** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

 

| ****(Mark One)**** |           |
|--------------------|----------------|
| **** ****     |           |
| ****ý****     | **** **** | ****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**** |
|                    |                |  |

 

****FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005****

**** ****

****OR****

 

 

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

 

****FOR THE TRANSITION PERIOD FROM                   TO               ****

** **

****COMMISSION FILE NUMBER 001-32380****

** **

**INTERLINE BRANDS, INC.**

(Exact name of registrant as specified in its charter)

 

| ****DELAWARE****                        | **** **** | ****03-0542659****          |
|-----------------------------------------|----------------|-----------------------------|
| ****(State or other jurisdiction of**** | **** **** | ****(I.R.S. Employer****    |
| ****incorporation or organization)****  | **** **** | ****Identification No.)**** |

 

****801 WEST BAY STREET****

****JACKSONVILLE, FLORIDA 32204****

****(Address of principal executive offices)****

 

**(904) 421-1400**

(Registrant’s telephone number, including area code)

 

**NOT APPLICABLE**

(Former name, former address and former fiscal year, if changed since last report)

 

                    Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  ****ý********  ****No  ****o****

 

                    Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  ****o********  ****No  ****ý****

 

                    Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ****o********  ****No  ****ý****

 

As of the close of business on November 10, 2005, there were 32,220,669 shares outstanding of the registrant’s common stock, $0.01 par value.

 

 

----

 

**TABLE OF CONTENTS**

 

 

 
| ****PART I — FINANCIAL INFORMATION**** |
|---------------------------------------------|
|                                        |   |   |
| ****Item 1.****                             | ****Financial Statements**** |   |
| **** ****                              | ****Unaudited Condensed Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004 **** |   |
| **** ****                              | ****Unaudited Condensed Consolidated Statements of Operations for the Three Months and Nine Months Ended September 30, 2005 and  September 24, 2004 **** |   |
| **** ****                              | ****Unaudited Condensed Consolidated Statement of Stockholders’ Equity for the Nine Months Ended September 30, 2005 **** |   |
| **** ****                              | ****Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and September 24, 2004 **** |   |
| **** ****                              | ****Notes to Unaudited Condensed Consolidated Financial Statements**** |   |
| ****Item 2. ****                       | ****Management’s Discussions and Analysis of Financial Condition and Results of Operations **** |   |
| ****Item 3.****                             | ****Quantitative and Qualitative Disclosures about Market Risk**** |   |
| ****Item 4.****                             | ****Controls and Procedures**** |   |
|                                        |   |   |
| ****PART II — OTHER INFORMATION****    |
|                                        |   |   |
| ****Item 1.****                             | ****Legal Proceedings**** |   |
| ****Item 2.****                             | ****Changes In Securities, Use Of Proceeds, And Issuer Purchases Of Equity Securities**** |   |
| ****Item 3.****                             | ****Defaults Upon Senior Securities**** |   |
| ****Item 4.****                             | Submission Of Matters To A Vote Of Security Holders |   |
| Item 5.                                     | Other Information |   |
| ****Item 6.****                             | ****Exhibits**** |   |
|                                        |   |   |
| ****SIGNATURES****                          |   |
|                                             |  |  |  |

 

 

**PART I. FINANCIAL INFORMATION**

 

ITEM 1.  FINANCIAL STATEMENTS.

 

