—			124,098			—
Non-cash stock compensation expense		—		—		—			—			98,248			—			—			98,248			—
Unrealized gains on derivatives designated and qualified as cash flow hedges, net of tax provision of $194,436		—		—		—			—			—			291,654			—			291,654			291,654
Reclassification of unrealized gains on derivatives, net of tax provision of $507		—		—		—			—			—			760			—			760			760

BALANCE, December 31, 2005 (unaudited)		9,620,084	$	9,620		2,410		$	(19,996	)	$	19,302,562		$	173,608		$	46,650,576		$	66,116,370		$	6,718,939

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

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VALLEY NATIONAL GASES INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)


	Six Months Ended
	December 31,
	2004			2005
NET CASH PROVIDED BY OPERATING ACTIVITIES	$	7,011,247		$	7,790,976


CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from disposal of assets		47,420			122,882
Purchases of property and equipment		(5,783,471	)		(4,937,688	)
Business acquisitions, net of cash acquired		^___			(23,715,018	)

Net cash used by investing activities		(5,736,051	)		(28,529,824	)


CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings		30,800,455			50,914,568
Principal payments on borrowings		(29,139,337	)		(27,607,858	)
Proceeds (repayment) of bank overdraft		(668,046	)		100,992
Dividend paid		(853,928	)		^___
Proceeds from exercise of stock options		218,024			273,977
Variable interest entity distribution		(802,107	)		(760,950	)


Net cash provided (used) by financing activities		(444,939	)		22,920,729


NET CHANGE IN CASH AND CASH EQUIVALENTS		830,257			2,181,881

CASH AND CASH EQUIVALENTS, beginning of period		549,002			1,322,397


CASH AND CASH EQUIVALENTS, end of period	$	1,379,259		$	3,504,278

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

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VALLEY NATIONAL GASES INCORPORATED

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION:

The accompanying condensed consolidated financial statements include the accounts of Valley National Gases Incorporated and wholly-owned subsidiaries and entities required to be consolidated pursuant to Financial Accounting Standards Board Interpretation No. 46R, “Consolidation of Variable Interest Entities,” (“FIN 46R”). The term “Valley” as used throughout this document is used to indicate Valley National Gases Incorporated and wholly-owned subsidiaries. The term “the Company” as used throughout this document is used to indicate Valley as well as entities required to be consolidated under FIN 46R. Effective with this adoption, the Company has two reportable segments: Valley and Variable Interests Entities. (See Note 9)

The condensed consolidated financial statements of the Company presented herein are unaudited. Certain information and footnote disclosures normally prepared in accordance with generally accepted accounting principles have been either condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. Although the Company believes that all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation have been made, interim periods are not necessarily indicative of the financial results of operations for a full year. As such, these financial statements should be read in conjunction with the financial statements and notes thereto included or incorporated by reference in the Company’s audited consolidated financial statements for the year ended June 30, 2005.

2. ORGANIZATION

Valley produces, packages and resells industrial gases, specialty gases and propane; and resells welding hard goods and equipment. Valley’s gas operations consist primarily of packaging and mixing industrial, medical and specialty gases, such as oxygen, nitrogen and argon, in pressurized cylinders and transporting these cylinders to customers from one of Valley’s 73 distribution or retail locations. In addition, Valley distributes propane to industrial and residential customers. Welding equipment and supplies sales includes welding machines, wire, fluxes and electrodes, as well as a wide variety of supporting equipment. Valley has been in operation since 1958 and currently operates in 14 states.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company’s financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. Certain of these accounting principles are more critical than others in gaining an understanding of the basis upon which the Company’s financial statements have been prepared. A comprehensive review of these policies is contained in Valley’s 2005 Annual Report on Form 10-K filed on September 28, 2005. Other than the adoption of SFAS 123R, “Accounting for Stock Based Compensation”, and SFAS 151, “Inventory Costs”, as discussed below, there have been no significant changes in accounting policies or the application thereof during the first six months of fiscal 2006.

TRADE RECEIVABLES

Valley makes 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

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doubtful accounts is determined based on historical experience, economic trends and management’s knowledge of significant accounts.

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


	2004			2005
Balance, June 30	$	747,309		$	672,822
Write-off of doubtful accounts		(185,025	)		(178,732	)
Provision for doubtful accounts		299,187			468,123

Balance, December 31	$	861,471		$	962,213

INVENTORY

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

The components of inventory are as follows:


	June 30,			December 31,
	2005			2005
				(Unaudited)
Hard goods	$	8,258,169		$	10,196,437
Gases		2,010,299			2,538,361
Reserves		(399,494	)		(992,896	)

	$	9,868,974		$	11,741,902

COST OF PRODUCTS SOLD, EXCLUDING DEPRECIATION

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

OPERATING, DISTRIBUTION AND ADMINISTRATIVE EXPENSES

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

DEPRECIATION

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

SHIPPING AND HANDLING FEES AND DISTRIBUTION COSTS

The Company recognizes delivery and freight charges to customers as elements of net sales. Costs of third-party freight are recognized as cost of products sold. The majority of the costs associated with the distribution of the Company’s products, which include direct labor and overhead associated with filling, warehousing and delivery by Company vehicles, is reflected in operating, distribution and administrative expenses and amounted to $12,688,000 and $10,590,000 for the six months ended December 31, 2005 and 2004, respectively. The Company conducts multiple operations out of the same facilities and does not allocate facility-related expenses to each operational function. Accordingly, there is no facility-related expense in the distribution costs disclosed above. Depreciation expense associated with the Company’s delivery fleet amounted to $984,000 and $728,000 for the six months ended December 31, 2005 and 2004, respectively, and is included in depreciation expense.

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Third party freight costs relating to the delivery of products to customers totaled $309,984 and $286,416 for the six months ended December 2005 and 2004, respectively, and were classified as operating, distribution and administrative expenses.

The Company has classified cost of deliveries by its employees and vehicles as operating, distribution and administrative expense which amounted to $9,381,000 and $7,617,000 for the six months ended December 2005 and 2004, respectively.

STOCK-BASED COMPENSATION

Effective July 1, 2005, the Company adopted the Statement of Financial Accounting Standards SFAS No. 123R to account for its stock-based compensation plan. Prior to July 1, 2005, the Company accounted for its stock based compensation plan under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issues to Employees”. Under these provisions, stock-based employee costs were not reflected in operating results for any period as the exercise price of all options granted was equal to or greater than the market value of the underlying common stock on the grant date. This adoption included the guidance provided in FSP FAS 123(R)-1, Classification and Measurement of Freestanding Financial Instruments Originally Issued in Exchange for Employee Services under FASB Statement No. 123(R), 123(R)-2 Practical Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123(R) 123(R)-3 Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards 123(R)-4 Classification of Options and Similar Instruments Issued as Employee Compensation That allow for Cash Settlement upon the Occurrence of a Contingent Event, which were issued in August, October and November of 2005, and February 2006.

Under SFAS No. 123R, the Company recognizes the compensation expense of a stock option award over the vesting period of the grant based on the fair value of the award under the prospective method as of the grant date. All options granted under the plan expire ten years after the grant date and vest three years after the grant date. The Company estimated the fair value of each of its awards on the grant date using the Black-Scholes option pricing model.

During the six months ended December 31, 2005, the Company recorded approximately $98,000 as compensation expense related to stock options. If Valley had elected to recognize compensation cost for their stock options for the six months ended December 30, 2004, under SFAS 123R, compensation expense would have been $42,672. If recorded, this expense would not have resulted in a change in earnings per share of $0.53. No options were granted or modified during the current fiscal year. Unrecognized compensation expense amounted to approximately $260,000 at December 31, 2005, of which approximately $82,000 is expected to be recorded during the balance of fiscal year 2006. Total stock compensation expense in the remainder of fiscal year 2006 could vary based upon future grants.

INCOME TAXES

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

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VARIABLE INTEREST ENTITIES

The Company leases buildings and equipment and rents cylinders from West Rentals, Inc., G.E.W. Real Estate, LLC, Real Equip-Lease, LLC, Acetylene Products Corporation and Plymouth Holding, LLC, entities that are engaged primarily in the purchase, development, sale and/or lease of real estate and that are controlled by Gary West, our Chairman and principal shareholder. Under Financial Accounting Standards Board Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN 46R”), we consolidated the financial statements of these related entities.

