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

OVERVIEW

Airgas, Inc. and its subsidiaries ("Airgas" or the "Company") had net sales for the quarter ended September 30, 2009 ("current quarter") of $962 million compared to $1.2 billion for the quarter ended September 30, 2008 ("prior year quarter"), a decline of 17%. Total same-store sales declined 19%, with hardgoods down 27% and gas and rent down 14%. Acquisitions contributed 2% sales growth in the quarter. The same-store sales decline was principally volume related with sales volumes down 18% and pricing down 1%. Lower sales volumes reflect broad-based weakness across most customer segments and geographies.

The Company's operating margin declined 110 basis points to 11.4% in the current quarter compared to 12.5% in the prior year quarter, but improved 40 basis points from 11.0% in the quarter ended June 30, 2009. The current quarter's operating margin reflects the effect of lower sales, partially offset by gross margin expansion of 370 basis points from the prior year quarter and the impact of expense reduction initiatives. The gross profit margin (excluding depreciation) expansion is primarily a result of the Company's product mix shifting away from hardgoods towards gas and rent, which carry a higher gross margin than hardgoods. Selling, distribution and administrative ("SD&A") expenses in the current quarter increased to 38.2% of sales, an increase of 340 basis points over the prior year quarter. The increase in SD&A expenses as a percent of sales was driven by the decline in sales and the mix shift to gas and rent, which carry higher operating expenses in relation to sales than hardgoods. The increase in operating expenses as a percentage of sales was mitigated by the Company's expense reduction initiatives executed in both the current quarter and the fourth quarter of the prior year. The current quarter operating expenses also include a charge of $1.7 million ($1 million after tax) or $0.01 per diluted share related to partial withdrawal from a multi-employer pension plan. Additionally, the Company incurred a charge related to the early extinguishment of debt of $2 million ($1.3 million after tax) or $0.02 per diluted share during the current quarter. Net earnings per diluted share declined 24% in the current quarter to $0.65 compared to $0.86 in the prior year quarter.

Expense Reduction Initiatives

In response to the slowing economy, the Company reacted quickly and effectively to mitigate the impact of declining sales. Between December 2008 and March 2009, as previously announced, the Company fully implemented $45 million of annual expense reductions, which were in addition to $10 million of expected annual savings in fiscal 2010 from ongoing efficiency initiatives. As a result, the Company experienced only a modest decline in operating margin, to 11.4%. During the current quarter, the Company implemented an additional $12 million of annual expense reductions for which the full benefit will be realized in the fiscal third quarter.

Multi-employer Pension Plan Withdrawal

The Company participates, with other employers, in several multi-employer pension plans providing defined benefits to union employees under the provisions of collective bargaining agreements ("CBAs"). Of the Company's approximately 14,000 employees, less than 5% are employed under CBAs, and fewer than 1.5% are employed under CBAs that include participation in multi-employer pension plans. Contributions are made to the plans in accordance with negotiated CBAs. The plans generally provide retirement benefits to participants based on their service to contributing employers. In connection with the renewal of certain labor contracts during the current quarter, the Company negotiated its partial withdrawal from participation in an underfunded multi-employer plan and will now contribute to a defined contribution plan for the affected union employees. In connection with the withdrawal from the multi-employer pension plan, the Company incurred a charge of $1.7 million ($1 million after tax).

The Company will continue its efforts to withdraw from such plans. Charges for withdrawal from plans under contracts that expire during the remainder of fiscal 2010 could be up to approximately $0.04 per diluted share. Though the latest information available to the Company from the plans was used in computing the current quarter charge and potential charges applicable to the remainder of fiscal 2010, the information, in some cases, does not reflect the market conditions that will impact the plans prior to any withdrawal. Multi-employer pension plan withdrawal liabilities are calculated with numerous assumptions, including, but not limited to, investment returns, assumed discount rates, benefit levels, the plan year in which a withdrawal is made and continued participation by other employers that are in the plans.

Financing

On September 11, 2009, the Company issued $400 million of 4.50% senior notes due September 15, 2014 (the "2009 Notes"). The net proceeds from the offering were used to repay debt under the Company's revolving credit facility.

