**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549**

 

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**FORM 10-Q**

 

**ý****          ****QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended September 30, 2005**

 

**or**

 

**o****          ****TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**Commissionfile number:**

**333-115490**

 

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**WII COMPONENTS, INC.**

(Exact name of registrant as specified in itscharter)

 
| **Delaware**             | ** ** | **No. 73-1662631**               |
|--------------------------|------------|---------------------------------------|
| (State of Incorporation) |       | (I.R.S. Employer Identification  No.) |

 

**525 LincolnAvenue SE, St. Cloud, Minnesota 56304**

(Address of principal executive offices) (ZipCode)

 

**(320) 252-1503**

(Registrant’s telephone number, Including areacode)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports) and (2) hasbeen subject to such filing requirements for the past 90 days.

 

Yes ý  No o.

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act.)

 

Yes o  No ý.

 

As of October 15, 2005, 21,751,331 shares ofvoting common stock, $.01 par value per share, were outstanding and 854,261shares of non-voting common stock, $.01 par value per share, were outstanding(all of which are privately owned and not traded on a public market).

 

 

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**WIICOMPONENTS, INC.**

 

**FORM 10-Q**

**QuarterEnded September 30, 2005**

 

**Table ofContents**

 
| **Part I—Financial Information**                                                                                                                          |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1. Financial  Statements                                                                                                                                       |   |
| Condensed Consolidated  Balance Sheets as of September 30, 2005 and December 31, 2004  (unaudited)                                                        | 3      |
| Condensed Consolidated  Statements of Operations for the Three Months Ended September 30, 2005  and the Three Months Ended September 30, 2004 (unaudited) | 4      |
| Condensed Consolidated  Statements of Operations for the Nine Months Ended September 30, 2005  and the Nine Months Ended September 30, 2004 (unaudited)   | 5      |
| Condensed Consolidated  Statement of Stockholders’ Equity for the Nine Months Ended September 30,  2005 (unaudited)                                       | 6      |
| Condensed Consolidated  Statements of Cash Flows for the Nine Months Ended September 30, 2005  and the Nine Months Ended September 30, 2004 (unaudited)   | 7      |
| Notes to Condensed Consolidated Financial  Statements (unaudited)                                                                                                   | 8      |
| Item 2. Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                 | 13     |
| Item 3. Quantitative and  Qualitative Disclosures about Market Risk                                                                                                 | 18     |
| Item 4. Controls and Procedures                                                                                                                                     | 19     |
|                                                                                                                                                                |   |
| **Part II-Other  Information**                                                                                                                                 |   |
| Item 1. Legal Proceedings                                                                                                                                           | 20     |
| Item 2. Unregistered Sales  of Equity Securities and Use of Proceeds                                                                                                | 20     |
| Item 3. Defaults Upon Senior  Securities                                                                                                                            | 20     |
| Item 4. Submission of  Matters to a Vote of Security Holders                                                                                                        | 20     |
| Item 5. Other Information                                                                                                                                           | 20     |
| Item 6. Exhibits                                                                                                                                                    | 20     |
| Signatures                                                                                                                                                          | 21     |

 

2

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**WII COMPONENTS, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(UNAUDITED)**

**(In thousands)**

 
| ** **                                     | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                     |       |                         |       |                        |       |
| Current Assets:                                |       |                         |       |                        |       |
| Cash                                           |       | $                            | 3,065      |                        | $          | 2 |   |
| Accounts receivable, net                       |       | 15,009                       |       | 9,564                       |       |
| Inventories                                    |       | 19,675                       |       | 16,742                      |       |
| Other current assets                           |       | 2,198                        |       | 3,381                       |       |
| Total current assets                           |       | 39,947                       |       | 29,689                      |       |
|                                           |       |                         |       |                        |       |
| Property, plant, and  equipment, net           |       | 45,472                       |       | 42,252                      |       |
| Goodwill                                       |       | 107,601                      |       | 107,601                     |       |
| Customer relationships                         |       | 15,311                       |       | 7,347                       |       |
| Noncompete agreements                          |       | 965                          |       | 1,201                       |       |
| Other assets                                   |       | 6,505                        |       | 6,897                       |       |
| TOTAL                                          |       | $                            | 215,801    |                        | $          | 194,987 |   |
| ** **                                     |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY** |       |                         |       |                        |       |
| Current Liabilities:                           |       |                         |       |                        |       |
| Current maturities of  long-term debt          |       | $                            | 1,111      |                        | $          | 928 |   |
| Accounts payable                               |       | 7,271                        |       | 5,808                       |       |
| Accrued payroll                                |       | 3,133                        |       | 3,207                       |       |
| Other current liabilities                      |       | 9,336                        |       | 9,107                       |       |
| Total current liabilities                      |       | 20,851                       |       | 19,050                      |       |
|                                           |       |                         |       |                        |       |
| Long-term debt, net of  current maturities     |       | 127,500                      |       | 120,000                     |       |
| Other noncurrent  liabilities                  |       | 6,040                        |       | 6,720                       |       |
|                                           |       |                         |       |                        |       |
| Stockholders’ Equity:                     |       |                         |       |                        |       |
| Common stock—voting                       |       | 217                          |       | 207                         |       |
| Common stock—nonvoting                    |       | 9                            |       | 9                           |       |
| Additional paid-in capital                     |       | 51,409                       |       | 45,410                      |       |
| Retained earnings                              |       | 9,775                        |       | 3,591                       |       |
| Total stockholders’ equity                |       | 61,410                       |       | 49,217                      |       |
| TOTAL                                          |       | $                            | 215,801    |                        | $          | 194,987 |   |

 

See notes to condensed consolidated financialstatements (unaudited).

 

3

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**WII COMPONENTS, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(UNAUDITED)**

**(In thousands)**

 
| ** **                                | ** ** | **Three Months  Ended  September 30, 2005** | ** ** | **Three Months  Ended  September 30, 2004** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| NET SALES                                 |       | $                                                | 68,067     |                                             | $          | 52,274 |   |
| COST OF SALES                             |       | 57,309                                           |       | 42,981                                           |       |
| Gross profit                              |       | 10,758                                           |       | 9,293                                            |       |
|                                      |       |                                             |       |                                             |       |
| OPERATING EXPENSES:                       |       |                                             |       |                                             |       |
| General and administrative                |       | 2,669                                            |       | 2,450                                            |       |
| Selling and marketing                     |       | 817                                              |       | 743                                              |       |
| Stock compensation expense                |       | 226                                              |       | 261                                              |       |
| (Gain)/Loss on sale of  assets            |       | (1                                               | )     | 10                                               |       |
| Total operating expenses                  |       | 3,711                                            |       | 3,464                                            |       |
|                                      |       |                                             |       |                                             |       |
| OPERATING INCOME                          |       | 7,047                                            |       | 5,829                                            |       |
|                                      |       |                                             |       |                                             |       |
| OTHER INCOME (EXPENSE):                   |       |                                             |       |                                             |       |
| Interest income                           |       | 7                                                |       | 9                                                |       |
| Interest expense                          |       | (3,454                                           | )          | (3,477                                           | )          |
| Other income                              |       | —                                           |       | 1                                                |       |
| Total other expense                       |       | (3,447                                           | )          | (3,467                                           | )          |
|                                      |       |                                             |       |                                             |       |
| INCOME BEFORE PROVISION FOR  INCOME TAXES |       | 3,600                                            |       | 2,362                                            |       |
| INCOME TAX PROVISION                      |       | 1,400                                            |       | 858                                              |       |
| NET INCOME                                |       | $                                                | 2,200      |                                             | $          | 1,504 |   |

 

See notes to condensed consolidated financialstatements (unaudited).