**INTERLINE BRANDS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004**

**(in thousands, except share data)**

 
| ** **                                                                                                                                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                                                                 | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| ** **                                                                                                                                                 | ** ** | ** **        | ** ** | ** **       | ** ** |
| **ASSETS**                                                                                                                                                 |       |              |       |             |       |
| CURRENT ASSETS:                                                                                                                                            |       |              |       |             |       |
| Cash and cash equivalents                                                                                                                                  |       | $                 | 1,610      |             | $          | 69,178 |   |
| Accounts receivable - trade (net of allowance for doubtful accounts of  $7,789 and $6,929)                                                                 |       | 126,059           |       | 98,511           |       |
| Accounts receivable - other                                                                                                                                |       | 10,761            |       | 17,828           |       |
| Inventory                                                                                                                                                  |       | 158,899           |       | 145,532          |       |
| Prepaid expenses and other current assets                                                                                                                  |       | 4,057             |       | 3,204            |       |
| Deferred income taxes                                                                                                                                      |       | 13,194            |       | 12,084           |       |
| Total current assets                                                                                                                                       |       | 314,580           |       | 346,337          |       |
|                                                                                                                                                       |       |              |       |             |       |
| PROPERTY AND EQUIPMENT, net                                                                                                                                |       | 30,262            |       | 28,767           |       |
|                                                                                                                                                       |       |              |       |             |       |
| GOODWILL                                                                                                                                                   |       | 249,638           |       | 203,848          |       |
|                                                                                                                                                       |       |              |       |             |       |
| OTHER INTANGIBLE ASSETS, net                                                                                                                               |       | 105,961           |       | 85,361           |       |
|                                                                                                                                                       |       |              |       |             |       |
| OTHER ASSETS                                                                                                                                               |       | 9,422             |       | 9,067            |       |
| TOTAL ASSETS                                                                                                                                               |       | $                 | 709,863    |             | $          | 673,380 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                              |       |              |       |             |       |
| CURRENT LIABILITIES:                                                                                                                                       |       |              |       |             |       |
| Current portion of long-term debt                                                                                                                          |       | $                 | 1,400      |             | $          | 1,000 |   |
| Revolver                                                                                                                                                   |       | 5,000             |       | —           |       |
| Accounts payable                                                                                                                                           |       | 69,498            |       | 53,260           |       |
| Accrued expenses and other current liabilities                                                                                                             |       | 25,955            |       | 22,180           |       |
| Accrued interest payable                                                                                                                                   |       | 5,927             |       | 3,042            |       |
| Accrued merger expenses                                                                                                                                    |       | 6,300             |       | 6,131            |       |
| Accrued income taxes payable                                                                                                                               |       | 4,702             |       | 7,372            |       |
| Total current liabilities                                                                                                                                  |       | 118,782           |       | 92,985           |       |
|                                                                                                                                                       |       |              |       |             |       |
| LONG TERM LIABILITIES:                                                                                                                                     |       |              |       |             |       |
| Deferred income taxes                                                                                                                                      |       | 33,660            |       | 25,221           |       |
| Long-term debt, net of current portion                                                                                                                     |       | 281,025           |       | 302,275          |       |
| Capital leases                                                                                                                                             |       | 1,167             |       | —           |       |
|                                                                                                                                                       |       |              |       |             |       |
| TOTAL LIABILITIES                                                                                                                                          |       | 434,634           |       | 420,481          |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                                              |       |              |       |             |       |
| SENIOR PREFERRED STOCK, $0.01 par value, 20,000,000 shares  authorized, no shares outstanding as of September 30, 2005 and December 31,  2004              |       | —            |       | —           |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                 |       |              |       |             |       |
| Common stock; $0.01 par value, 100,000,000 authorized; 32,220,669 issued  and outstanding as of September 30, 2005 and 32,102,820 as of December 31,  2004 |       | 322               |       | 321              |       |
| Accumulated deficit                                                                                                                                        |       | (282,160          | )          | (301,836         | )          |
| Additional paid-in capital                                                                                                                                 |       | 558,232           |       | 556,346          |       |
| Deferred compensation                                                                                                                                      |       | (2,165            | )          | (2,787           | )          |
| Accumulated other comprehensive income                                                                                                                     |       | 1,000             |       | 855              |       |
| TOTAL STOCKHOLDERS’ EQUITY                                                                                                                            |       | 275,229           |       | 252,899          |       |
| TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY                                                                                                          |       | $                 | 709,863    |             | $          | 673,380 |   |

 

*See accompanying notes to unaudited condensedconsolidated financial statements.*

 

1

 

**INTERLINE BRANDS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

**THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2005 ANDSEPTEMBER 24, 2004**

**(in thousands, except share and per share data)**

 