NEW ACCOUNTING STANDARDS

In November 2004, the FASB issued SFAS No. 151 that requires that items such as idle facility expense, excessive spoilage, double freight and handling costs be recognized as current period charges. In addition, it requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The standard was effective July 1, 2005 and no current period charges were required to be recognized.

In December 2004, the FASB issued Staff Position (FSP) No. 109-1 providing guidance on accounting for the manufacturing tax deduction provided for in the American Jobs Creation Act of 2004. The staff position calls for the tax deduction to be accounted for as a special deduction, beginning with our 2006 tax year. The adoption of this position did not materially affect our effective tax rate.

In February 2005, the FASB issued Emerging Issues Task Force (EITF) No. 04-10 “Determining Whether to Aggregate Segments That Do Not Meet the Quantitative Thresholds.” This statement clarifies the aggregation criteria of operating segments as defined in SFAS No. 131. This statement is effective for fiscal years ending after September 15, 2005. Management is in the process of evaluating the impact the issue will have on the Company’s results of operations and financial position.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections.” This statement replaces APB 20 cumulative effect accounting with retroactive restatement of comparative financial statements. It applies to all voluntary changes in accounting principle and defines “retrospective application” to differentiate it from restatements due to incorrect accounting. The provisions of this statement are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 and will become effective for Valley in fiscal 2007.

SUPPLEMENTAL CASH FLOW INFORMATION


	For the Six Months Ended
	December 31,
	2004		2005
Non-cash financing activity and investing activity ^__
Dividend payable		—		961,377
Non-cash adjustment to goodwill		—		570,221
Fixed asset purchases in accounts payable		159,505		270,656

RECLASSIFICATIONS

Certain reclassifications have been made to prior year amounts to conform with the current year presentation. These reclassifications had no effect on reported net earnings.

4. ACQUISITIONS:

Valley acquires businesses engaged in the distribution of industrial, medical and specialty gases, related welding supplies and accessories and propane.

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Acquisitions have been recorded using the purchase method of accounting and, accordingly, results of their operations have been included in Valley’s consolidated financial statements since the effective dates of the respective acquisitions. Valley allocates the purchase price based upon the fair value at the date of acquisition in accordance with SFAS No. 141, “Business Combinations”. Any contingencies are recorded when resolved.

On October 31, 2005, Valley acquired Reynolds (“Reynolds”) Welding Supply Company, a distributor of packaged industrial gases and welding supplies from five locations in Minnesota and one in southeastern South Dakota. Valley acquired all of the common stock of Reynolds and its wholly owned subsidiaries, Welders Supply Company, Inc. and Twin City Oxygen Company, for a purchase price of $18 million, subject to adjustment based upon outstanding indebtedness and cash balances on the closing date. For its fiscal year ended December 31, 2004, Reynolds reported aggregate sales of $19.5 million, approximately 53% of which was from packaged industrial gases and cylinder rental and 47% was from hard goods and welding supplies. The results of operations of Reynolds are included in the Company’s condensed consolidated statements of operations for the period from November 1, 2005 to December 31, 2005.

On December 1, 2005, Valley acquired United Propane Services, LLC. (“United”), a propane distributor with a single operating location, plus two satellite storage locations in north-central Pennsylvania, for a purchase price of $2.3 million. In calendar year 2004, United had sales of approximately $2.2 million. The results of operations of United are included in the Company’s condensed consolidated statements of operations for the period from December 1, 2005 to December 31, 2005.

The following table summarizes the allocation of the total purchase price to the fair values of the assets acquired and liabilities assumed as of the date of the acquisitions (in thousands):


Cash and cash equivalents	$	424
Accounts receivable		2,724
Inventory		2,374
Fixed assets including cylinders, bulk tanks and other equipment		15,273
Non-compete agreements		374
Customer relationships		1,682
Goodwill		9,201
Accounts payable		(842	)
Accrued compensation		(167	)
Other liabilities		(1,440	)
Deferred income taxes		(5,012	)
Debt		(374	)

Net assets acquired	$	24,217
Professional fees paid		(78	)
Cash acquired		(424	)

Total purchase price	$	23,715

The fixed assets acquired were assigned useful lives consistent with Valley’s previously owned assets while customer relationships were assigned a useful life of 20 years and will be amortized on a straight line basis. As these acquisitions were completed in the current quarter, the purchase price allocations are estimated and subject to change, as well as post-closing adjustments which may occur in the fourth quarter of fiscal 2006. Approximately $0.3 million of the $9.2 million of goodwill acquired will be deductible for tax purposes.

The following summarized unaudited pro forma results of operations for the six months ended December 31, 2005, illustrate the estimated effects of the acquisitions, as if the transactions were consummated as of the beginning of the fiscal year. 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.

- 13 -


	Six Months Ended
	December 31,
	2005		2004
Net sales	$	106,361,000	$	90,427,000
Net earnings before income taxes		10,340,000		8,453,000
Pro forma net earnings		6,368,000		5,338,000
Pro forma diluted earnings per share	$	0.65	$	0.55

5. GOODWILL AND INTANGIBLE ASSETS:

On July 1, 2001, Valley adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” under which goodwill and other intangible assets with indefinite lives are not amortized. Each year, Valley evaluates the intangible assets for impairment with any resulting impairment reflected as an operating expense. Valley’s intangibles, other than goodwill, consist of noncompete agreements, consulting agreements and customer relationships for which Valley has assigned definite lives equal to the terms of the agreements. As of June 30, 2005 and December 31, 2005, Valley’s noncompete agreements, consulting agreements and customer lists are summarized as follows:


			Accumulated				Accumulated
	Gross		Amortization				Amortization		Weighted
	Amount		as of		Gross Amount as of		as of		Average
	as of		June 30,		December 31, 2005		December 31, 2005		Amortization Period
	June 30, 2005		2005		(unaudited)		(unaudited)		(years)
Non-competition agreements	$	8,443,480	$	7,196,332	$	8,816,980	$	7,579,234		9.0
Consulting agreements		150,000		70,833		150,000		95,833		3.0
Customer relationships		1,342,893		62,150		3,024,423		112,685		17.5

Total	$	9,936,373	$	7,329,315	$	11,991,403	$	7,787,752

Amortization expense for the six months ended December 31, 2005 totaled $458,437. Estimated amortization expense for the remainder of fiscal 2006 as of December 31, 2005 and the next five fiscal years is summarized as follows:


Fiscal year Ending
June 30,
Remainder of 2006	$	315,461
2007	$	610,089
2008	$	568,839
2009	$	297,625
2010	$	188,588
2011	$	188,588

The changes in the carrying amount of goodwill for the six months ended December 31, 2005 are as follows:


Balance as of June 30, 2005	$	45,482,910
Goodwill acquired and final purchase price adjustments		9,777,742

Balance as of December 31, 2005	$	55,260,652

On June 30 2005, Valley completed the acquisition of Plymouth Wayne Welding Supplies, Inc., a distributor of packaged industrial gases with whom the Company had previously entered into a put/call option agreement. Plymouth Wayne, which operates from four locations in Southeastern Michigan adjacent to our current markets, generated annual revenue of approximately $11.9 million in its fiscal year ended August 31, 2004. We acquired all of the common stock of Plymouth Wayne for $7.8 million, including $1 million we paid when we signed the put/call agreement in May 1998 and assumed and refinanced approximately $3.6 million of debt.

- 14 -

The value of assets acquired were subject to a post-closing adjustment which occurred in the second quarter fiscal 2006, in the amount of $570,000 which consisted primarily of changes in fixed asset values, intangible assets and the related tax effect.

6. EARNINGS PER SHARE

Basic earnings per share were computed based on the weighted average number of common shares issued and outstanding during the relevant periods. Diluted earnings per share were computed based on the weighted average number of common shares issued and outstanding plus additional shares assumed to be outstanding to reflect the dilutive effect of common stock equivalents using the treasury stock method.