 

4

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**WII COMPONENTS, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(UNAUDITED)**

**(In thousands)**

 
| ** **                                | ** ** | **Nine Months  Ended  September 30, 2005** | ** ** | **Nine Months  Ended  September 30, 2004** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| NET SALES                                 |       | $                                               | 192,181    |                                            | $          | 151,210 |   |
| COST OF SALES                             |       | 161,060                                         |       | 124,710                                         |       |
| Gross profit                              |       | 31,121                                          |       | 26,500                                          |       |
|                                      |       |                                            |       |                                            |       |
| OPERATING EXPENSES:                       |       |                                            |       |                                            |       |
| General and administrative                |       | 7,441                                           |       | 7,264                                           |       |
| Selling and marketing                     |       | 2,433                                           |       | 2,242                                           |       |
| Stock compensation expense                |       | 1,261                                           |       | 652                                             |       |
| Loss on sale of assets                    |       | 18                                              |       | 11                                              |       |
| Total operating expenses                  |       | 11,153                                          |       | 10,169                                          |       |
|                                      |       |                                            |       |                                            |       |
| OPERATING INCOME                          |       | 19,968                                          |       | 16,331                                          |       |
|                                      |       |                                            |       |                                            |       |
| OTHER INCOME (EXPENSE):                   |       |                                            |       |                                            |       |
| Interest income                           |       | 14                                              |       | 28                                              |       |
| Interest expense                          |       | (10,014                                         | )          | (9,394                                          | )          |
| Loss on modification of  debt             |       | —                                          |       | (3,454                                          | )          |
| Other income                              |       | 6                                               |       | 15                                              |       |
| Total other expense                       |       | (9,994                                          | )          | (12,805                                         | )          |
|                                      |       |                                            |       |                                            |       |
| INCOME BEFORE PROVISION FOR  INCOME TAXES |       | 9,974                                           |       | 3,526                                           |       |
| INCOME TAX PROVISION                      |       | 3,790                                           |       | 1,280                                           |       |
| NET INCOME                                |       | $                                               | 6,184      |                                            | $          | 2,246 |   |

 

See notes to condensed consolidated financialstatements (unaudited).

 

5

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**WII COMPONENTS, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

**(UNAUDITED)**

**(In thousands, except shareamounts)**

 
| ** **                                    | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | ** **  | ** ** | ** **   | ** ** |
|-----------------------------------------------|------------|------------------|------------|----------------|------------|-------------|------------|--------------|------------|
| ** **                                    | ** ** | **Voting**       | ** ** | **Nonvoting**  | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Shares**       | ** ** | **Amount**     | ** ** | **Shares**  | ** ** | **Amount**   | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Total** | ** ** |
| BALANCE-December 31, 2004                |       | 20,734,843       |       | $              | 207        |        | 854,261    |         | $          | 9 |   | $ | 45,410 |   | $ | 3,591 |   | $ | 49,217 |   |
| Stock compensation expense                    |       |             |       |           |       |        |       |         |       | 1,261 |   |   |   | 1,261 |   |
| Issuance of common stock to fund  acquisition |       | 1,016,488        |       | 10             |       |        |       |         |       | 4,738 |   |   |   | 4,748 |   |
| Net income                                    |       |             |       |           |       |        |       |         |       |   |   | 6,184 |   | 6,184 |   |
| BALANCE-September 30, 2005               |       | 21,751,331       |       | $              | 217        |        | 854,261    |         | $          | 9 |   | $ | 51,409 |   | $ | 9,775 |   | $ | 61,410 |   |

 

See notes to condensed consolidated financialstatements (unaudited).

 

6

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**WII COMPONENTS, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

**(In thousands)**

 
| ** **                                                                         | ** ** | **Nine Months  Ended  September 30, 2005** | ** ** | **Nine Months  Ended  September 30, 2004** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| OPERATING ACTIVITIES:                                                              |       |                                            |       |                                            |       |
| Net income                                                                         |       | $                                               | 6,184      |                                            | $          | 2,246 |   |
|                                                                               |       |                                            |       |                                            |       |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                                            |       |                                            |       |
| Loss on modification of  debt                                                      |       | —                                          |       | 3,454                                           |       |
| Depreciation and  amortization                                                     |       | 5,669                                           |       | 5,210                                           |       |
| Loss on sale of assets                                                             |       | 18                                              |       | 11                                              |       |
| Stock compensation expense                                                         |       | 1,261                                           |       | 652                                             |       |
|                                                                               |       |                                            |       |                                            |       |
| Change in operating assets  and liabilities:                                       |       |                                            |       |                                            |       |
| Accounts receivable                                                                |       | (5,076                                          | )          | (657                                            | )     |
| Inventories                                                                        |       | (1,834                                          | )          | (856                                            | )          |
| Other current assets                                                               |       | 1,221                                           |       | 1,081                                           |       |
| Accounts payable                                                                   |       | 1,078                                           |       | (2,101                                          | )     |
| Accrued payroll and other  current liabilities                                     |       | (1,750                                          | )          | 1,208                                           |       |
| Net cash provided by  operating activities                                         |       | 6,771                                           |       | 10,248                                          |       |
|                                                                               |       |                                            |       |                                            |       |
| INVESTING ACTIVITIES:                                                              |       |                                            |       |                                            |       |
| Purchases of property,  plant, and equipment                                       |       | (5,968                                          | )          | (3,729                                          | )          |
| Proceeds from sale of  assets                                                      |       | 193                                             |       | 2                                               |       |
| Change in other assets                                                             |       | —                                     |       | (161                                            | )          |
| Grand Valley acquisition                                                           |       | —                                          |       | (15,937                                         | )     |
| Dimension Moldings, Inc  acquisition                                               |       | (9,289                                          | )          | —                                     |       |
| Net cash used in investing  activities                                             |       | (15,064                                         | )          | (19,825                                         | )          |
|                                                                               |       |                                            |       |                                            |       |
| FINANCING ACTIVITIES:                                                              |       |                                            |       |                                            |       |
| Principal payments under  long-term financing agreements                           |       | (16,496                                         | )          | (87,943                                         | )          |
| Borrowings of long-term  debt                                                      |       | 23,500                                          |       | 135,783                                         |       |
| Dividend distribution                                                              |       | —                                          |       | (21,450                                         | )          |
| Repurchase of common stock                                                         |       | —                                          |       | (17,550                                         | )          |
| Issuance of common stock                                                           |       | 4,747                                           |       | 8,250                                           |       |
| Debt issue costs                                                                   |       | (395                                            | )          | (7,385                                          | )          |
| Termination of interest  rate collar                                               |       | —                                          |       | 52                                              |       |
| Net cash provided by  financing activities                                         |       | 11,356                                          |       | 9,757                                           |       |
|                                                                               |       |                                            |       |                                            |       |
| NET INCREASE IN CASH                                                               |       | 3,063                                           |       | 180                                             |       |
| CASH—Beginning of period                                                      |       | 2                                               |       | 39                                              |       |
|                                                                               |       |                                            |       |                                            |       |
| CASH—End of period                                                            |       | $                                               | 3,065      |                                            | $          | 219 |   |
|                                                                               |       |                                            |       |                                            |       |
| SUPPLEMENTAL CASH FLOW  INFORMATION:                                               |       |                                            |       |                                            |       |
| Cash paid for interest                                                             |       | $                                               | 12,312     |                                            | $          | 8,950 |   |
|                                                                               |       |                                            |       |                                            |       |
| Cash paid for income taxes—net                                                |       | $                                               | 2,293      |                                            | $          | 323 |   |
| NONCASH ACTIVITY:                                                                  |       |                                            |       |                                            |       |
| Conversion of subordinated  convertible note and accrued interest to common stock  |       | $                                               | —     |                                            | $          | 20,850 |   |

 

See notes to condensed consolidated financialstatements (unaudited).

 

7

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**WII COMPONENTS, INC. ANDSUBSIDIARIES**

**NOTES TO CONDENSED**

**CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**1. NATURE OF BUSINESS**

 

***Company Background***—WII Components, Inc. (formerly WIIHoldings, Inc. and referred to herein as the “Company”), a Delawarecorporation, was formed to acquire 100% of the common stock of WoodcraftIndustries, Inc. and its Subsidiaries in a buyout (the “Acquisition”) fromthe former owners. On April 9, 2003, pursuant to a sale agreement betweenthe Company and the former owners, the Company acquired the common stock ofWoodcraft Industries, Inc. for a total of approximately$145 million.  The Company has noindependent assets or operations separate from its consolidated subsidiaries.

 

The Acquisition was accounted for using the purchasemethod of accounting. Accordingly, the assets acquired and the liabilitiesassumed by the Company were recorded at fair value as of the date of theAcquisition. The excess of the purchase price over the fair value of the assetsacquired and liabilities assumed totaling approximately $104.0 million wasrecorded as goodwill.

 

In February 2004, the Company completed anequity restructuring using the proceeds from its $120 million 10% seniornotes offering (Note 5) to pay off the outstanding term loans andrevolving line of credit, to pay a dividend of approximately $21.5 million,to repurchase approximately $17.5 million of the Company’s outstandingcommon stock, and to pay financing costs of approximately $7.4 million.