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **September 30,**      | ** ** | **September 24,**     | ** ** | **September 30,** | ** ** | **September 24,** | ** ** |
| ** **                                          | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| NET SALES                                           |       | $                      | 225,811    |                  | $          | 190,400 |   | $ | 625,968 |   | $ | 548,383 |   |
| COST OF SALES                                       |       | 139,701                |       | 117,214               |       | 387,117 |   | 338,529 |   |
| Gross Profit                                        |       | 86,110                 |       | 73,186                |       | 238,851 |   | 209,854 |   |
| OPERATING EXPENSES :                                |       |                   |       |                  |       |   |   |   |   |
| Selling, general and administrative expenses        |       | 58,885                 |       | 49,724                |       | 167,141 |   | 148,062 |   |
| Depreciation and amortization                       |       | 3,361                  |       | 2,988                 |       | 9,699 |   | 9,414 |   |
| Secondary offering expenses                         |       | 923                    |       | —                |       | 923 |   | — |   |
| Total Operating Expense                             |       | 63,169                 |       | 52,712                |       | 177,763 |   | 157,476 |   |
| OPERATING INCOME                                    |       | 22,941                 |       | 20,474                |       | 61,088 |   | 52,378 |   |
| CHANGE IN FAIR VALUE OF INTEREST RATE SWAPS         |       | —                 |       | 1,503                 |       | — |   | 6,201 |   |
| LOSS ON EXTINGUISHMENT OF DEBT                      |       | —                 |       | —                |       | (10,340 | ) | — |   |
| INTEREST EXPENSE                                    |       | (6,694                 | )          | (10,269               | )          | (18,709 | ) | (30,563 | ) |
| INTEREST INCOME                                     |       | 45                     |       | 32                    |       | 171 |   | 65 |   |
| OTHER INCOME                                        |       | 188                    |       | 119                   |       | 474 |   | 300 |   |
| Income before income taxes                          |       | 16,480                 |       | 11,859                |       | 32,684 |   | 28,381 |   |
| PROVISION FOR INCOME TAXES                          |       | 6,762                  |       | 4,932                 |       | 13,008 |   | 11,246 |   |
| NET INCOME                                          |       | 9,718                  |       | 6,927                 |       | 19,676 |   | 17,135 |   |
| PREFERRED STOCK DIVIDENDS                           |       | —                 |       | (14,170               | )          | — |   | (41,155 | ) |
| NET INCOME (LOSS) APPLICABLE TO COMMON STOCKHOLDERS |       | $                      | 9,718      |                  | $          | (7,243 | ) | $ | 19,676 |   | $ | (24,020 | ) |
| INCOME (LOSS) PER COMMON SHARE - BASIC              |       | $                      | 0.30       |                  | $          | (110.13 | ) | $ | 0.62 |   | $ | (365.22 | ) |
| INCOME (LOSS) PER COMMON SHARE - DILUTED            |       | $                      | 0.30       |                  | $          | (110.13 | ) | $ | 0.61 |   | $ | (365.22 | ) |
|                                                |       |                   |       |                  |       |   |   |   |   |
| WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC         |       | 32,061,828             |       | 65,769                |       | 31,979,374 |   | 65,769 |   |
| WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED       |       | 32,521,809             |       | 65,769                |       | 32,399,670 |   | 65,769 |   |

 

*See accompanying notes to unaudited condensedconsolidated financial statements*

 

2

 

**INTERLINE BRANDS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(UNAUDITED)**

**NINE MONTHS ENDED SEPTEMBER 30, 2005**

**(in thousands, except share data)**

 