	Three Months Ended				Six Months Ended
	December 31,				December 31,
	2004		2005		2004		2005
Net earnings available for common stock	$	3,493,057	$	4,390,710	$	5,056,431	$	6,426,525


Basic earnings per common share:
Weighted average common shares		9,492,746		9,596,067		9,489,221		9,586,274


Basic earnings per common share	$	0.37	$	0.46	$	0.53	$	0.67


Diluted earnings per common share:
Weighted average common shares		9,492,746		9,596,067		9,489,221		9,586,274

Shares issuable from assumed conversion of common stock equivalents		162,477		156,720		141,852		151,241


Weighted average common and common equivalent shares		9,655,223		9,752,787		9,631,073		9,737,515


Diluted earnings per common share	$	0.36	$	0.45	$	0.53	$	0.66

All options to purchase shares of common stock during the three and six months ended December 31, 2005 and 2004, respectively, were included in the computation of diluted earnings per common share as the options’ exercise price was less than the average market price of the common stock for the respective periods. The weighted average common and common equivalent shares outstanding were calculated in accordance with SFAS 123R.

7. LEASE OBLIGATIONS

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

Certain lease agreements contain rent escalation clauses that are generally based on changes in the consumer price index over the escalation term. These leases are accounted for in accordance SFAS No. 29, “Contingent Rentals”. Our lease arrangements do not include any step rent provisions, capital improvement funding or significant lease concessions. Leasehold improvements are depreciated over the life of the lease or the useful life of the asset, whichever is shorter, which is consistent with the lease term used to recognize rent expense.

The Company renewed certain lease arrangements during the first six months of fiscal year 2006. Minimum future rental payments under non-cancelable operating leases, including consideration of expected renewals at estimated payment amounts based on average increases over the last three years, for the remainder of fiscal year 2006 and each of the next five fiscal years are as follows:

- 15 -


Fiscal year ending							Elimination		Final
June 30,	Real Estate		Equipment		Subtotal		(1)		Total
Remainder of 2006	$	2,063,266	$	25,350	$	2,088,616	$	1,231,843	$	856,773
2007		4,172,887		26,100		4,198,987		2,499,433		1,699,554
2008		4,277,210		—		4,277,210		2,561,919		1,715,291
2009		4,384,140		—		4,384,140		2,625,967		1,758,173
2010		4,493,743		—		4,493,743		2,691,616		1,802,127
2011		4,606,087		—		4,606,087		2,758,907		1,847,180

Totals	$	23,997,333	$	51,450	$	24,048,783	$	14,369,685	$	9,679,098


(1)		Reflects the elimination of intercompany rent as a result of FIN 46R, “Consolidation of Variable Interest Entities”.

8. COMMITMENTS AND CONTINGENCIES

Some industrial gases and propane are flammable, explosive products. Serious personal injury and property damage can occur in connection with its transportation, storage, production or use. We also have employment claims arising from time to time. Valley, in the ordinary course of business, is threatened with or is named as a defendant in various lawsuits which, among other items, seek actual and punitive damages for product liability, personal injury and property damage. Valley maintains liability insurance policies with insurers in such amounts and with such coverages and deductibles as Valley believes is reasonable and prudent. However, there can be no assurance that such insurance will be adequate to protect Valley from material expenses related to such personal injury or property damage or that such levels of insurance will continue to be available in the future at economical prices. Management is of the opinion that there are no known claims or known contingent claims that are likely to have a material adverse effect on the results of operations, financial condition or cash flows of Valley.

Valley leases buildings and equipment and rents cylinders from related parties, including the sole shareholder prior to Valley’s initial public offering and corporations owned by such sole shareholder and former officers of Valley. Valley concluded that the related party lease agreement entities (“Variable Interest Entities”) were required to be consolidated pursuant to common control provisions under FIN 46R (see Note 9). These lease agreements have various maturity dates through April 2013.

In September 1991, in connection with the purchase by Valley of certain assets of Praxair, Inc. (Praxair), Valley, Gary E. West and certain of his affiliates entered into a Right of First Refusal Agreement with Praxair for a period of 15 years. In March 1997, the parties to such agreement entered into an Amended and Restated Right of First Refusal Agreement (the Right of First Refusal Agreement) in connection with Valley’s reorganization. Pursuant to this agreement, if at any time during the term of the agreement Valley wishes to accept a third party offer to purchase all or a material part of the assets of Valley, or Mr. West and his affiliates wish to accept an offer to purchase shares of capital stock of Valley (the Capital Stock) owned by them in a transaction that would result in Mr. West and his affiliates collectively owning less than 51% of Valley’s issued and outstanding shares of Capital Stock on a fully diluted basis or owning less than 51% of the combined voting power of all outstanding voting securities of Valley, Praxair will have a right of first refusal to match the offer. In addition, in the absence of a third party offer, if (a) Mr. West and his affiliates wish to sell shares of Common Stock which would result in their owning collectively less than 51% or more of Valley’s issued and outstanding shares of Common Stock, (b) Valley wishes to sell all or a material part of its assets, or (c) Valley wishes to issue additional shares or options or securities exercisable or convertible into shares of Common Stock, pursuant to employee stock options, a public offering, private placement, merger, share exchange or otherwise, which in the aggregate on a fully diluted basis would result in Mr. West and his affiliates collectively owning less than 51% of all the issued outstanding shares of Common Stock, then Praxair will

- 16 -

have the right to purchase from Mr. West and his affiliates up to all of the issued and outstanding shares of Common Stock held by them (but not less than 51% of all of the issued and outstanding shares of Valley’s Common Stock on a fully diluted basis) at the then prevailing market price. If Praxair does purchase shares of Capital Stock from Mr. West and his affiliates as described in this paragraph, then Mr. West and his affiliates will be bound by certain non-compete provisions, as described in the Right of First Refusal Agreement, for a period of three years from such purchase.

9. VARIABLE INTEREST ENTITIES

Valley leases buildings and equipment and rents cylinders under operating leases from related parties, collectively referred to as “Variable Interest Entities.” These entities include West Rentals, Inc., G.E.W. Real Estate, LLC, Real Equip-Lease LLC, Acetylene Products Corporation and Plymouth Holding, LLC. The primary activity of these entities is to purchase, develop, sell and/or lease real estate. Valley has historically entered into these leases with these related parties to preserve its capital to support its strategy of growing through acquisitions. Valley’s Chairman, who is the beneficial owner of 75% of Valley’s common stock, beneficially owns greater than 50% of each of these entities. These arrangements are supported by a master lease agreement, as well as certain individual lease agreements, that do not contain a bargain purchase option, fixed renewal option or residual value guarantee. Valley has no equity interest in any of the entities included in the Variable Interest Entities. Additionally, the creditors and beneficial interest holders of the entities have no recourse to the general credit of Valley.

Based upon FIN 46R, in situations where no contractual residual value guarantees exist, a related party lease is presumed to contain an implied residual value guarantee. Therefore, as a result of the implied residual value guarantee, Valley is considered the primary beneficiary of the related party lease agreements, and management concluded that each of these entities represent a variable interest entity under the provisions of FIN 46R. Accordingly, Valley has consolidated the historical balance sheet of the entities as of March 31, 2004, the date of adoption of the consolidation provision of FIN 46R. All intercompany balances have been eliminated in consolidation.

The variable interest entities had outstanding debt, consisting primarily of asset-backed mortgages for real estate, of $9.1 million at December 31, 2005. The carrying value of the land and buildings that secure this debt was approximately $7.7 million as of December 31, 2005. This debt carries various interest rates ranging from 3.3% to 7.3% and various maturities from 2006 to 2016. Some of the mortgages on which the variable interest entities are obligated are personally guaranteed by Valley’s Chairman, Gary E. West.