 

The Company acquired a cabinet door manufactureroperating under the name Grand Valley Door Co. (“Grand Valley”) on April 30,2004 (Note 4).

 

The Company acquired substantially all of the assetsa molding manufacturer operating under the name Dimension Moldings, Inc.on July 28, 2005 (Note 4).  Thoseassets are being operated as a division of Woodcraft Industries, Inc, which isreferred to as Woodcraft Middlefield.

 

***Description ofBusiness***—TheCompany is a leading manufacturer of wood cabinet doors, hardwood components,and engineered wood products in the United States. Its products are soldprincipally to leading national and regional kitchen and bathroom cabinetmanufacturers. Its reputation for high quality and reliable performance hasenabled the Company to establish strong, long-standing relationships with itscustomers. Its customers, in turn, distribute products through various saleschannels, including specialty kitchen and bathroom cabinetry dealers, homecenter retailers, and homebuilders.

 

***Basis ofPresentation***—TheCompany prepared the accompanying unaudited condensed consolidated financialstatements following the requirements of the Securities and Exchange Commissionfor interim reporting. As permitted under those rules, certain notes or otherfinancial information normally required by accounting principles generallyaccepted in the United States of America have been condensed or omitted.Therefore, the Company suggests that these financial statements be read inconjunction with the consolidated financial statements and accompanying notesfor the year ended December 31, 2004 included in its Form 10-K asfiled with the Securities and Exchange Commission on March 31, 2005. Thecondensed consolidated balance sheet as of December 31, 2004 has beenderived from the audited consolidated financial statements at that date, butdoes not include all the information and notes required by accountingprinciples generally accepted in the United States of America for completepresentation.

 

In our opinion, theaccompanying unaudited condensed consolidated financial statements include alladjustments (consisting of normal recurring items) considered necessary topresent fairly, when read in conjunction with the consolidated financialstatements and accompanying notes for the period ended December 31, 2004included in our Form 10-K as filed with the Securities and ExchangeCommission on March 31, 2005, our financial position, results ofoperations and cash flows for the periods presented.

 

***Principles ofConsolidation***—Theunaudited condensed consolidated financial statements include the accounts ofthe Company and its wholly owned subsidiaries. On April 9, 2003, theCompany completed the acquisition of Woodcraft Industries, Inc. and itswholly owned subsidiaries, PrimeWood, Inc. (“PrimeWood”) and BrentwoodAcquisition, Corp. (“Brentwood”).  On April 30,2004 the Company completed the acquisition of Grand Valley, and on July 28,2005 the Company completed the acquisition of substantially all of the assetsof Dimension Moldings, Inc. (Note 4). All intercompany accounts andtransactions have been eliminated in the preparation of the consolidatedfinancial statements.

 

8

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**2. SIGNIFICANT ACCOUNTING POLICIES**

 

***Inventories***—Inventories consisted of the following (inthousands):

 
| ** **      | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials   |       | $                            | 10,964     |                        | $          | 9,995 |   |
| Work in process |       | 6,766                        |       | 4,796                       |       |
| Finished goods  |       | 2,897                        |       | 2,901                       |       |
| LIFO adjustment |       | (952                         | )          | (950                        | )          |
|            |       | $                            | 19,675     |                        | $          | 16,742 |   |

 

The majority of inventory is valued at the lower oflast-in, first-out (“LIFO”) cost or market. The remainder of the inventory isvalued under the first-in, first-out method (“FIFO”). As of September 30,2005 and December 31, 2004, inventory on the LIFO method represented 58%and 60%, respectively, of consolidated inventories.

 

***Goodwill***—As discussed in Note 3, in 2002, theCompany adopted and accounts for goodwill in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 142, *Goodwill and Other Intangible Assets*. Inpart, SFAS No. 142 states that companies are no longer required toamortize goodwill but instead must evaluate goodwill for impairment at leastannually. Previously, goodwill was amortized over its estimated useful life.The Company has elected to perform its annual tests for goodwill impairment asof December 31 of each year. Fair value is measured using the presentvalue of expected future cash flows.

 

***CustomerRelationships—***CustomerRelationships relates to intangible assets recorded through the purchase priceallocation of the Grand Valley acquisition ($7.9 million) and the acquisitionof the assets of Dimension Moldings, Inc. ($8.7 million) for relationships withsignificant customers. The intangible assets are being amortized over theestimated life of 10 years. Amortization for the nine-month period ended September 30,2005 was $740,000.  As of September 30,2005, the net Customer Relationship intangible asset was $15.3 million.  Expected amortization is as follows for theyears ending December 31 (in thousands):

 
| 2005      |   | $     | 1,154  |   |
|-----------|--------|-------|--------|--------|
| 2006      |   | 1,657 |   |
| 2007      |   | 1,657 |   |
| 2008      |   | 1,657 |   |
| 2009      |   | 1,657 |   |
| 2010-2015 |   | 8,269 |   |

 

***NoncompeteAgreement***—Noncompeteagreements primarily relate to agreements with the former owners of Brentwood,Grand Valley, and Dimension Moldings, Inc. Noncompete rights are beingamortized over the applicable terms of the agreements (5 years, 7 years,and 5 years respectively), and are expected to be fully amortized by July 2007,April 2011, and July 2010 respectively. Amortization for thenine-month period ended September 30, 2005 was $337,000.  As of September 30, 2005 the netnoncompete agreement intangible asset was $1.0 million.  Expected amortization is as follows for theyears ending December 31 (in thousands):

 
| 2005      |   | $   | 450    |   |
|-----------|--------|-----|--------|--------|
| 2006      |   | 464 |   |
| 2007      |   | 285 |   |
| 2008      |   | 34  |   |
| 2009      |   | 34  |   |
| 2010-2011 |   | 35  |   |

 

***Stock Options*****—**In April 2003, the 2003 Stock Option andGrant Plan (“2003 Plan”) was approved by the stockholders of the Company. The2003 Plan allows the granting of both incentive stock options and nonqualifiedstock options. Under the terms of the 2003 Plan, a maximum of 2,500,000 sharesof stock, subject to adjustment, were made available for awards to officers,employees, directors, consultants, and other key persons of the Company. Awardsmay include, but are not limited to, stock options, restricted stock,unrestricted stock awards, and substitute performance awards.

 

In May 2003, 1,617,000 options were granted withterms of 10 years from the date of grant, and at an exercise price of$3.00 per share under the 2003 Plan. Issued options vest in equal annual installments over four years.  The fair value of options granted during thenine months ended December 31, 2003 was estimated on the date of the grantusing the Black-Scholes option-pricing model with the following assumptions: arisk-free interest rate of 3.0%, an expected life of six years, and novolatility.  During 2004, 100,000 optionswere cancelled.  As a part of the February 2004equity restructuring (Note 5), the Company repriced the outstanding stockoptions. The Company has adopted variable plan accounting for these optionsfrom the date of the repricing.  TheCompany recorded $1,261,000 and $652,000 of noncash compensation expense forthese repriced options during the nine month periods ended September 30,2005 and September 30, 2004, respectively. As of December 31, 2004, the 1,517,000 options had an exerciseprice of $1.78 per share and a weighted average remaining contractual life ofeight and one-half years.

 

9

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In April and November 2004, the Companygranted 489,000 and 50,000 options, respectively, under the 2003 Plan. The fairvalue of these options was estimated on the date of the grant using theBlack-Scholes option-pricing model with the following assumptions: a risk-freeinterest rate in April and November of 3.9% and 4.2%, respectively,an expected life of six years, and no volatility.

 

In August 2005, the Company granted 255,000options under the 2003 Plan. The fair value of these options was estimated onthe date of the grant using the Black-Scholes option-pricing model with thefollowing assumptions: a risk-free interest rate of 4.2%, an expected life ofsix years, and no volatility.