During the current quarter, the Company repurchased $58 million of its $400 million 7.125% senior subordinated notes that are due on October 1, 2018 (the "2008 Notes") at an average price of 102.2%. In conjunction with the repurchase of the notes, the Company recognized a loss on the early extinguishment of debt of $2 million ($1.3 million after tax). The loss related to the redemption premium and the write-off of unamortized debt issuance costs.

Additionally, during the current quarter, the Company announced the redemption of its $150 million 6.25% senior subordinated notes due July 15, 2014 (the "2004 Notes"). On October 13, 2009, the Company redeemed the 2004 Notes in full at a premium of 103.125% of the principal amount with borrowings under the Company's revolving credit facility. In conjunction with the redemption of the 2004 Notes, the Company will recognize a loss on the early extinguishment of debt of approximately $6 million ($4 million after tax) or $0.05 per diluted share that will be reflected in the Company's fiscal third quarter ending December 31, 2009. The charge relates to the redemption premium and the write-off of unamortized debt issuance costs.

Business Segments

The Company aggregates its operations, based on products and services, into two reportable business segments, Distribution and All Other Operations. During the fourth quarter of fiscal 2009, the Company changed the operating practices and organization of its air separation production facilities and national specialty gas labs. The new operating practices and organization reflect the evolution of these businesses and their role in supporting the regional distribution companies. The regional distribution companies market to and manage the end customer relationships, coordinating and cross-selling the Company's multiple product and service offerings in a closely coordinated and integrated manner. As a result of these changes, the air separation production facilities and national specialty gas labs are now reflected in the Distribution business segment. Also as a result of an organizational realignment, Airgas National Welders is now part of the Distribution business segment. Comparisons to prior periods that follow reflect the business segment realignment.

Looking Forward

Current challenging economic conditions provide limited visibility into future sales and earnings, which should be taken into consideration when evaluating the Company's guidance. Looking forward, the Company expects earnings per diluted share of $0.62 to $0.65 for the third quarter ending December 31, 2009, which includes the $0.05 per diluted share loss on the early extinguishment of debt, noted above. For fiscal 2010, the Company expects earnings of $2.62 to $2.72 per diluted share, which includes $0.03 per diluted share of charges in the second quarter related to the withdrawal from a multi-employer pension plan and the early debt extinguishment, and $0.05 per diluted share of charges in the third quarter related to the early debt extinguishment, noted above. Due to the uncertainties surrounding contract negotiations and the determination of multi-employer pension plan withdrawal liabilities, the third quarter and fiscal 2010 guidance above does not incorporate the potential impact of future multi-employer pension plan withdrawal charges.

RESULTS OF OPERATIONS: THREE MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2008

STATEMENT OF EARNINGS COMMENTARY

Net Sales

Net sales decreased 17% to $962 million for the three months ended September 30, 2009 compared to the three months ended September 30, 2008, driven by a same-store sales decline of 19% partially offset by incremental sales of 2% contributed by acquisitions. Gas and rent same-store sales declined 14% and hardgoods declined 27%. Same-store sales were driven by volume declines of 18% and a 1% price decline. Pricing for most products was stable and steep declines in costs and prices for ammonia, fuel gases and filler metals accounted for the overall pricing decline. Strategic products account for about 40% of revenues and include safety products, bulk, medical, and specialty gases, as well as carbon dioxide and dry ice. The Company has identified these products as strategic because it believes they have good long-term growth profiles relative to the Company's core industrial gas and welding products due to favorable end customer markets, application development, increasing environmental regulation, strong cross-selling opportunities or a combination thereof. In the aggregate, these products declined 9% on a same-store sales basis in the current quarter compared to the prior year quarter with growth in medical offset by declines in all other strategic product categories.

The Company estimates same-store sales growth based on a comparison of current period sales to prior period sales, adjusted for acquisitions and divestitures. The pro forma adjustments consist of adding acquired sales to, or subtracting sales of divested operations from, sales reported in the prior period. The table below reflects actual sales and does not include the pro forma adjustments used in calculating the same-store sales metric. The intercompany eliminations represent sales from the All Other Operations business segment to the Distribution business segment.