- 17 -

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

A S S E T S


	As of December 31, 2005
	(unaudited)
				Variable
				Interest
	Valley			Entities
	Segment			Segment			Eliminations			Company
CURRENT ASSETS:
Cash and cash equivalents	$	2,621,427		$	882,851		$	—		$	3,504,278
Accounts receivable, net of allowance for doubtful accounts of $962,213		27,610,264			250,072			(117,696	)		27,742,640
Inventory		11,741,902			—			—			11,741,902
Prepaids and other		1,462,135			11,264			—			1,473,399
Current deferred tax asset		1,722,153			—			—			1,722,153
Refundable taxes		—			—			—			—


Total current assets		45,157,881			1,144,187			(117,696	)		46,184,372


PROPERTY, PLANT AND EQUIPMENT:
Land		175,000			2,022,415			—			2,197,415
Buildings and improvements		8,400,643			14,486,271			—			22,886,914
Equipment		114,814,863			1,397,653			—			116,212,516
Transportation equipment		21,096,668			173,249			—			21,269,917
Furniture and fixtures		9,078,487			182,656			—			9,261,143


Total property, plant and equipment		153,565,661			18,262,244			—			171,827,905

Accumulated depreciation		(55,968,756	)		(4,927,016	)		—			(60,895,772	)


Net property, plant and equipment		97,596,905			13,335,228			—			110,932,133


OTHER ASSETS:
Intangible assets, net of accumulated amortization of $7,787,752		4,203,651			—			—			4,203,651
Goodwill		55,260,652			—			—			55,260,652
Deposits and other assets		537,247			13,742			—			550,989


Total other assets		60,001,550			13,742			—			60,015,292


TOTAL ASSETS	$	202,756,336		$	14,493,157		$	(117,696	)	$	217,131,797

- 18 -

LIABILITIES AND STOCKHOLDERS’ EQUITY


	As of December 31, 2005
	(unaudited)
				Variable Interest
	Valley			Entities
	Segment			Segment		Eliminations			Company
CURRENT LIABILITIES:

Current maturities of long-term debt	$	927,660		$	3,270,042	$	—		$	4,197,702
Bank overdraft		—			100,992		—			100,992
Accounts payable		12,603,623			310,630		—			12,914,253
Accrued compensation and employee benefits		4,106,160			2,481		—			4,108,641
Other current liabilities		7,032,616			187,382		(117,696	)		7,102,302


Total current liabilities		24,670,059			3,871,527		(117,696	)		28,423,890

LONG-TERM DEBT, less current maturities		78,040,115			5,819,101		—			83,859,216
DEFERRED TAX LIABILITY		33,198,411			—		—			33,198,411
OTHER LONG-TERM LIABILITIES		731,381			—		—			731,381


Total liabilities		136,639,966			9,690,628		(117,696	)		146,212,898


MINORITY INTEREST IN VARIABLE INTEREST ENTITIES		—			—		4,802,529			4,802,529

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS’ EQUITY:
Preferred stock, par value, $.01 per share— Authorized, 5,000,000 shares, none Issued or Outstanding
Common stock, par value, $.001 per share— Authorized, 30,000,000 shares; Issued, 9,620,084 shares, Outstanding, 9,617,674 shares		9,620			3,800		(3,800	)		9,620
Paid-in-capital		19,302,562			335,985		(335,985	)		19,302,562
Retained earnings		46,650,576			4,462,744		(4,462,744	)		46,650,576
Accumulated other comprehensive income (loss)		173,608			—		—			173,608
Treasury stock at cost, 2,410 shares		(19,996	)		—		—			(19,996	)


Total stockholders’ equity		66,116,370			4,802,529		(4,802,529	)		66,116,370


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	202,756,336		$	14,493,157	$	(117,696	)	$	217,131,797

- 19 -

The following table shows the consolidating balance sheet of the Company at June 30, 2005:

A S S E T S


	As of June 30, 2005
				Variable
				Interest
	Valley			Entities
	Segment			Segment			Eliminations			Company
CURRENT ASSETS:
Cash and cash equivalents	$	548,925		$	773,472		$	—		$	1,322,397
Accounts receivable, net of allowance for doubtful accounts of $672,822		16,825,355			248,851			(117,696	)		16,956,510
Inventory		9,868,974			—			—			9,868,974
Prepaids and other		1,026,410			10,000			—			1,036,410
Current deferred tax asset		1,774,379			—			—			1,774,379
Refundable taxes		1,471,519			—			—			1,471,519


Total current assets		31,515,562			1,032,323			(117,696	)		32,430,189


PROPERTY, PLANT AND EQUIPMENT:
Land		75,000			2,024,915			—			2,099,915
Buildings and improvements		7,512,593			13,904,065			—			21,416,658
Equipment		99,138,620			1,193,886			—			100,332,506
Transportation equipment		19,075,833			173,249			—			19,249,082
Furniture and fixtures		8,581,988			174,322			—			8,756,310


Total property, plant and equipment		134,384,034			17,470,437			—			151,854,471

Accumulated depreciation		(53,073,285	)		(4,663,811	)		—			(57,737,096	)


Net property, plant and equipment		81,310,749			12,806,626			—			94,117,375


OTHER ASSETS:
Intangible assets, net of accumulated amortization of $7,329,315		2,607,058			—			—			2,607,058
Goodwill		45,482,910			—			—			45,482,910
Deposits and other assets		434,687			13,742			—			448,429


Total other assets		48,524,655			13,742			—			48,538,397


TOTAL ASSETS	$	161,350,966		$	13,852,691		$	(117,696	)	$	175,085,961

- 20 -

LIABILITIES AND STOCKHOLDERS’ EQUITY


	As of June 30, 2005
				Variable
				Interest
	Valley			Entities
	Segment			Segment		Eliminations			Company
CURRENT LIABILITIES:

Current maturities of long-term debt	$	1,434,427		$	2,240,017	$	—		$	3,674,444
Accounts payable		8,390,239			288,818		—			8,679,057
Accrued compensation and employee benefits		4,181,792			—		—			4,181,792
Interest rate derivatives		196,741			—		—			196,741
Other current liabilities		4,846,043			111,870		(117,696	)		4,840,217


Total current liabilities		19,049,242			2,640,705		(117,696	)		21,572,251

LONG-TERM DEBT, less current maturities		54,832,776			6,092,987		—			60,925,763
DEFERRED TAX LIABILITY		26,935,848			—		—			26,935,848
OTHER LONG-TERM LIABILITIES		670,615			—		—			670,615


Total liabilities		101,488,481			8,733,692		(117,696	)		110,104,477


MINORITY INTEREST IN VARIABLE INTEREST ENTITIES		—			—		5,118,999			5,118,999

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS’ EQUITY:
Preferred stock, par value, $.01 per share— Authorized, 5,000,000 shares, none Issued or Outstanding
Common stock, par value, $.001 Per share- Authorized, 30,000,000 shares;
Issued, 9,620,084 shares, Outstanding, 9,574,999 shares		9,620			3,800		(3,800	)		9,620
Paid-in-capital		19,160,327			335,985		(335,985	)		19,160,327
Retained earnings		41,185,428			4,779,214		(4,779,214	)		41,185,428
Accumulated other comprehensive income (loss)		(118,806	)		—		—			(118,806	)
Treasury stock at cost, 45,085 shares		(374,084	)		—		—			(374,084	)


Total stockholders’ equity		59,862,485			5,118,999		(5,118,999	)		59,862,485


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	161,350,966		$	13,852,691	$	(117,696	)	$	175,085,961

-21-

The following table shows the consolidating income statement of the Company for the six months ended December 31, 2005 (unaudited):


				Variable
				Interest
	Valley			Entities
	Segment			Segment			Eliminations			Company
NET SALES	$	98,081,347		$	1,187,890		$	(1,187,890	)		$	98,081,347
COSTS AND EXPENSES
Cost of products sold, excluding depreciation		48,378,808			—			—				48,378,808
Operating, distribution and administrative		33,647,716			420,651			(1,187,890	)			32,880,477
Depreciation		3,507,919			289,997			—				3,797,916
Amortization of intangibles		458,437			—			—				458,437
Gain on disposal of assets		(36,332	)		(28,683	)		—				(65,015	)

Total costs and expenses		85,956,548			681,965			(1,187,890	)			85,450,623

INCOME FROM OPERATIONS		12,124,799			505,925			—				12,630,724

INTEREST EXPENSE		1,898,323			174,248			—				2,072,571
OTHER INCOME, NET		207,739			112,802			—				320,541

EARNINGS BEFORE MINORITY INTEREST		10,434,215			444,479			—				10,878,694
MINORITY INTEREST		—			444,479			—				444,479

NET EARNINGS BEFORE TAXES		10,434,215			—			—				10,434,215
PROVISION FOR INCOME TAXES		4,007,690			—			—				4,007,690

NET EARNINGS	$	6,426,525		$	—		$	—			$	6,426,525

The following table shows the consolidating income statement of the Company for the six months ended December 31, 2004 (unaudited):


			Variable
			Interest
	Valley		Entities
	Segment		Segment		Eliminations			Company
NET SALES	$	79,403,892	$	1,024,797	$	(1,024,797	)	$	79,403,892