 

The Company accounts for the options under AccountingPrinciples Board Opinion No. 25, *Accountingfor Stock Issued to Employees*, under which no compensation cost hasbeen recognized as of the original grant date. Had compensation cost for theoptions been determined consistent with SFAS No. 123, *Accounting for Stock-Based Compensation*,the Company’s net income would have been the following pro forma amounts forthe indicated periods (in thousands):

 
| ** **  | ** ** | **Nine Months Ended  September 30, 2005** | ** ** | **Three Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2004** | ** ** | **Three Months Ended  September 30, 2004** | ** ** |
|-------------|------------|------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|-------------------------------------------------|------------|
|        |       |                                           |       |                                            |       |                                           |       |                                            |       |
| As reported |       | $                                              | 6,184      |                                            | $          | 2,200                                          |       | $                                               | 2,246      |   | $ | 1,504 |   |
| Pro forma   |       | 6,095                                          |       | 2,165                                           |       | 2,176                                          |       | 1,477                                           |       |
|             |            |                                                |            |                                                 |            |                                                |            |                                                 |            |  |  |  |  |

 

***New AccountingPronouncements***—In December 2004,the FASB revised SFAS No. 123 and issued SFAS No. 123(R).  This Statement supersedes APB No. 25,which resulted in no stock-based employee compensation cost related to stockoptions if the options granted had an exercise price equal to the market valueof the underlying common stock on the date of grant. SFAS No. 123(R)requires recognition of employee services provided in exchange for a share-basedpayment based on the grant date fair market value.  In April 2005, the SEC delayed theeffective date of SFAS No. 123(R) to fiscal years beginning after June 15,2005.  As a result, the Company isrequired to adopt SFAS No. 123(R) as of January 1, 2006.  As of the effective date, this Statementapplies to all new awards issued as well as awards modified, repurchased, orcancelled.  For stock-based awards issuedprior to the effective date, compensation cost attributable to future serviceswill be recognized as the remaining service is rendered.  The Company may elect to restate priorperiods by applying a modified retrospective method to periods prior to theeffective date.  The Company is in theprocess of determining which method of adoption it will elect (see “StockOptions” above for SFAS No. 123 required disclosures).

 

**3. GOODWILL**

 

Effective January 1, 2002, the Company adoptedand began accounting for goodwill in accordance with SFAS No. 142 whichstates that companies are no longer required to amortize goodwill but insteadmust evaluate goodwill for impairment annually, if not more frequently. TheCompany has elected to perform its annual tests for goodwill impairment as of December 31of each year. Previously, goodwill was amortized over its estimated usefullife. Based on the impairment tests performed on December 31, 2004, theCompany’s fair value exceeds the carrying value, resulting in no goodwillimpairment.  There were no changes in thecarrying amount of goodwill between December 31, 2004 and September 30,2005.

 

**4. ACQUISITIONS**

 

On April 30, 2004, theCompany acquired a cabinet door manufacturer operating under the name of GrandValley Door Co. The acquisition was accomplished through the acquisition ofsubstantially all of the assets of Ohio Door Company and certain land andimprovements from Grand Valley Investment LLC. The Company paid a cash purchaseprice at closing of $16 million and, if the business acquired achievescertain sales and profit margin targets, an additional $1.0 million willbe payable prior to June 30, 2006. Approximately half of the purchaseprice was funded with borrowings under the senior secured revolving creditfacility and the remainder was funded from the proceeds of an equitycontribution from existing stockholders. The acquired company is a 100% ownedsubsidiary of the Company and, on June 25, 2004, agreed to fully andunconditionally guarantee the senior notes on a joint and several basis withthe Company’s existing subsidiary guarantors.

 

The acquisition of Grand Valley was accounted forusing the purchase method of accounting. Accordingly, the assets acquired andthe liabilities assumed by the Company were recorded at fair value as of thedate of the acquisition. The excess of the purchase price over the fair valueof the assets acquired and liabilities assumed totaling $3.8 million wasrecorded as goodwill. Based upon the Company’s final purchase price allocation,$7.9 million of the purchase price was recorded as an other intangible asset,Customer Relationship (Note 2). The pro forma effects of this transaction arenot material to the Company’s results of operations. The components of thepurchase price allocation are as follows (in thousands):

 
| Current assets                  |   | $      | 386    |   |
|---------------------------------|--------|--------|--------|--------|
| Property, plant, and  equipment |   | 4,491  |   |
| Other assets                    |   | 125    |   |
| Goodwill                        |   | 3,770  |   |
| Customer relationship           |   | 7,872  |   |
| Noncompete agreement            |   | 100    |   |
| Assets acquired                 |   | 16,744 |   |
| Liabilities assumed             |   | 807    |   |
| Net assets acquired             |   | $      | 15,937 |   |

 

10

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On July 28, 2005, theCompany acquired substantially all of the assets of a moldings manufactureroperating under the name of Dimension Moldings, Inc.  The Company paid a cash purchase price atclosing of $9.3 million and will be required to pay up to anaggregate of $7.0 million if certain earnings targets are met at the end ofeach calendar year from 2005 to 2010.  Slightly less than half of the purchase pricepaid at closing was funded with borrowings under the senior secured revolvingcredit facility and the remainder was funded from the proceeds of an equitycontribution from existing stockholders. The acquired assets of DimensionMoldings, Inc. are now operated and owned by Woodcraft Industries, Inc.,the Company’s subsidiary.

 

The acquisition of the assets of Dimension Moldings, Inc.was accounted for using the purchase method of accounting. Accordingly, theassets acquired and the liabilities assumed by the Company were recorded atfair value as of the date of the acquisition, including assigning value tocertain intangible assets acquired (a customer relationship for $8.7 millionand a noncompete for $0.1 million).  Thispurchase price allocation is preliminary and the Company expects to completetheir review by the end of the year.  Basedon this preliminary purchase price allocation, the Company determined the fairvalue of the net assets acquired exceeded the $9.3 million closing purchaseprice by approximately $1.9 million.  Asa result, the Company recorded a current liability for $1.9 million, which willbe reduced at the time the contingent consideration is resolved.  Any portion of the contingent considerationliability not paid during the earnout period will be recorded as a gain.  Any contingent consideration paid in excessof this amount will be recorded as goodwill. The pro forma effects of this transaction are not material to theCompany’s results of operations. The components of the preliminary purchaseprice allocation are as follows (in thousands):

 
| Current assets                 |   | $      | 1,504  |   |
|--------------------------------|--------|--------|--------|--------|
| Property, plant, and equipment |   | 1,271  |   |
| Customer Relationship          |   | 8,704  |   |
| Noncompete agreement           |   | 100    |   |
| Assets acquired                |   | 11,579 |   |
| Liabilities assumed            |   | (436   | )      |
| Net assets acquired            |   | 11,143 |   |
| Contingent consideration       |   | (1,854 | )      |
| Closing purchase price         |   | $      | 9,289  |   |

 

**5. FINANCING ARRANGEMENTS**

 

Long-term debt consists of the following (inthousands):

 
| ** **                                                                                     | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Senior notes (10%) due 2012                                                                    |       | $                       | 120,000    |                        | $          | 120,000 |   |
| Term Loan (8.5%) due 2010                                                                      |       | 7,500                   |       | —                      |       |
| Revolver (9.0% and 5.37% at  September 30, 2005 and December 31, 2004, respectively) |       | —                  |       | —                      |       |
| Total debt                                                                                     |       | 127,500                 |       | 120,000                     |       |
| Less current maturities                                                                        |       | —                  |       | —                      |       |
|                                                                                           |       | $                       | 127,500    |                        | $          | 120,000 |   |

 

***Senior Notes***—On February 18, 2004, the Companycompleted the offering of $120 million of 10% senior notes due 2012. The netproceeds of the offering of the senior notes were used to pay off theoutstanding term loans and revolving line of credit, to pay a dividend ofapproximately $21.5 million, to repurchase approximately$17.5 million of the Company’s outstanding common stock, and to payfinancing costs of $7.4 million. Additionally in February 2004, theCompany entered into a new $25 million revolving line of credit.

 

***Credit Facility -***On September 23, 2005, the Companyentered into an Amended and Restated Credit Facility replacing the $25.0million revolving line of credit.  Thenew credit facility includes a $40.0 million revolving line of credit, a $7.5million nonamortizing term loan, and a $7.5 million nonamortizing capital expenditureloan to be drawn upon through June 30, 2006.  The outstanding principal bears interest at afluctuating rate equal to either the base rate plus 2.75% per annum or LIBORplus 3.0% per annum.  It is optional forthe Company, without penalty, to prepay the term loan and capital expenditure loanthroughout the loan commitment period.

 

The Company’s senior secured credit facility and theindenture for the notes imposes certain restrictions on it, includingrestrictions on its ability to incur indebtedness, pay dividends, makeinvestments, grant liens, sell our assets and engage in certain otheractivities.  The Company must comply withcertain financial covenants under the credit facility including maintenance ofa minimum fixed charge coverage ratio, a maximum total leverage ratio and anEBITDA minimum.  As of September 30,2005, the Company was in compliance with these covenants.  Indebtedness under its senior secured creditfacility is secured by substantially all of its assets, including real andpersonal property, inventory, accounts receivable, intellectual property andother intangibles.