                                      Three Months Ended
      Net Sales                         September 30,              Increase/
      (In thousands)                2009            2008          (Decrease)
      Distribution                $ 857,443      $ 1,035,188      $  (177,745 )    -17 %
      All Other Operations          111,599          134,889          (23,290 )    -17 %
      Intercompany eliminations      (6,776 )         (8,169 )          1,393

                                  $ 962,266      $ 1,161,908      $  (199,642 )    -17 %

The Distribution business segment's principal products include industrial, medical, and specialty gases, and process chemicals; cylinder and equipment rental; and hardgoods. Industrial, medical, and specialty gases are distributed in cylinders and bulk containers. Equipment rental fees are generally charged on cylinders, cryogenic liquid containers, bulk and micro-bulk tanks, tube trailers, and welding equipment. Hardgoods consist of welding consumables and equipment, safety products, construction supplies, and maintenance, repair and operating supplies.

Distribution business segment sales declined 17% compared to the prior year quarter with a decline in same-store sales of 19%, partially offset by incremental sales of 2% contributed by current and prior year acquisitions. The Distribution business segment gas and rent same-store sales declined 12% with volumes down 11% and pricing down 1%. The decline in pricing was driven by steep declines in costs and pricing for fuel gases, as well as some pricing decline in welder rentals. Hardgoods same-store sales declined 27% with volumes down 26% and pricing down 1%. The decline in pricing reflects a decline in cost and pricing for filler metals. Both gas and rent and hardgoods volumes were negatively impacted by the general slowdown in economic activity and customers' delaying or deferring capital projects.

Sales of strategic gas products sold through the Distribution business segment in the current quarter declined 7%. Among strategic gas products, bulk gas sales were down 9% due to the impact of production slowdowns in the metal fabrication and steel segments, as well as reduced activity from oil field service customers, partially offset by growth in the food-freezing segment. Medical gases were up 1% as a result of new business signings, partially offset by slowing in elective and non-critical medical procedures which reduced overall demand. Specialty gases were down 13% primarily from a general softening in demand in the chemicals processing industry.

Sales of core industrial gases, which experienced the sharpest volume declines, were down 21% for the quarter, while the related rental revenues were down only 3%. In addition, revenues from the Company's rental welder business experienced a 21% decline in same-store sales.

Contributing to the decline in Distribution hardgoods same-store sales were declines in both safety products and our RadnorŪ brand product offerings. Safety product sales declined 15% in the quarter attributed to low plant operating rates and rising unemployment. Our RadnorŪ private label line was down 23% for the quarter, driven by the overall drop in hardgoods volumes.

The All Other Operations business segment consists of six business units. The primary products manufactured and distributed are carbon dioxide, dry ice, nitrous oxide, ammonia and refrigerant gases.

The All Other Operations business segment sales decreased 17% compared to the prior year quarter, with a 24% decline in same-store sales offset modestly by a 7% contribution from acquisitions. The sales decline was driven largely by lower pricing in ammonia products related to a corresponding drop in raw materials, and lower refrigerant volumes, reflecting mild summer weather in the eastern U.S. and the deferral of maintenance and conversion projects in light of current economic conditions.

Gross Profits (Excluding Depreciation)

Gross profits (excluding depreciation) do not reflect deductions related to depreciation expense and distribution costs. The Company reflects distribution costs as an element of selling, distribution and administrative expenses and recognizes depreciation on all its property, plant and equipment in the Consolidated Statement of Earnings line item, "Depreciation." Other companies may report certain or all of these costs as elements of their cost of products sold and, as such, the Company's gross profits (excluding depreciation) discussed below may not be comparable to those of other businesses.

Consolidated gross profits (excluding depreciation) decreased 11% principally due to a same-store sales decline offset somewhat by an expansion of gross profit margins (excluding depreciation). The consolidated gross profit margin (excluding depreciation) in the current quarter increased 370 basis points to 55.7% compared to 52.0% in the prior year quarter. The margin expansion was primarily driven by the Distribution business segment.

                                      Three Months Ended
        Gross Profits (ex. Depr.)       September 30,         Increase/
        (In thousands)                 2009        2008       (Decrease)
        Distribution                $  480,892   $ 546,827   $    (65,935 )    -12 %
        All Other Operations            54,941      57,061         (2,120 )     -4 %

                                    $  535,833   $ 603,888   $    (68,055 )    -11 %

The Distribution business segment's gross profits (excluding depreciation) decreased 12% compared to the prior year quarter. The Distribution business segment's gross profit margin (excluding depreciation) was 56.1% versus 52.8% in the prior year quarter, an increase of 330 basis points. The improvement in the Distribution business segment's gross profit margin (excluding depreciation) largely reflects a shift in sales mix toward gas and rent, which carry higher gross profit margins (excluding depreciation) than hardgoods. As a percentage of the Distribution business segment's sales, gas and rent increased to 60.9% in the current quarter as compared to 56.0% in the prior year quarter.