COSTS AND EXPENSES
Cost of products sold, excluding Depreciation		37,549,164		—		—			37,549,164
Operating, distribution and Administrative		27,839,849		393,321		(1,024,797	)		27,208,373
Depreciation		3,060,000		263,367		—			3,323,367
Amortization of intangibles		622,221		56		—			622,277
Loss on disposal of assets		61,272		—		—			61,272

Total costs and expenses		69,132,506		656,744		(1,024,797	)		68,764,453

INCOME FROM OPERATIONS		10,271,386		368,053		—			10,639,439

INTEREST EXPENSE		2,241,782		106,416		—			2,348,198
OTHER INCOME, NET		125,929		115,207		—			241,136

EARNINGS BEFORE MINORITY INTEREST		8,155,533		376,844		—			8,532,377
MINORITY INTEREST		—		376,844		—			376,844

NET EARNINGS BEFORE TAXES		8,155,533		—		—			8,155,533
PROVISION FOR INCOME TAXES		3,099,102		—		—			3,099,102

NET EARNINGS	$	5,056,431		—		—		$	5,056,431

- 22 -

The following table shows the consolidating income statement of the Company for the three months ended December 31, 2005 (unaudited):


				Variable Interest
	Valley			Entities
	Segment			Segment		Eliminations			Company
NET SALES	$	56,418,116		$	600,896	$	(600,896	)	$	56,418,116
COSTS AND EXPENSES
Cost of products sold, excluding depreciation		28,426,906			—		—			28,426,906
Operating, distribution and administrative		17,845,061			199,071		(600,896	)		17,443,236
Depreciation		1,854,519			151,015		—			2,005,534
Amortization of intangibles		219,580			—		—			219,580
Loss on disposal of assets		(27,557	)		—		—			(27,557	)

Total costs and expenses		48,318,509			350,086		(600,896	)		48,067,699

INCOME FROM OPERATIONS		8,099,607			250,810		—			8,350,417

INTEREST EXPENSE		1,081,301			100,314		—			1,181,615
OTHER INCOME, NET		78,506			36,842		—			115,348
EARNINGS BEFORE MINORITY INTEREST		7,096,812			187,338		—			7,284,150
MINORITY INTEREST		—			187,338		—			187,338

NET EARNINGS BEFORE TAXES		7,096,812			—		—			7,096,812
PROVISION FOR INCOME TAXES		2,706,102			—		—			2,706,102

NET EARNINGS	$	4,390,710			—		—		$	4,390,710

The following table shows the consolidating income statement of the Company for the three months ended December 31, 2004 (unaudited):


			Variable Interest
	Valley		Entities
	Segment		Segment		Eliminations			Company
NET SALES	$	43,203,376	$	524,947	$	(524,947	)	$	43,203,376
COSTS AND EXPENSES
Cost of products sold, excluding Depreciation		20,635,179		—		—			20,635,179
Operating, distribution and Administrative		14,006,145		191,387		(524,947	)		13,672,585
Depreciation		1,590,000		161,240		—			1,751,240
Amortization of intangibles		278,531		28		—			278,559
Loss on disposal of assets		43,113		—		—			43,113

Total costs and expenses		36,532,968		352,655		(524,947	)		36,380,676

INCOME FROM OPERATIONS		6,650,408		172,292		—			6,822,700

INTEREST EXPENSE		1,091,122		57,085		—			1,148,207
OTHER INCOME, NET		74,676		63,688		—			138,364
EARNINGS BEFORE MINORITY INTEREST		5,633,962		178,895		—			5,812,857
MINORITY INTEREST		—		178,895		—			178,895

NET EARNINGS BEFORE TAXES		5,633,962		—		—			5,633,962
PROVISION FOR INCOME TAXES		2,140,905		—		—			2,140,905

NET EARNINGS	$	3,493,057		—		—		$	3,493,057

10. SEGMENT DATA

Effective with the adoption of FIN 46R and the required consolidation of certain variable interest entities, the Company has two reportable segments: Valley and Variable Interest Entities. Since these are two separate and distinct businesses, the financial information for each business is maintained and managed separately. The results of operations and assets for each of these segments are derived from each business’ financial reporting system. All intercompany activity is eliminated in consolidation.

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

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The Valley reportable segment operates 73 retail and distribution locations in 14 states. All locations offer the same core products of packaged gases, welding equipment and supplies. All locations generally sell to customers in the metal fabrication, construction, general industrial, research and laboratory, hospital and other medical, commercial, agricultural and residential industries. Management considers each of the locations to be an operating segment as defined in Financial Accounting Standards Board (FASB) No. 131, however, none of these locations individually meet the quantitative thresholds stated in FASB No. 131 of 10% of revenue (or profits or assets) to be deemed a reportable segment. Since these operating segments are similar in products sold, types of customers, methods of distribution and regulatory environment, management concluded that these operating segments should be aggregated into one reporting segment in accordance with FASB No. 131.

Identifiable assets by reporting segment are as follows (See Note 9):


	June 30,		December 31,
	2005		2005
Valley	$	161,350,966	$	202,756,336
Variable Interest Entities		13,734,995		14,375,461

Total assets	$	175,085,961	$	217,131,797

Refer to Note 9 for revenue and income by reporting segment.


Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto appearing elsewhere in this report.

Forward-Looking Statements

This form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The statements regarding Valley National Gases Incorporated contained herein that are not historical in nature, particularly those that utilize terminology such as “may,” “will,” “should,” “likely,” “expects,” “anticipates,” “estimates,” “believes” or “plans,” or comparable terminology, are forward-looking statements based on current expectations and assumptions, and entail various risks and uncertainties that could cause actual results to differ materially from those expressed in such forward-looking statements.

Valley undertakes no obligation to correct or update any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any future disclosure Valley makes on related subjects in future reports to the SEC.

OVERVIEW

OPERATIONS

We are a leading distributor of industrial, medical and specialty gases, and related welding equipment and supplies, in 14 states in the eastern United States. We also have a growing presence in the distribution of non-pipeline propane in our geographic markets.

We generate revenue through the sale of packaged industrial, medical and specialty gases and rental and delivery charges for the cylinders and tanks in which they are delivered, as well as through sale of related welding equipment and supplies. We sell packaged gases to customers for manufacturing, industrial, metal production and fabrication, construction, health care, mining, oil and chemicals and other applications. Sale of our packaged gases is generally not seasonal. We also sell propane to the residential, commercial and industrial markets. Typical residential and commercial uses include conventional space heating, water heating and cooking. Typical

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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. In the 2005 fiscal year, packaged gases and rental, together with related equipment and supplies, accounted for approximately 73% of our net sales, while propane accounted for approximately 27% of our net sales.

Our cost of products sold include the direct cost of industrial, medical and specialty gases pursuant to supply arrangements and open purchase orders with four out of the five major gas producers in the United States, the purchase of hard goods from a number of vendors and the purchase of propane from one of the three major propane suppliers. Although the cost of the gases we sell is subject to formula pricing and variation based on market prices for such gases, because packaging, delivery and other service constitutes a substantial portion of the cost and the value of the packaged gases we provide our customers, we believe that we are not significantly exposed to decreased margins because of those variations.

Our operating, distribution and administrative expenses primarily are composed of delivery expense, salaries, benefits, professional fees, transportation equipment operating costs, facility lease expenses and general office expenses. We believe 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. We also incur depreciation expense related to our fixed assets, including cylinders which are depreciated over a period of 12 to 30 years and delivery vehicles that we depreciate over a period of 3 to 7 years.

ACQUISITIONS

We believe that we have been successful in executing our strategy of growth through acquisitions, having completed over 33 acquisitions since 1997, the year of our initial public offering. 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. For many acquisitions, we believe 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. Some acquisitions have had, and we expect that some future acquisitions may have, a dilutive effect upon our income from operations and income before tax for a period following their consummation. This dilution can occur because some of the benefits of acquisitions, such as leveraging of operating and administrative expenses, improved product gross margins and expected sales growth, occur over time. In most cases, the operating cash flow of an acquired business has been positive in a relatively short period of time after consummation of the acquisition.