 

11

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Each of the Company’s subsidiaries, which are all100% owned subsidiaries of the Company, have fully and unconditionallyguaranteed the senior notes on a joint and several basis. The Company has noindependent assets or operations. As a result, the Company has not presentedseparate financial statements of the subsidiary guarantors.

 

***Capital Leases*****-**The Company has outstanding capital leasesrelating to manufacturing equipment.  Asof September 30, 2005 the Company had $2.6 million of capital leaseobligations, of which $1.1 million was current and as of December 31, 2004the Company had $3.1 million of capital lease obligations, of which $0.9million was current.

 

***SubordinatedConvertible Debt***—TheCompany issued approximately $20 million of 5% Convertible SubordinatedNotes due April 9, 2004 in April 2003. These notes were convertibleat any time prior to maturity, unless previously redeemed, at the option of theholders into shares of the Company’s common stock at a conversion price of$3.00 per share, subject to certain adjustments. The notes are subordinated tothe Company’s senior indebtedness. The notes were not subordinated to theCompany’s trade payables or other general creditors of the Company. On February 9,2004, these notes, along with approximately $0.9 million of relatedaccrued interest, were converted into approximately 7.0 million shares ofthe Company’s $0.01 par value common stock.

 

**6. RELATED-PARTY TRANSACTIONS**

 

The Company has a managementservices agreement with an affiliate of its primary investor whereby theCompany pays a transaction fee to the affiliate for services provided for eachfinancing, refinancing, acquisition, or similar nonrecurring transaction. TheCompany paid $1.7 million to this affiliate for services related to the currentowner acquisition which is recorded as goodwill, and $1.2 million for financingservices which was recorded in other assets as deferred financing costs.  The deferred financing costs weresubsequently written off in conjunction with the February 2004 financingtransaction as discussed in Note 1. In addition, the Company paid $2.4million to this affiliate related to the February 2004 financing transaction,which is recorded in other assets as deferred financing costs. The Company paid$320,000 which was included in the purchase price allocation to this affiliatefor services related to the acquisition of Grand Valley, $224,000 of which wasincluded in goodwill, and $96,000 of which is recorded in other assets asfinancing costs.  The Company receivedservices from this affiliate related to the acquisition of the assets of DimensionMoldings, Inc. totalling $313,000, which was included in the purchase priceallocation.

 

The Company entered into noncompete agreements on April 30,2004 with the former owners of Grand Valley, and on July 28, 2005 with theowners of Dimension Moldings, Inc. (Notes 2 and 4).

 

12

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### **Item 2. Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

**FORWARD-LOOKINGSTATEMENTS**

 

Certain statements in this report are “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995. Statements that are predictive in nature, that depend upon or refer tofuture events or conditions or that include words such as “believe,” “anticipate,”“expect,” “estimate,” “may,” “will,” “should,” “continue,” “plans,” “intends,” “likely”or other similar expressions are forward-looking statements. We caution youthat forward-looking statements involve unknown risks, uncertainties and otherfactors that may cause our actual results and performance to differ materiallyfrom any future results or performance expressed or implied by theseforward-looking statements.

 

Without limiting the generality of the precedingstatement, all statements in this report providing estimates and projectionsconcerning or relating to the following matters are forward-looking statements:

 

•      financial results and conditions;

 

•      margins, costs and expenditures;

 

•      cash flows and growth rates;

 

•      demand for our products;

 

•      industry trends;

 

•      new product and customer initiatives and future relationships;

 

•      our current plans for capital expenditures;

 

•      manufacturing and other cost-saving initiatives; and

 

•      our liquidity and capital resources.

 

In addition, we, through our senior management, fromtime to time make forward-looking public statements concerning our expectedfuture operations and performance and other developments. Such forward-lookingstatements are necessarily estimates reflecting our judgment based upon currentinformation and involve a number of risks and uncertainties. There can be noassurance that other factors will not affect the accuracy of theseforward-looking statements or that our actual results will not differmaterially from the results anticipated in such forward-looking statements.Although we believe that these forward-looking statements are based onreasonable assumptions, you should be aware that many factors could affect ouractual financial results or results of operations and could cause actualresults to differ materially from those expressed in the forward-lookingstatements. Those factors include, among other things:

 

•      our high degree of leverage and significant debt service obligations;

 

•      our ability to integrate acquired businesses;

 

•      our need for additional manufacturing capacity;

 

•      restrictions under the indenture governing the notes and our seniorsecured revolving credit facility;

 

•      changes in interest rates and general economic, homebuilding industry orhome repair and remodeling industry conditions;

 

•      changes in the price of raw materials;

 

•      interruptions in deliveries of raw materials or finished goods;

 

•      the highly competitive nature of our industry; and

 

•      increases in the cost of labor.

 

13

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**Overview**

 

We are one of the leadingmanufacturers of hardwood cabinet doors and components and engineered woodproducts in the United States. Our products include (1) hardwood cabinetdoor components, face frames and drawer fronts, (2) fully assembledhardwood cabinet doors, (3) rigid thermofoil, or RTF, cabinet doors andcomponents, (4) veneer raised panels, or VRPs, and (5) a variety oflaminated and profile-wrapped components. We generate approximately 93% of oursales from the kitchen and bath cabinet manufacturing industry. Our customers,in turn, distribute their products through various sales channels, includingspecialty kitchen and bath cabinet dealers, home center retailers andhomebuilders. We conduct all of our operations through our Woodcraft,PrimeWood, Grand Valley and Brentwood subsidiaries and we operate ten facilitieslocated in Minnesota, North Dakota, Oregon, Ohio, West Virginia, Kansas, andKentucky that allow us to distribute our products nationwide.

 

We consummatedfour strategic acquisitions that have substantially enhanced our marketposition, product breadth and geographic reach. In June 1998, we acquiredour PrimeWood subsidiary, or PrimeWood, a manufacturer of RTF, VRP andprofile-wrapped engineered wood products based in North Dakota. In July 2002,we acquired our Brentwood subsidiary, or Brentwood, a manufacturer of solidwood and RTF cabinet doors located in Oregon. In April 2004, we acquiredour Grand Valley subsidiary, or Grand Valley, a manufacturer of cabinet doorslocated in Ohio.  In July 2005, weacquired substantially all of the assets of Dimension Moldings, Inc.(DMI), an Ohio corporation in the business of manufacturing hardwood componentmoldings.

 

WII Components, Inc.(formerly known as WII Holdings, Inc.), a Delaware corporation, which werefer to as the Company, was formed to acquire Woodcraft Industries, Inc.and its subsidiaries, through a stock purchase on April 9, 2003, which werefer to as the Acquisition. For accounting purposes, the Acquisition wasrecorded with an effective date of April 1, 2003. The Acquisition wasaccounted for using the purchase method of accounting. Accordingly, the assetsacquired and the liabilities assumed by the Company were recorded at fair valueas of April 1, 2003 and included $104.0 million for goodwill.

 

In February 2004, we entered into a new seniorsecured revolving credit facility and used the proceeds from the sale of our10% Senior Notes due 2012 to pay off the term loans and revolving line ofcredit under our old senior credit facility, pay a dividend of approximately$21.5 million, to repurchase an aggregate of 3,317,580 shares of ourvoting and non-voting common stock from all of our existing stockholders on aproportionate basis for an aggregate purchase price of approximately$17.5 million or $5.29 per share and to pay financing costs of $7.4 million.

 

In September 2005, we amended and restated theexisting senior secured revolving credit facility by expanding the revolvingline of credit capacity to $40.0 million, advancing a $7.5 million nonamortizingterm loan, and allowing the flexibility to advance up to $7.5 million through June 30,2006 on a nonamortizing capital expenditure loan.  We have the option, without penalty, toprepay the term loan and capital expenditure loan throughout the loancommitment period.