 
| ** **                                 | ** ** | ** **        | ** ** | ** **       | ** ** | ** **   | ** ** | ** **     | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-------------------|------------|------------------|------------|--------------|------------|----------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                                 | ** ** | ** **        | ** ** | ** **       | ** ** | ** **   | ** ** | **Additional** | ** ** | ** **        | ** ** | **Other**              | ** ** | **Total**  | ** ** |
| ** **                                 | ** ** | **Common  Stock** | ** ** | **(Accumulated** | ** ** | **Paid In**  | ** ** | **Deferred**   | ** ** | **Comprehensive** | ** ** | **Stockholders’** | ** ** |
| ** **                                 | ** ** | **Shares**        | ** ** | **Amount**       | ** ** | **Deficit)** | ** ** | **Capital**    | ** ** | **Compensation**  | ** ** | **Income**             | ** ** | **Equity** | ** ** |
| ** **                                 | ** ** | ** **        | ** ** | ** **       | ** ** | ** **   | ** ** | ** **     | ** ** | ** **        | ** ** | ** **             | ** ** | ** ** | ** ** |
| BALANCE, DECEMBER  31, 2004                |       | 32,102,820        |       | $                | 321        |         | $          | (301,836       | )          | $                 | 556,346    |                   | $          | (2,787     | )          | $ | 855 |   | $ | 252,899 |   |
|                                       |       |              |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Stock based  compensation                  |       |              |       |             |       |         |       |           |       | 718               |       |                   |       | 718        |       |
|                                       |       |              |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Offering costs                             |       |              |       |             |       |         |       | (116           | )          |              |       |                   |       | (116       | )          |
|                                       |       |              |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Issuance of  restricted stock              |       | 5,000             |       |             |       |         |       | 96             |       | (96               | )          |                   |       | —     |       |
|                                       |       |              |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Common stock  issued through stock options |       | 112,849           |       | 1                |       |         |       | 1,906          |       |              |       |                   |       | 1,907      |       |
|                                       |       |              |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Comprehensive  income:                     |       |              |       |             |       |         |       |           |       |              |       |                   |       |       |       |
|                                       |       |              |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Net income                                 |       |              |       |             |       | 19,676       |       |           |       |              |       |                   |       |       |       |
|                                       |       |              |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Foreign currency  translation              |       | —            |       |             |       |         |       |           |       |              |       | 145                    |       |       |       |
|                                       |       |              |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Total  comprehensive income                |       | —            |       | —           |       | —       |       | —         |       | —            |       | —                 |       | 19,821     |       |
|                                       |       |              |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| BALANCE,  SEPTEMBER 30, 2005               |       | 32,220,669        |       | $                | 322        |         | $          | (282,160       | )          | $                 | 558,232    |                   | $          | (2,165     | )          | $ | 1,000 |   | $ | 275,229 |   |

* *

*See accompanying notes tounaudited condensed consolidated financial statements.*

 

3

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**INTERLINEBRANDS, INC AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS (UNAUDITED)**