On October 31, 2005, Valley acquired Reynolds Welding Supply Company, a distributor of packaged industrial gases and welding supplies from five locations in Minnesota and one in southeastern South Dakota. Valley acquired all of the common stock of Reynolds and its wholly owned subsidiaries, Welders Supply Company, Inc. and Twin City Oxygen Company, for a purchase price of $18 million, subject to adjustment based upon outstanding indebtedness and cash balances on the closing date. For its fiscal year ended December 31, 2004, Reynolds reported aggregate sales of $19.5 million, approximately 53% of which was from packaged industrial gases in cylinder rental and 47% was from hard goods and welding supplies.

On December 1, 2005, Valley acquired United Propane Services, LLC., a propane distributor with a single operating location, plus two satellite storage locations in north-central Pennsylvania, for a purchase price of $2.3 million. In calendar year 2004, United had sales of approximately $2.2 million.

In part to manage our operations independent of the effect of acquisitions, we monitor the results of each of our 73 locations separately. Although each location is therefore a separate operating segment, because no single store generates an amount of revenue or income, or maintains assets, in excess of the thresholds in accounting releases that would require us to report them as separate segments, and because all stores offer similar products and services, we report their results on an aggregate

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basis. We do maintain records of “same store sales,” which are sales from those stores that have been operated by us for both comparative periods. The value of sales increase related to acquisitions is determined by the specific sales of each acquired location. New stores would be considered in same store sales once we have operated them for the entire comparison period.

VARIABLE INTEREST ENTITIES

We lease buildings and equipment and rent cylinders from West Rentals, Inc., G.E.W. Real Estate, LLC, Real Equip-Lease LLC, Acetylene Products Corporation and Plymouth Holding, LLC, entities that are engaged primarily in the purchase, development, sale and/or lease of real estate and that are controlled by Gary West, our Chairman and principal shareholder. Under accounting interpretations that were effective for us on March 31, 2004, and because we are under common control with these entities, we were required to consolidate in our financial statements, the financial statements of these related entities. In consolidation, the rent expense we pay to these entities is eliminated, resulting in us reporting slightly less operating, distribution and administrative expense and slightly more income from operations. Because some of the properties held by the variable interest entities are financed, and because of the amount of depreciable assets these entities hold, the consolidation results in us reporting slightly more interest and depreciation expense. Further, because we classify the rental income from third parties that these entities generate as “other income” for our purposes, these entities result in our reporting more other income. Substantially all of the effect of these entities on our net income is eliminated when we deduct the net effect as a minority interest. The real property and equipment held by these entities results in our reporting significantly higher balances of buildings and equipment on our balance sheet. Although these entities are controlled by related parties, we have no equity interest in any of them and the creditors and beneficial interest holders of these entities have no recourse to our general credit.

CRITICAL ACCOUNTING POLICIES

The preparation of our financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions and estimates that affect the amounts we report in our consolidated financial statements and accompanying notes included herein. We describe the significant accounting policies and methods that we use to prepare our consolidated financial statements in Note 3. The most critical accounting matters in which we use estimates include our determination of the net carrying value of our trade receivables, inventories, goodwill, other intangible assets and employee health care benefit reserves. If our estimates have to be revised, we may be required to adjust the carrying value of these assets, affecting our results of operations during the period when the adjustment is recorded, and affecting our net assets and equity. The following critical accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the consolidated financial statements.

TRADE RECEIVABLES

We estimate the collectability of our trade receivables. We have established an allowance for doubtful accounts to adjust the carrying value of trade receivables to fair value based on the amount of trade receivables that we estimate are uncollectible. We establish the allowance for doubtful accounts based on our historical experience, economic trends and our knowledge of significant accounts. Although we believe that the allowance for doubtful accounts as of December 31, 2005 is adequate, if a significant customer refuses to pay a large account, or if economic conditions cause a class of customers to be unable to pay accounts, we might be required to increase the provision for doubtful accounts, affecting our income.

INVENTORIES

Our inventories are stated at the lower of cost or market, cost being determined by the first-in first-out method. We write down our 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

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future are less favorable than those estimated, additional inventory write-downs may be required. Estimates of physical losses of inventory are made on a quarterly basis based upon historical results.

GOODWILL AND OTHER INTANGIBLE ASSETS

We adopted SFAS No. 142, “Goodwill and Other Intangible Assets”, as of July 1, 2001. SFAS No. 142 requires goodwill and intangible assets with indefinite useful lives not to be amortized, but instead to be tested for impairment at least annually. We have elected to perform our annual test for indications of goodwill impairment as of June 30th of each year. In testing the impairment of goodwill, we consider a variety of valuation methods, including formal criteria of the Uniform Standards of Professional Appraisal Practice (“USPAP”) for assessment of the fair market value of a business as a whole. In accordance with USPAP, we use a discounted cash flow analysis including, where applicable, appropriate market-based deductions, control premiums and discounts, and take into account any extraordinary assumptions and hypothetical conditions which may have an impact on our determination. In addition to this approach for valuing our business as a whole, we also consider goodwill by location or groups of locations based upon our operating segments. The application of each of these methods involves a number of estimates and assumptions, and the weighting and balancing of the methods and their results also involves assumptions and the application of considerable judgment. We may be required to adjust our assumptions and estimates when events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. To the extent we make this determination, we would be required to reduce the carrying value of our goodwill by taking a charge that will reduce our earnings in the period taken and reduce our equity at the end of the period. We cannot be certain that the assumptions and judgments we have made regarding the carrying value of our goodwill will prove accurate and that we will not be required to take impairment charges in the future. No triggering events occurred during the current fiscal year.

EMPLOYEE HEALTH CARE BENEFITS RESERVES

We have self-funded health care benefit programs in place through which a third party administrator settles and pays claims by our employees on an on-going basis. We estimate the level of outstanding claims, at any point in time, including claims incurred but not reported, based upon historical payment patterns, knowledge of individual claims and estimates of health care costs. We have stop-loss insurance coverage in place to limit the extent of individual claims.

VALUATION OF LONG-LIVED ASSETS

Long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Estimates of the remaining useful lives of assets are reviewed at least annually at the close of the fiscal year. Determination of recoverability is based on an estimate of discounted or undiscounted future cash flows resulting from the use of the assets and their eventual disposition. Measurement of an impairment loss for long-lived assets that management expects to hold and use is based on the fair value of the assets.

INCOME TAXES

We account for income taxes in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes,” under which deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the estimated tax rate at the date of reversal. These differences are classified as current or non-current based upon the classification of the related asset or liability. For temporary differences that are not related to an asset or liability, classification is based upon the expected reversal date of the temporary difference. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. We estimate and record additional tax expense based on uncertain tax positions taken by the Company within statutory limitations. This estimate is adjusted when tax audits are completed or when the statute of limitations expires on those recorded tax positions. In fiscal 2006, a manufacturing tax deduction provided for in the American Jobs Creation Act of 2004 is

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effective for the Company. In addition, revisions to the Ohio State tax law is effective for the current fiscal year.

VARIABLE INTEREST ENTITIES

RESULTS OF OPERATIONS

The following table presents information about our results of operations as a percentage of net sales. Results for any one or more periods are not necessarily indicative of continuing trends.