 

**Results of Operations**

 

***Three Months Ended September 30,2005 Compared to the Three Months Ended September 30, 2004***

 

The following table outlines, for the three monthsended September 30, 2005 and for the three months ended September 30,2004, selected operating data derived from our consolidated statements ofoperations and presents this information as a percentage of net sales:

 
| ** **               | ** ** | **Three Months Ended  September 30, 2005** | ** ** | **Three Months Ended  September 30, 2004** | ** ** |
|--------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **               | ** ** | **(dollars in thousands)**                      | ** ** |
| Net sales                |       | $                                               | 68,067     |                                            | $          | 52,274 |   |
| *% of net sales*         | * *   | *100.0*                                         | *%*        | *100.0*                                         | *%*        |
| Cost of sales            |       | 57,309                                          |       | 42,981                                          |       |
| *% of net sales*         | * *   | *84.2*                                          | *%*        | *82.2*                                          | *%*        |
| * *                 | * *   | * *                                        | * *   | * *                                        | * *   |
| Gross profit             |       | 10,758                                          |       | 9,293                                           |       |
| *% of net sales*         | * *   | *15.8*                                          | *%*        | *17.8*                                          | *%*        |
| Operating expenses       |       | 3,711                                           |       | 3,464                                           |       |
| *% of net sales*         | * *   | *5.4*                                           | *%*        | *6.6*                                           | *%*        |
| * *                 | * *   | * *                                        | * *   | * *                                        | * *   |
| Operating income         |       | 7,047                                           |       | 5,829                                           |       |
| *% of net sales*         | * *   | *10.4*                                          | *%*        | *11.2*                                          | *%*        |
| Other expenses (income): |       |                                            |       |                                            |       |
| Interest expense         |       | 3,454                                           |       | 3,477                                           |       |
| *% of net sales*         | * *   | *5.1*                                           | *%*        | *6.7*                                           | *%*        |
| Other income, net        |       | (7                                              | )          | (10                                             | )          |
| *% of net sales*         | * *   | *0.0*                                           | *%*        | *0.0*                                           | *%*        |
| Income tax provision     |       | 1,400                                           |       | 858                                             |       |
| *% of net sales*         | * *   | *2.1*                                           | *%*        | *1.6*                                           | *%*        |
| * *                 | * *   | * *                                        | * *   | * *                                        | * *   |
| Net income               |       | 2,200                                           |       | 1,504                                           |       |
| *% of net sales*         | * *   | *3.2*                                           | *%*        | *2.9*                                           | *%*        |
|                          |            |                                                 |            |                                                 |            |  |  |

 

14

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*Net sales.*  Net sales increased$15.8 million, or 30.2%, from $52.3 million for the three monthsended September 30, 2004 to $68.1 million for the three months ended September 30,2005.  Sales in our hardwood product lineincreased $14.0 million attributable to a combination of (i) increasesin volume due to overall industry growth and market share gain, (ii) increasein volume due to two full months of Woodcraft Middlefield in 2005, and (iii) toa lesser extent upward price adjustments made in response to increases in rawmaterial costs. The remaining $1.8 million increase in sales relates toour engineered wood products line and is attributable to increases in volumedue to overall industry growth and market share gain.

 

*Cost of sales.*  Costof sales increased $14.3 million, or 33.3%, from $43.0 million forthe three months ended September 30, 2004 to $57.3 million for thethree months ended September 30, 2005. This increase in cost of sales isattributable to (i) increased material, labor and overhead costs relatedto volume growth, (ii) inflation, primarily in respect to hardwood rawmaterial costs, and (iii) higher material and labor costs due tooperational inefficiencies at our Grand Valley operating facility. These costswere offset in part by the spreading of our fixed costs over a larger salesbase and higher operating efficiencies at our other facilities.

 

*Gross profit.*  Gross profit increased$1.5 million, or 16.1%, from $9.3 million for the three months ended September 30,2004 to $10.8 million for the same period in 2005 as a result of thefactors described above. As a percentage of net sales, our gross profitdecreased 200 basis points from 17.8% for the three months ended September 30,2004 to 15.8% for the same period in 2005. This decrease reflects highermaterial and labor costs due to operational inefficiencies at our Grand Valleyoperating facility and increases in our raw material costs, offset in part bythe spreading of our fixed costs over a larger sales base and improvedoperating efficiencies at our other facilities.

 

*Operating expenses.* Operating expenses increased $0.2 million, or 5.7%, from$3.5 million for the three months ended September 30, 2004 to$3.7 million for the same period in 2005. The increase consists of (i) $0.2million due to the inclusion of two full months of operations of WoodcraftMiddlefield, which includes $0.1 of amortization for a Customer Relationshipintangible asset, and (ii) $0.2 million of higher professional fees.  The increase is partially offset by adecrease of $0.2 million for higher bonus expense in 2004 compared to 2005.

 

*Operating income.* Operating income increased by $1.3 million, or 22.4%, from$5.8 million for the three months ended September 30, 2004 to$7.1 million for the three months ended September 30, 2005 as aresult of the net effect of the factors described above.

 

*Interest expense.* Interest expense remained constant at $3.5 million for the threemonths ended September 30, 2004 and September 30, 2005.

 

*Other income.*  Other income decreased from$10,000 of other income for the three months ended September 30, 2004 to$7,000 for the three months ended September 30, 2005.

 

*Income tax provision.*  Incometax expense increased $0.6 million, or 75.0% from $0.8 million forthe three months ended September 30, 2004 to $1.4 million for thethree months ended September 30, 2005 as a result of higher earnings. Theeffective tax rate increased 260 basis points from 36.3% in 2004 to 38.9% in2005 due to permanent differences and higher state taxes due to business growthin multistate jurisdictions.

 

*Net income.*  Net income increased$0.7 million, or 46.7%, from $1.5 million for the three months ended September 30,2004 to $2.2 million for the three months ended September 30, 2005 asa result of the factors described above.

 

***Nine Months Ended September 30,2005 Compared to the Nine Months Ended September 30, 2004***

 

The following table outlines, for the nine monthsended September 30, 2005 and for the nine months ended September 30,2004, selected operating data derived from our consolidated statements ofoperations and presents this information as a percentage of net sales:

 
| ** **               | ** ** | **Nine Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2004** | ** ** |
|--------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **               | ** ** | **(dollars in thousands)**                     | ** ** |
| Net sales                |       | $                                              | 192,181    |                                           | $          | 151,210 |   |
| *% of net sales*         | * *   | *100.0*                                        | *%*        | *100.0*                                        | *%*        |
| Cost of sales            |       | 161,060                                        |       | 124,710                                        |       |
| *% of net sales*         | * *   | *83.8*                                         | *%*        | *82.5*                                         | *%*        |
| * *                 | * *   | * *                                       | * *   | * *                                       | * *   |
| Gross profit             |       | 31,121                                         |       | 26,500                                         |       |
| *% of net sales*         | * *   | *16.2*                                         | *%*        | *17.5*                                         | *%*        |
| Operating expenses       |       | 11,153                                         |       | 10,169                                         |       |
| *% of net sales*         | * *   | *5.8*                                          | *%*        | *6.7*                                          | *%*        |
| * *                 | * *   | * *                                       | * *   | * *                                       | * *   |
| Operating income         |       | 19,968                                         |       | 16,331                                         |       |
| *% of net sales*         | * *   | *10.4*                                         | *%*        | *10.8*                                         | *%*        |
| Other expenses (income): |       |                                           |       |                                           |       |
| Interest expense         |       | 10,014                                         |       | 9,394                                          |       |
| *% of net sales*         | * *   | *5.2*                                          | *%*        | *6.2*                                          | *%*        |
| Other loss (income), net |       | (20                                            | )          | 3,411                                          |       |
| *% of net sales*         | * *   | *0.0*                                          | *%*        | *2.3*                                          | *%*        |
| Income tax provision     |       | 3,790                                          |       | 1,280                                          |       |
| *% of net sales*         | * *   | *2.0*                                          | *%*        | *0.8*                                          | *%*        |
| * *                 | * *   | * *                                       | * *   | * *                                       | * *   |
| Net income               |       | 6,184                                          |       | 2,246                                          |       |
| *% of net sales*         | * *   | *3.2*                                          | *%*        | *1.5*                                          | *%*        |
|                          |            |                                                |            |                                                |            |  |  |

 

15

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*Net sales.*  Net sales increased$41.0 million, or 27.1%, from $151.2 million for the nine monthsended September 30, 2004 to $192.2 million for the nine months ended September 30,2005.  Sales in our hardwood product lineincreased $36.0 million attributable to a combination of (i) increasesin volume due to overall industry growth and market share gain, (ii) increasesin volume due to the acquisition of Grand Valley in April 2004 and theassets of Dimension Moldings, Inc. in July 2005, and (iii) to alesser extent upward price adjustments made in response to increases in rawmaterial costs. The remaining $5.0 million increase in sales relates toour engineered wood products line and is attributable to increases in volumedue to overall industry growth and market share gain.