The All Other Operations business segment's gross profits (excluding depreciation) decreased 4%, primarily as a result of lower sales volumes for ammonia, refrigerants, and dry ice due to both slowing in the economy and strong prior year quarter results for dry ice in the wake of major hurricanes. The decline in gross profits as a result of these factors was partially offset by a prior year acquisition in the refrigerants business. The All Other Operations business segment's gross profit margin (excluding depreciation) increased 690 basis points to 49.2% in the current quarter from 42.3% in the prior year quarter. The increase in the All Other Operations business segment's gross profit margin (excluding depreciation) was driven by the margin improvement in the ammonia business reflecting lower product costs and a favorable shift in sales mix.

Operating Expenses

SD&A expenses consist of labor and overhead associated with the purchasing, marketing and distributing the Company's products, as well as costs associated with a variety of administrative functions such as legal, treasury, accounting, tax and facility-related expenses.

SD&A expenses declined $36 million, or 9%, in the current quarter as compared to the prior year quarter resulting from a $43 million decline in operating costs offset by approximately $7 million of incremental operating costs associated with acquired businesses. The $43 million decrease in SD&A expense reflects lower variable costs due to the decline in sales, the benefits from the Company's expense reduction initiatives and lower diesel fuel costs. As a percentage of net sales, SD&A expense increased 340 basis points to 38.2% compared to 34.8% in the prior year quarter driven by the overall decline in sales and by the shift in sales mix to gas, which carries higher operating expenses in relation to sales and corresponding higher gross margins. Additionally, current quarter SD&A expenses include a charge of $1.7 million related to partial withdrawal from a multi-employer pension plan.

Depreciation expense of $53 million increased $4 million, or 8%, in the current quarter as compared to the prior year quarter. The increase primarily reflects capital investments in revenue generating assets to support customer demand, such as cylinders, bulk tanks, and rental welders, the two new air separation units in New Carlisle, Indiana, and Carrollton, Kentucky, and infrastructure spending on cylinder fill plants and branch locations. Amortization expense of $5 million in the current quarter decreased slightly as compared to the prior year quarter's amortization expense of $6 million.

Operating Income

Consolidated operating income of $110 million decreased 24% in the current quarter on significant slowing in sales partially offset by gross profit margin (excluding depreciation) expansion and the Company's expense reduction initiatives. The operating income margin decreased 110 basis points to 11.4% compared to 12.5% in the prior year quarter, but improved 40 basis points from 11.0% in the quarter ended June 30, 2009.

                                   Three Months Ended
          Operating Income           September 30,         Increase/
          (In thousands)            2009        2008       (Decrease)
          Distribution           $   92,388   $ 125,799   $    (33,411 )    -27 %
          All Other Operations       17,429      19,189         (1,760 )     -9 %

                                 $  109,817   $ 144,988   $    (35,171 )    -24 %

Operating income in the Distribution business segment decreased 27% in the current quarter. The Distribution business segment's operating income margin decreased 140 basis points to 10.8% compared to 12.2% in the prior year quarter. The operating margin decline was driven by the significant decline in sales partially offset by favorable mix-driven gross profit margin (excluding depreciation) expansion, and the Company's expense reduction initiatives.

Operating income in the All Other Operations business segment decreased 9% compared to the prior year quarter. The All Other Operations business segment's operating income margin of 15.6% was 140 basis points higher than the operating income margin of 14.2% in the prior year quarter. The increase in operating margin resulted principally from margin expansion in the ammonia business generated by declining product costs.

Interest Expense and Discount on Securitization of Trade Receivables

Interest expense, net, and the discount on securitization of trade receivables totaled $18 million, representing a decrease of $7 million, or 28%, compared to the prior year quarter. The decrease primarily resulted from lower weighted-average interest rates related to the Company's variable rate debt instruments and lower average debt levels. A majority of the Company's variable rate debt is based on a spread over the London Interbank Offered Rate ("LIBOR").