	Three Months Ended						Six Months Ended
	December 31,						December 31,
	2005			2004			2005			2004
Net Sales		100.0	%		100.0	%		100.0	%		100.0	%
Cost of products sold, excluding depreciation		50.4			47.8			49.3			47.3
Operating, distribution and administrative		30.8			31.6			33.5			34.3
Depreciation		3.6			4.1			3.8			4.1
Amortization of intangibles		0.4			0.6			0.5			0.8

Total costs and expenses		85.2			84.1			87.1			86.5

Income from operations		14.8			15.9			12.9			13.5

Interest expense		2.1			2.7			2.1			2.9
Other income, net		0.3			0.2			0.4			0.2

Earnings before minority interest		13.0			13.4			11.2			10.8
Minority interest		0.3			0.4			0.5			0.5

Net earnings before taxes		12.7			13.0			10.7			10.3
Provision for income taxes		4.8			5.0			4.1			3.9

Net earnings		7.9	%		8.0	%		6.6	%		6.4	%

RESULTS OF OPERATIONS

Comparison of Three Months Ended December 31, 2005 and 2004

Our net sales increased $13.2 million, or 30.6%, to $56.4 million for the three months ended December 31, 2005 from $43.2 million for the three months ended December 31, 2004. Acquisitions made during the preceding twelve months contributed $6.5 million of the increase in net sales, while same-store sales increased $6.7 million, or 15.5%. Packaged gases and cylinder rental revenue represented 34.1% of net sales for the three months ended December 31, 2005 and hard goods represented 34.4% of net sales, with total revenue from our packaged gas business representing 68.5% of net sales. In comparison, packaged gases and cylinder rental revenue represented 34.1% of net sales for the three months ended December 31, 2004 and hard goods represented 35.0% of net sales, with total revenue from our packaged gas business representing 69.1% of net sales. Sales of hard goods increased $4.3 million, or 28.3%, from the three months ended December 31, 2004 to the three months ended December 31, 2005, reflecting the impact of acquisitions totaling $3.1 million and increased demand from the improved economy. Packaged gases and cylinder rent increased $4.5 million, or 30.5%, reflecting the impact of acquisitions totaling $3.0 million and increased demand from the improved economy and increased prices. Propane sales represented 31.5% of net sales in the three months ended December 31, 2005 compared to 30.9% of net sales in the three months ended December 31, 2004. Propane sales increased $4.4 million, or 33.2%, in the three months ended December 31, 2005 compared to the three months ended December 31, 2004 due primarily to price increases. In addition, propane volume increased 12.5% for the three

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months ended December 31, 2005 compared to the prior period which included approximately 3.4% related to acquisitions made during the current period.

Our cost of products sold increased $7.8 million, or 37.6%, to $28.4 million for the three months ended December 31, 2005 compared to $20.6 million for the three months ended December 31, 2004. Acquisitions made during the last twelve months contributed $3.4 million of the change while same-store cost of products sold increased $4.4 million. Cost of products sold as a percentage of net sales increased to 50.4% for the three months ended December 31, 2005 from 47.8% for the first quarter 2004. This increase in cost of products sold as a percentage of sales is primarily the result of increased propane costs, partially offset by increased sale prices.

Operating, distribution and administrative expenses increased $3.8 million, or 27.6%, to $17.4 million in the three months ended December 31, 2005 compared to $13.6 million in the three months ended December 31, 2004. Of this increase, $2.4 million was related to acquired businesses while base business expenses increased $1.4 million. Operating, distribution and administrative expenses increased as distribution and delivery costs resulting from higher fuel and vehicle repair costs and increased professional expenses were offset by reductions in personnel costs, building and equipment rent and bad debt expense. During the current quarter, the Company recorded approximately $46,000 as compensation expenses related to stock options under SFAS No 123R, and anticipates $82,000 to be recorded during the balance of this fiscal year although this is subject to change due to future option grants, exercises and other factors. Operating, distribution and administrative expenses as a percentage of sales were 30.8% for the three months ended December 31, 2005 compared to 31.6% for the three months ended December 31, 2004.

Depreciation expense increased $0.3 million reflecting depreciation related to the variable interest entities and increased depreciation resulting from capital expenditures and acquisitions.

Amortization of intangibles decreased $0.1 million to $0.2 million for the three months ended December 31, 2005 compared to $0.3 million for the three months ended December 31, 2004. This decrease was primarily the result of certain intangibles becoming fully amortized.

Interest expense remained the same at $1.2 million for the three months ended December 31, 2005 and December 31, 2004, respectively. Higher outstanding debt balances and higher current interest rates were offset by the expiration of certain swap agreements that had fixed rates that were higher than current interest rates.

Minority interest earnings reflect the elimination of net pre-tax income earned by the variable interest entities. The amount eliminated is primarily related to operating expense as disclosed above, partially offset by expenses incurred by the entities.

Our effective tax rate in the three months ended December 31, 2005 increased to 38.1% compared to 38.0% in the three months ended December 31, 2004.

For the reasons stated above, our net income increased $0.9 million, or 26.9%, to $4.4 million for the three months ended December 31, 2005 compared to $3.5 million for the three months ended December 31, 2004. Fully diluted earnings per share increased to $0.45 for the first quarter 2005 compared to $0.36 for the three months ended December 31, 2004.

Comparison of Six Months Ended December 31, 2005 and 2004

Our net sales increased $18.7 million, or 23.5%, to $98.1 million for the six months ended December 31, 2005 from $79.4 million for the six months ended December 31, 2004. Acquisitions made during the preceding twelve months contributed $9.7 million of the increase in net sales, while same-store sales increased $9.0 million, or 11.2%. Packaged gases and cylinder rental revenue represented 36.9% of net sales for the six months ended December 31, 2005 and hard goods represented 37.1% of net sales, with total revenue from our packaged gas business representing 74.0% of net sales. In comparison, packaged gases and cylinder rental revenue represented 37.4% of net sales for the six months ended December 31, 2004 and hard goods represented 37.4% of net sales, with total revenue from our packaged gas business representing 74.8% of net

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sales. Sales of hard goods increased $6.7 million, or 22.6%, from the six months ended December 31, 2004 to the six months ended December 31, 2005, reflecting the impact of acquisitions totaling $4.8 million, increased demand from the improved economy. Packaged gases and cylinder rent increased $6.4 million, or 21.6%, reflecting the impact of acquisitions totaling $4.4 million and increased demand from the improved economy and increased prices. Propane sales represented 26.0% of net sales in the six months ended December 31, 2005 compared to 25.2% of net sales in the six months ended December 31, 2004. Propane sales increased $5.5 million, or 27.7%, in the six months ended December 31, 2005 compared to the 2004 period due primarily to price increases. In addition, propane volume increased 8.4% for the six months compared to the prior period which included approximately 2.2% related to acquisitions made during the current period.

Our cost of products sold increased $10.8 million, or 28.7%, to $48.4 million for the six months ended December 31, 2005 compared to $37.6 million for the six months ended December 31, 2004. Acquisitions made during the last twelve months contributed $5.1 million of the change while same-store cost of products sold increased $5.7 million. Cost of products sold as a percentage of net sales increased to 49.3% for the six months ended December 31, 2005 from 47.3% for the six months ended December 31, 2004. This increase in cost of products sold as a percentage of sales is primarily the result of increased propane costs, partially offset by increased sale prices.

Operating, distribution and administrative expenses increased $5.7 million, or 20.8%, to $32.9 million in the six months ended December 31, 2005 compared to $27.2 million in the 2004 period. Of this increase, $3.6 million was related to acquired businesses while base business expenses increased $2.1 million. Operating, distribution and administrative expenses increased as distribution and delivery costs resulting from higher fuel and vehicle repair costs and increased professional expenses were offset by reductions in personnel costs, building and equipment rent and bad debt expense. During the current six months, the Company recorded approximately $98,000 as compensation expenses related to stock options under SFAS No 123R, and anticipates $82,000 to be recorded during the balance of this fiscal year although this is subject to change due to future option grants and other factors. Operating, distribution and administrative expenses as a percentage of sales were 33.5% for the six months ended December 31, 2005 compared to 34.3% for the six months ended December 31, 2004.

Depreciation expense increased $0.5 million reflecting depreciation related to the variable interest entities and increased depreciation resulting from capital expenditures and acquisitions.

Amortization of intangibles decreased $0.2 million to $0.4 million in the six months ended December 31, 2005 compared to $0.6 million in the six months ended December 31, 2004. This decrease was primarily the result of certain intangibles becoming fully amortized.

Interest expense decreased $0.3 million, or 11.7%, to $2.1 million for the six months ended December 31, 2005 compared to $2.4 million in the six months ended December 31, 2004. Higher outstanding debt balances and higher current interest rates were offset by the expiration of certain swap agreements that had fixed rates that were higher than current interest rates.

Our effective tax rate in the six months ended December 31, 2005 increased to 38.4% compared to 38.0% in the six months ended December 31, 2004.

For the reasons stated above, our net income increased $1.4 million, or 27.9%, to $6.5 million for the six months ended December 31, 2005 compared to $5.1 million for the six months ended December 31, 2004. Fully diluted earnings per share increased to $0.66 for the six months ended December 31, 2005 compared to $0.53 for the six months ended December 31, 2004.