 

*Cost of sales.*  Costof sales increased $36.4 million, or 29.2%, from $124.7 million for thenine months ended September 30, 2004 to $161.1 million for the ninemonths ended September 30, 2005. This increase in cost of sales isattributable to (i) increased material, labor and overhead costs relatedto volume growth, (ii) inflation, primarily in respect to hardwood rawmaterial costs, (iii) higher quality and scrap costs due to the rollout ofa new door program, and (iv) higher material and labor costs due tooperatonal inefficiencies at our Grand Valley operating facility. These costswere offset in part by the spreading of our fixed costs over a larger salesbase and higher operating efficiencies at our other facilities.

 

*Gross profit.*  Gross profit increased$4.6 million, or 17.4%, from $26.5 million for the nine months ended September 30,2004 to $31.1 million for the same period in 2005 as a result of thefactors described above. As a percentage of net sales, our gross profitdecreased 130 basis points from 17.5% for the nine months ended September 30,2004 to 16.2% for the same period in 2005. This decrease reflects (i) increasesin our raw material costs compared to the same period in 2004, (ii) higherquality and scrap costs due to the rollout of a new door program, and (iii) highermaterial and labor costs due to operational inefficiencies at our Grand Valleyoperating facility; offset in part by the spreading of our fixed costs over alarger sales base and improved operating efficiencies at out other facilities.

 

*Operating expenses.* Operating expenses increased $0.9 million, or 8.8%, from$10.2 million for the nine months ended September 30, 2004 to$11.1 million for the same period in 2005. The increase consists of (i) $0.6million for additional stock compensation expense in 2005, (ii) $0.8 milliondue to the inclusion of nine full months of operations of Grand Valley in 2005,which includes $0.3 million of amortization for a Customer Relationship intangibleasset, (iii) $0.2 million due to the inclusion of two full months ofoperations of Woodcraft Middlefield, which includes $0.1 million ofamortization for a Customer Relationship intangible asset,  (iv) $0.1 million for nine full monthsof amortization on financing fees related to the 2004 credit facility, and (v) $0.3million for additional professional fees. This increase is partially offset by (i) $0.8 million ofadditional incentive compensation paid to certain key employees in February 2004in recognition of our improved financial performance and the successfulcompletion of the offering of the senior notes, and (ii) $0.3 million ofconsulting and noncompete expense in 2004 for the previous owner of asubsidiary of Woodcraft Industries, Inc. As a percentage of sales, operating expenses declined from 6.7% for thenine months ended September 30, 2004 to 5.8% for the same period in 2005,reflecting the scale benefits of a higher sales base in 2005.

 

*Operating income.* Operating income increased by $3.7 million, or 22.7%, from$16.3 million for the nine months ended September 30, 2004 to$20.0 million for the nine months ended September 30, 2005 as aresult of the net effect of the factors described above.

 

*Interest expense.* Interest expense increased $0.6 million, or 6.4%, from$9.4 million for the nine months ended September 30, 2004 to$10.0 million for the nine months ended September 30, 2005. Thisincrease relates to the increase in debt and the higher interest rate inconnection with the issuance of the $120.0 million senior notes in February 2004.

 

*Other loss (income).*  Otherincome increased from $3.4 million of other loss for the nine months ended September 30,2004 to $20,000 of other income for the nine months ended September 30,2005.  This increase relates to the $3.4million write-off of financing fees related to the senior credit facility from April 2003,which was subsequently paid-off in February 2004.

 

*Income tax provision.*  Incometax expense increased $2.5 million, or 192.3% from $1.3 million forthe nine months ended September 30, 2004 to $3.8 million for the ninemonths ended September 30, 2005 as a result of higher earnings. Theeffective tax rate increased 170 basis points from 36.3% in 2004 to 38.0% in2005 due to permanent differences and higher state taxes due to business growthin multistate jurisdictions.

 

*Net income.*  Net income increased$4.0 million, or 181.8%, from $2.2 million for the nine months ended September 30,2004 to $6.2 million for the nine months ended September 30, 2005 asa result of the factors described above.

 

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**Liquidity and Capital Resources**

 

Our primary cash needs areworking capital, capital expenditures and debt service. We have historicallyfinanced these cash requirements through internally generated cash flow andfunds borrowed under our existing senior secured credit facilities.

 

*Refinancing*.  On February 18, 2004, weissued $120.0 million of 10% senior notes due in 2012, and paid the entireoutstanding balance of our old senior secured credit facility and terminatedthe related credit agreement. Under that credit facility, we had threeoutstanding term loans and a $15.0 million revolving credit facility. Ourexisting $55.0 million credit facility, which was amended and restated in September 2005,provides for revolving credit of up to $40.0 million subject to aborrowing base, $7.5 million nonamortizing term loan, and $7.5 millionnonamortizing capital expenditure loan to be drawn upon through June 30, 2006.  The outstanding principal bears interest at afluctuating rate equal to either the base rate plus 2 3¤4% per annum or LIBOR plus 3.0% per annum. As of September 30, 2005the borrowing base allowed for full availability of the $40.0 million revolvingcredit.  As of September 30, 2005and December 31, 2004 we had $7.5 million and nothing, respectively,outstanding under our credit facility. We must comply with certain financialcovenants under our credit facility including maintenance of a minimum fixedcharge coverage ratio, a maximum total leverage ratio and an EBITDA minimum. Asof September 30, 2005 and December 31, 2004 we were in compliancewith these covenants.  As of September 30,2005 we had $2.6 million of capital lease obligations, of which $1.1 millionwas current and as of December 31, 2004 we had $3.1 million ofcapital lease obligations, of which $0.9 million was current.

 

The acquisition of substantially all of the assets ofDimension Moldings, Inc, and associated fees and expenses were funded one-halfby the sale of shares of the Company’s voting common stock to existingstockholders, and the remainder with operating cash and a draw down on theCompany’s senior secured credit facility. The Company intends to fund any earn-out payments due to the sellerequally through raising additional equity, and with funds from its seniorsecured credit facility.

 

Our existing senior secured revolving credit facilityand the indenture for the senior notes imposes certain restrictions on us,including restrictions on our ability to incur indebtedness, pay dividends,make investments, grant liens, sell our assets and engage in certain otheractivities. Indebtedness under our existing senior secured revolving creditfacility is secured by substantially all of our assets, including our real andpersonal property, inventory, accounts receivable, intellectual property andother intangibles.

 

*Cash flow from operating activities.*  As of December 31,2004, we had $2,000 of cash and cash equivalents available for working capitalpurposes.  As of September 30, 2005,we had approximately $3.1 million of cash and cash equivalents available forworking capital purposes.  Cash providedby operating activities for the nine months ended September 30, 2005 and2004 was $6.8 million and $10.2 million, respectively.

 

*Cash flow from investing activities.*  Netcash used in investing activities was $15.1 million for the nine monthsended September 30, 2005 and $19.8 million for the nine months ended September 30,2004. Capital expenditures were $6.0 million for the nine months ended September 30,2005 compared to $3.7 million for the same period in 2004.  Net cash used in investing activitiesincludes $9.3 million for the nine months ended September 30, 2005 due tothe acquisition of the assets of Dimension Moldings, Inc..  The nine months ended September 30, 2004included $15.9 million due to the acquisition of Grand Valley.

 

*Cash flow from financing activities.*  Netcash provided by financing activities for the nine months ended September 30,2005 of $11.4 million, primarily attributable to cash inflows from the new$7.5 million term loan funded under the new financing agreement and $4.7million for stock issued for the Dimension Moldings, Inc.acquisition.  Net cash provided by financingactivities in the nine month period ended September 30, 2004 totaled$9.8 million.

 

*Dividends.*  We are limited by our currentdebt covenants regarding the payment of dividends. On February 24, 2004,we used $39.0 million of the net proceeds from the offering of the oldnotes to make payments to our stockholders through a combination of dividendsand redemptions of common stock.

 

We anticipate that the funds generated by operationsand funds available under the senior secured credit facility will be sufficientto meet working capital requirements and to finance capital expenditures overthe next twelve months. We cannot provide assurances that our business willgenerate sufficient cash flow from operations, that anticipated net salesgrowth and operating improvements will be realized or that future borrowingswill be available under our senior secured credit facility in an amountsufficient to enable us to service our indebtedness, including the notes, or tofund our other liquidity needs. We are currently approaching our fullmanufacturing capacity.  We intend toincur capital expenditures in order to continue to fulfill increasedmanufacturing demands, including without limitation, the expenditure of anaggregate amount between $16.0 to $18.0 million to finance the acquisition of aroughmill facility in Pennsylvania and the expansion of capacity at our St.Cloud door facility.  In addition, wecannot provide assurances that we will be able to refinance any of ourindebtedness, including our senior secured revolving credit facility and thenotes, on commercially reasonable terms, if at all.