The Company participates in a securitization agreement with three commercial banks to sell up to $345 million of qualifying trade receivables ($360 million at September 30, 2008). The amount of outstanding receivables under the agreement was $273 million at September 30, 2009 versus $360 million at September 30, 2008. The discount on the securitization of trade receivables represents the difference between the carrying value of the receivables and the proceeds from their sale. The amount of the discount varies on a monthly basis depending on the amount of receivables sold and market rates.

Loss on Debt Extinguishment

During the current quarter, the Company repurchased $58 million of its 2008 Notes at an average price of 102.2%. In conjunction with the repurchase of the notes, the Company recognized a loss on the early extinguishment of debt of $2 million. The loss related to the redemption premium and the write-off of unamortized debt issuance costs.

Income Tax Expense

The effective income tax rate was 39.2% of pre-tax earnings in the current quarter compared to 39.3% in the prior year quarter. The Company expects the overall effective tax rate for fiscal 2010 to be between 39.0% and 39.5% of pre-tax earnings.

Net Earnings

Net earnings were $54.5 million, or $0.65 per diluted share, compared to $72.8 million, or $0.86 per diluted share, in the prior year quarter. The current quarter's net earnings include the loss related to the early debt extinguishment of $1.3 million, or $0.02 per diluted share, and the charge related to partial withdrawal from a multi-employer pension plan of $1.0 million, or $0.01 per diluted share.

RESULTS OF OPERATIONS: SIX MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO THE SIX MONTHS ENDED SEPTEMBER 30, 2008

STATEMENT OF EARNINGS COMMENTARY

Net Sales

Net sales decreased 15% to $1.9 billion for the six months ended September 30, 2009 ("current period") compared to the six months ended September 30, 2008 ("prior year period"), driven by a same-store sales decline of 18% partially offset by incremental sales of 3% contributed by acquisitions. Gas and rent same-store sales declined 12% and hardgoods declined 27%. Same-store sales were driven by volume declines of 18% with price remaining flat. Strategic products account for about 40% of revenues. In the aggregate, these products declined 9% on a same-store sales basis in the current period compared to the prior year period with growth in medical offset by declines in all other strategic product categories.

                                       Six Months Ended
     Net Sales                          September 30,               Increase/
     (In thousands)                 2009             2008          (Decrease)
     Distribution                $ 1,729,300      $ 2,055,485      $  (326,185 )    -16 %
     All Other Operations            224,623          237,125          (12,502 )     -5 %
     Intercompany eliminations       (12,400 )        (13,988 )          1,588

                                 $ 1,941,523      $ 2,278,622      $  (337,099 )    -15 %

Distribution business segment sales declined 16% compared to the prior year period with a decline in same-store sales of 18%, partially offset by incremental sales of 2% contributed by current and prior year acquisitions. The Distribution business segment gas and rent same-store sales declined 10% with volumes down 11%, slightly offset by a positive 1% pricing impact. Hardgoods same-store sales declined 27% driven entirely by lower volumes. Both gas and rent and hardgoods volumes were negatively impacted by the general slowdown in economic activity and customers delaying or deferring capital projects.

Sales of strategic gas products sold through the Distribution business segment in the current period declined 5%. Among strategic gas products, bulk gas sales were down 7% due to the impact of production slowdowns in the metal fabrication and steel segments, and reduced activity from oil field service customers. Medical gases were up 3% as a result of new business signings, which were partially offset by a reduction in overall demand for medical gases related to elective and non-critical procedures that was more pronounced in the second fiscal quarter. Specialty gases were down 12% resulting from a general softening in demand in the chemicals processing industry.

Sales of core industrial gases, which experienced the sharpest volume declines, were down 18% for the current period, while the related rental revenues were down only 1%. In addition, revenues from the Company's rental welder business experienced a 20% decline in same-store sales as compared to the prior year period.

Distribution hardgoods same-store sales declined 27% driven entirely by lower volumes. Safety product sales declined 16% in the current period attributed to plant shutdowns, shift reductions, and rising unemployment. Our RadnorŪ private label line was down 22% for the current period, driven by the overall drop in hardgoods volumes.

The All Other Operations business segment sales decreased 5% compared to the prior year period with a 21% decline in same-store sales offset by incremental sales of 16% contributed by acquisitions, primarily related to the refrigerants business. The decline in same-store sales reflects lower pricing for ammonia . . .