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LIQUIDITY AND CAPITAL RESOURCES

Historically, we have financed our 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 December 31, 2005, we had working capital of approximately $17.8 million, as compared to $10.9 million as of June 30, 2005, reflecting primarily an increase in accounts receivable, inventory levels and available cash resulting from acquisitions made for the six month period. Funds provided by operations for the six months ended December 31, 2005 were approximately $7.8 million, as compared to $7.0 million for the six months ended December 31, 2004. This increase of $0.8 million is attributable to the $1.4 million increase in net earnings, the increase of $3.2 million in accounts payable, increased accounts receivable and inventory of $4.3 million offset by positive cash flow from other operating assets and liabilities. Funds used for investing activities were approximately $28.5 million for the six months ended December 31, 2005 consisting primarily of capital spending and acquisitions, as compared to $5.7 million for the six months ended December 31, 2004 principally for capital spending. The Company anticipates capital expenditures of approximately $3.2 million for the remainder of fiscal year June 30, 2006. Funds provided for financing activities for the six months ended December 31, 2005 were approximately $22.9 million as net borrowings of $50.9 million, proceeds of $0.1 million from a bank overdraft and funds received through the exercise of stock options totaling $0.3 million were offset by debt repayment of $27.6 million and a distribution by the variable interest entities of $0.8 million. The Company’s cash balance increased $2.2 million during the six months ended December 31, 2005 to $3.5 million. On November 23, 2005 Valley authorized a $.10 dividend per share to be paid on January 5, 2006 to shareholders of record as of December 21, 2005.

At December 31, 2005, we had the following contractual obligations:


	Payments Due By Period (In Thousands)
				Less Than			1-3			4-5		More Than
Contractual Obligations	Total			6 Months			Years			Years		5 Years
Long-Term Debt Including Current Maturities	$	88,057		$	3,315		$	81,002		$	1,548	$	2,192
Estimated Interest Payments		15,767			2,519			12,841			314		93
Interest Rate Swap Payments		2,645			575			2,070			^___		^___
Interest Rate Swap Receipts		(2,530	)		(550	)		(1,980	)		^___		^___
Operating Leases, Net of Intercompany Eliminations		9,679			857			5,173			3,649		^___
Purchase Obligations		2,668			1,334			1,334			^___		^___

Total Obligations	$	116,286		$	8,050		$	100,440		$	5,511	$	2,285

Certain of these obligations are sensitive to changes in interest rates including interest rate swaps and debt obligations. For debt obligations, the table provides contractually obligated payment amounts, including estimated interest, by period due. For interest rate swaps, payments and receipts are calculated based upon notional amounts at weighted average rates by expected (contractual) maturity dates. 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. Purchase obligations represent the total value of all open purchase orders for the purchase of inventory and distribution vehicles. Other long-term liabilities at December 31, 2005 and June 30, 2005 consist primarily of deferred revenue related to cylinder rentals with an average term of seven to ten years, which has been excluded from the table above.

On April 30, 2004, Valley entered into an amended credit agreement establishing a $75 million revolving note with a maturity of five years, replacing the previous revolving and term notes. Covenant requirements under the amended agreement are not significantly different from those under the previous agreement. On October 31, 2005, the Company entered into an agreement to increase the outstanding credit available under the above revolving note by $15 million to $90 million.

The weighted average interest rate for substantially all of the borrowings under the credit facility was 5.43% as of December 31, 2005. As of December 31, 2005, availability under the revolving loan was approximately $11.8 million, with outstanding

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borrowings of approximately $77.2 million and outstanding letters of credit of approximately $1.0 million. The credit facility is secured by all of Valley’s assets. The revolving loan is used primarily to fund acquisitions. Valley is not required to make principal payments on outstanding balances of the revolving loan as long as certain covenants are satisfied. Interest is charged on the revolving loan at either the lender’s prime rate or various LIBOR rates, at Valley’s discretion, plus an applicable spread.

The loan agreement for the credit facility, as amended, contains various financial covenants applicable to Valley, including covenants requiring minimum fixed charge coverage and maximum funded debt to EBITDA. As of December 31, 2005, Valley was in compliance with these covenants and believes that it will continue to be in compliance through at least the next twelve months.

We are obligated under various promissory notes related to the financing of acquisitions that have various rates of interest ranging from 5.75% to 11.0% per annum and maturities through 2010. The outstanding balance of these notes as of December 31, 2005 was $1.8 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 Valley’s credit facility.

The schedule of maturities by segment as of December 31, 2005 of our debt is as follows:


			Variable Interest
Fiscal year ending June 30,	Valley		Entities		Company
Remainder of 2006	$	459,268	$	2,855,784	$	3,315,052
2007	$	710,798	$	834,090	$	1,544,888
2008	$	299,613	$	861,339	$	1,160,952
2009	$	77,404,365	$	891,801	$	78,296,166
2010	$	61,708	$	823,940	$	885,648
2011	$	32,024	$	630,710	$	662,734
Thereafter	$	^___	$	2,191,478	$	2,191,478

Total	$	78,967,776	$	9,089,142	$	88,056,918

We enter into contractual agreements in the ordinary course of business to hedge 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 not be significant.

Interest rate swap agreements are used to reduce interest rate risks and costs inherent in our debt portfolio. We enter into these agreements to change the variable/fixed interest rate mix of our debt portfolio in order to maintain the percentage of fixed and variable debt within certain parameters we have established. Accordingly, we enter into agreements to effectively convert variable-rate debt to fixed-rate debt. As of December 31, 2005, we had $40.0 million in notional amounts outstanding under interest rate swap agreements. These swaps have an average pay rate of 4.6% versus a receive rate of 4.4% at December 31, 2005.

Purchase obligations represent the total value of open purchase orders, consisting primarily of inventory and capital expenditures, as of the period ending date.

We believe that cash generated from operations, borrowing availability under our credit facility and the ability to obtain financing with sellers of businesses will be sufficient to satisfy our requirements for operating funds, capital expenditures and future acquisitions for at least the next twelve months.

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New Accounting Standards

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs,” that requires that items such as idle facility expense, excessive spoilage, double freight and handling costs be recognized as current period charges. In addition, it requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The standard was effective July 1, 2005 and no current period charges were required to be recognized.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The table below provides information about Valley’s derivative financial instruments and other financial instruments at December 31, 2005 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.

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	Balance of															There					Fair
	2006			2007			2008			2009			2010			After			Total		Value
	(In Thousands)
Liabilities
Long term debt - Valley
Fixed rate	$	459		$	711		$	300		$	189		$	62		$	32		$	1,752	$	1,554
Average interest rate		8.86	%		6.43	%		6.37	%		4.55	%		4.82	%		4.90	%
Variable rate										$	77,216								$	77,216	$	77,216
Average interest rate											5.43	%
Long term debt - Variable Interest
Entities mortgage debt
Fixed rate	$	2,856		$	834		$	861		$	892		$	824		$	2,822		$	9,089	$	7,521
Average interest rate		7.60	%		5.74	%		4.71	%		4.75	%		4.79	%		4.72	%
Interest rate swaps
Variable to fixed	$	40,000		$	—		$	—		$	—		$	—		$	—		$	—	$	289
Average pay rate		4.6	%		—			—			—			—			—			—
Average receive rate		4.4	%		—			—			—			—			—			—
Commitments										$
Operating leases	$	2,089		$	4,199		$	4,277		$	4,384		$	4,494		$	4,606		$	24,049
Intercompany elimination (1)		1,232			2,499			2,562			2,626			2,692			2,759			14,370

Company total	$	857		$	1,700		$	1,715		$	1,758		$	1,802		$	1,847		$	9,679


(1)		Reflects the elimination of intercompany rent as a result of FIN 46R, “Consolidation of Variable Interest Entities” at December 31, 2005.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer, William A. Indelicato, and its Chief Financial Officer, James P. Hart, the Company evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were adequately designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in applicable rules and forms.

(b) Changes in Internal Controls

During the fiscal quarter covered by this report, there have not been any significant changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15 (f) under the Exchange Act) that have materially affected or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 6. Exhibit Index


10.1		Second Amendment to Third Amended and Restated Credit Agreement

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

31.2		Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

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

32.2		Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed by the undersigned thereunto duly authorized.


		VALLEY NATIONAL GASES INCORPORATED

February 14, 2006		/s/ James P. Hart James P. Hart
		Chief Financial Officer and
		Duly Authorized Officer

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VALLEY NATIONAL GASES INC 10-Q