 

**Inflation**

 

Our cost of sales is subject to inflationarypressures on labor costs, prices of the raw materials we use and variousoverhead costs. We generally have been able over time to offset the effects ofinflation and price fluctuations through a combination of sales price increasesand operational efficiencies.  Wecurrently believe that raw material cost pressure is moderating.  We continue to attempt to pass along thesecosts, but such efforts typically lag behind in material costs and we can notguarantee a full offset.

 

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**Seasonality**

 

Our sales historically have been moderately seasonal,reflecting the temporary slow down in consumer purchasing activity during thewinter holiday season and the summer months.

 

### **Critical Accounting Policies**

 

The preparation of financial statements in conformitywith GAAP requires management to make estimates, assumptions and judgments thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Because of the uncertainty inherent in these matters, actual results coulddiffer from those estimates. We believe that the estimates, assumptions andjudgments involved in the accounting policies below have the greatest potentialimpact on our financial statements.

 

*Revenue recognition.*  Werecognize revenues and related cost of sales when title passes, which isusually upon shipment of product under FOB shipping point terms. Returns areestimated and provided for at the time of sale based on historical experienceand current trends.

 

*Allowance for doubtful accounts.*  Wemake estimates of potentially uncollectible accounts receivable. Our reservesare based on an analysis of customers’ accounts and historical write-offexperience. Our analysis includes the age of the receivable, customercreditworthiness and general economic conditions. We believe the results couldbe materially different if historical trends do not reflect actual results orif economic conditions worsened.

 

*Goodwill.*  We adopted Statement ofFinancial Accounting Standards, or SFAS No. 142, *Goodwill andOther Intangible Assets*, and accordingly have discontinued theamortization of goodwill. We evaluate goodwill for impairment annually orwhenever an indicator of impairment occurs. If events or circumstances change,including reductions in anticipated cash flows generated by operations,goodwill could become impaired and result in a charge to earnings.

 

*Impairment of long-lived assets.*  Weevaluate the carrying value of long-lived assets, such as property, plant andequipment, for impairment when events or changes in circumstances indicate thatthe carrying amount of an asset or group of assets may not be recoverable.Assets are grouped and evaluated for impairment at the lowest level for whichthere are identifiable cash flows. If impairment indicators are present and theestimated future undiscounted cash flows are less than the carrying value ofthe asset or group of assets, the carrying value is reduced to its estimatedfair value. Fair value is estimated based on the best information available,including prices for similar assets or results of valuation techniques such asdiscounting estimated future cash flows.

 

*Insurance benefit accruals.*  Eachaccounting period, we estimate an amount to accrue for medical costs incurredbut not yet reported under our self-funded employee medical and workerscompensation insurance plans. We base our determination on an evaluation ofpast rates of claim payouts and trends in the amount of payouts. Thisdetermination requires significant judgment and assumes past patterns arerepresentative of future payment patterns. A significant shift in usage andpayment patterns within these plans could necessitate significant adjustmentsto these accruals in future accounting periods.

 

*Purchase accounting.*  Weaccounted for our acquisitions under the purchase method of accounting and,accordingly, the acquired assets and liabilities assumed are recorded at theirrespective fair values. The recorded values of assets and liabilities are basedon third-party estimates and valuations when available. The remaining valuesare based on management’s judgments and estimates. Our financial position andresults from operations may be affected by changes in estimates and judgments.

 

*Income taxes.*  As part of the process ofpreparing our consolidated financial statements, we are required to estimateour income in each of the jurisdictions in which we operate. This processinvolves estimating our actual current tax exposure along with assessingtemporary differences resulting from differing treatment of items, such ascapital assets, for tax and accounting purposes. These differences result indeferred tax assets and liabilities, which are included within our consolidatedbalance sheets. We also must assess the likelihood that our deferred tax assetwill be recovered from taxable income and, to the extent we believe recovery isnot likely, we must establish a valuation allowance.

 

**New Accounting Standards**

 

See Note 2 of theConsolidated Financial Statements for information pertaining to recentlyadopted accounting standards or accounting standards to be adopted in thefuture.

 

### **Item 3. Quantitative and Qualitative Disclosures aboutMarket Risk**

 

Weare subject to various market risks such as fluctuating lumber prices andinterest rates.

 

*Commodity price risk.* Hardwood lumber accounts for the largest portion of our material costs.Our profitability is therefore affected by the prices of lumber which mayfluctuate based on a number of factors beyond our control, including, amongothers, changes in supply and

 

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demand,general economic conditions, labor costs, competition and, in some cases,government regulation. Though we are not dependent on any single supplier forour raw materials, we have no long-term supply contracts and thus, are subjectto changes in the prices charged by our suppliers. The prices for the primaryhardwood species we use in the production of our hardwood doors and componentsare subject to some volatility.

 

*Interest rate risk.*  We areexposed to market risk relating to changes in interest rates in respect of aportion of our long-term debt and a portion of our capital leases. As of September 30,2005, we had nothing outstanding under our senior secured revolving creditfacility. In addition, as of that date, we had approximately $1.0 millionof capital leases that bear interest at variable rates. We believe that a onepercent (1%) increase in the interest rates currently in effect would not havea material adverse effect on our financial condition or results of operations.

 

### **Item 4. Controls and Procedures**

 

(a)           Evaluation of disclosure controls andprocedures.

 

As required by Rule 13a-15 under the SecuritiesExchange Act of 1934, we carried out an evaluation under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, of the effectiveness of our disclosure controlsand procedures as of September 30, 2005. In designing and evaluating ourdisclosure controls and procedures, we and our management recognize that anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving the desired control objectives, and ourmanagement necessarily was required to apply its judgment in evaluating andimplementing possible controls and procedures. Based upon that evaluation, ourChief Executive Officer and Chief Financial Officer have concluded that theybelieve that, as of September 30, 2005, our disclosure controls andprocedures were reasonably effective to ensure that information required to bedisclosed by us in the reports we file or submit under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the Securities and Exchange Commission’s rules and forms. We willcontinue to review and document our disclosure controls and procedures on anongoing basis, and may from time to time make changes aimed at enhancing theireffectiveness and to ensure that our systems evolve with our business.

 

(b)           Changes in internal controls over financialreporting.

 

None.

 

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**PART II—OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

None.

 

**Item 2. Unregistered Sales of Equity Securities and Use ofProceeds**

 

None.

 

**Item 3. Defaults Upon Senior Securities**

 

None.

 

**Item 4. Submission of Matters to a Vote of Security Holders**

 

None.

 

**Item 5. Other Information**

 

None.

 

### **Item 6.Exhibits**

 

10.1         Amended and Restated Credit Agreement dated asof September 23, 2005 by and among WII Components, Inc., Antares CapitalCorporation, and The Financial Institutions Party thereto

31.1         Certification of Vice President, Treasurer andSecretary of WII Components, Inc., pursuant to Rules 13a-14(a) and15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of2002

31.2         Certification of Chief Executive Officer ofWII Components, Inc., pursuant to Rules 13a-14(a) and 15d-14(a),as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1*       Certification of Vice President, Treasurer andSecretary of WII Components, Inc., pursuant to 18 U.S.C. Section 1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2*       Certification of Chief Executive Officer ofWII Components, Inc., pursuant to 18 U.S.C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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*              This certification shall not be deemed “filed”for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwisesubject to the liability of that section, nor shall it be deemed to beincorporated by reference into any filing under the Securities Act of 1933 orthe Securities Exchange Act of 1934.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                          | WII COMPONENTS, INC. |
|-------------------------------|----------------------|
|                          |                 |
| Dated: November 14, 2005 | By:                  |
|                          |                 | */s/ John Fitzpatrick* |
|                          |                 | John Fitzpatrick |
|                          |                 | Chief Executive Officer |
|                          |                 | (Principal Executive Officer) |
| Dated: November 14, 2005 |                 |   |
|                          |                 | */s/ Dale B. Herbst* |
|                          |                 | Dale B. Herbst |
|                          |                 | Vice President, Treasurer and Secretary |
|                          |                 | (Principal Financial and Accounting Officer) |

 

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