**NINE MONTHS ENDED SEPTEMBER 30,2005 AND SEPTEMBER 24, 2004**

**(in thousands)**

** **
| ** **                                                                         | ** ** | **September 30, 2005** | ** ** | **September 24, 2004** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| OPERATING ACTIVITIES :                                                             |       |                   |       |                   |       |
| Net Income                                                                         |       | $                      | 19,676     |                   | $          | 17,135 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                   |       |                   |       |
| Depreciation and amortization                                                      |       | 9,699                  |       | 9,414                  |       |
| Amortization and write-off of debt issuance costs                                  |       | 3,482                  |       | 1,428                  |       |
| Redemption premium on 11.5% senior subordinated notes                              |       | 8,050                  |       | —                 |       |
| Stock based compensation                                                           |       | 718                    |       | —                 |       |
| Loss on disposal of property and equipment                                         |       | 53                     |       | —                 |       |
| Change in fair value of interest rate swaps                                        |       | —                 |       | (6,201                 | )          |
| Interest income on shareholder notes                                               |       | —                 |       | (30                    | )          |
| Deferred income taxes                                                              |       | (2,160                 | )          | 3,754                  |       |
| Income tax effect from exercise of stock options                                   |       | 215                    |       | —                 |       |
| Changes in assets and liabilities, net of business acquired:                       |       |                   |       |                   |       |
| Accounts receivable - trade                                                        |       | (23,882                | )          | (24,108                | )          |
| Accounts receivable - other                                                        |       | 4,974                  |       | 1,435                  |       |
| Inventory                                                                          |       | (3,782                 | )          | (18,625                | )          |
| Prepaid expenses and other current assets                                          |       | (428                   | )          | 350                    |       |
| Other assets                                                                       |       | (354                   | )          | (210                   | )          |
| Accrued interest payable                                                           |       | 2,885                  |       | 5,254                  |       |
| Accounts payable                                                                   |       | 11,598                 |       | 11,778                 |       |
| Accrued expenses and other current liabilities                                     |       | 3,066                  |       | 477                    |       |
| Accrued merger expenses                                                            |       | (307                   | )          | (416                   | )          |
| Accrued income taxes payable                                                       |       | (2,670                 | )          | 6,064                  |       |
| Net cash provided by operating activities                                          |       | 30,833                 |       | 7,499                  |       |
| INVESTING ACTIVITIES :                                                             |       |                   |       |                   |       |
| Purchase of property and equipment, net                                            |       | (5,899                 | )          | (5,359                 | )          |
| Purchase of business, net of cash acquired                                         |       | (71,195                | )          | (510                   | )          |
| Net cash used in investing activities                                              |       | (77,094                | )          | (5,869                 | )          |
| FINANCING ACTIVITIES :                                                             |       |                   |       |                   |       |
| Increase in revolver, net                                                          |       | 5,000                  |       | 7,000                  |       |
| Repayment of long-term debt                                                        |       | (70,850                | )          | (5,250                 | )          |
| Proceeds from financing transaction                                                |       | 50,000                 |       |                   |       |
| Payment of redemption premium on 11.5% senior subordinated notes                   |       | (8,050                 | )          | —                 |       |
| Payment of debt issuance costs                                                     |       | (836                   | )          | (587                   | )          |
| Initial public offering costs                                                      |       | (616                   | )          | —                 |       |
| Proceeds from stock options exercised                                              |       | 1,693                  |       | —                 |       |
| Proceeds from exercise of underwriters over-allotment options                      |       | 2,333                  |       | —                 |       |
| Payments of capital lease obligations                                              |       | (126                   | )          | —                 |       |
| Net cash (used in) provided by financing activities                                |       | (21,452                | )          | 1,163                  |       |
| EFFECT OF EXCHANGE RATE  CHANGES ON CASH AND CASH EQUIVALENTS                      |       | 145                    |       | 89                     |       |
| NET (DECREASE) INCREASE IN  CASH AND CASH EQUIVALENTS                              |       | (67,568                | )          | 2,882                  |       |
| CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD                                    |       | 69,178                 |       | 1,612                  |       |
| CASH AND CASH EQUIVALENTS,  END OF PERIOD                                          |       | $                      | 1,610      |                   | $          | 4,494 |   |
| SUPPLEMENTAL DISCLOSURE OF  CASH FLOW INFORMATION                                  |       |                   |       |                   |       |
| Cash paid during the period for :                                                  |       |                   |       |                   |       |
| Interest                                                                           |       | $                      | 13,124     |                   | $          | 23,853 |   |
| Income taxes (net of refunds)                                                      |       | $                      | 17,633     |                   | $          | 457 |   |
| SCHEDULE OF NON-CASH  INVESTING AND FINANCING ACTIVITIES                           |       |                   |       |                   |       |
| Dividends on preferred stock                                                       |       | $                      | —     |                   | $          | 41,155 |   |
| Adjustment to goodwill on business acquired                                        |       | $                      | 9,473      |                   | $          | — |   |

* *

*See accompanying notes tounaudited condensed consolidated financial statements.*

 

4

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**1.     BASIS OF PRESENTATION**

 

        The accompanying unaudited interimfinancial statements of Interline Brands, Inc., a Delaware corporation, and itssubsidiaries (“Interline” or the “Company”) have been prepared in accordancewith accounting principles generally accepted in the United States of Americaand the rules and regulations of the Securities and Exchange Commission, whichapply to interim financial statements. These unaudited condensed consolidatedfinancial statements do not include all disclosures provided in the annualfinancial statements and should be read in conjunction with the financialstatements and notes thereto contained in the Annual Report on Form 10-K forInterline Brands, Inc. for the year ended December 31, 2004 as filed with theSecurities and Exchange Commission on March 31, 2005 and amended by a report onForm 10-K/A filed on April 15, 2005.

 

       All adjustments which are in the opinionof management, necessary for a fair statement of the results for the interimperiods presented have been recorded. The results of operations for the interimperiods presented are not necessarily indicative of the results to be expectedfor the full year.

 

During December2004, the Company completed its initial public offering (the “IPO”). Immediatelyprior to the closing of the IPO, a reincorporation merger occurred and theCompany became the parent company of its principal operating subsidiary,Interline Brands, Inc., a New Jersey corporation (“Interline New Jersey”). Inthe reincorporation merger, the holders of the preferred stock of Interline NewJersey received an aggregate of $55 million in cash and 19,183,321 shares ofthe Company’s common stock and the holders of the common stock of Interline NewJersey received 0.01218 shares of the Company’s common stock per share ofInterline New Jersey common stock, or 66,667 shares of the Company’s commonstock in total. In addition, holders of options to purchase shares of thecommon stock of Interline New Jersey were converted into options to purchaseshares of the Company’s common stock. The Company restated earnings per shareand shares outstanding for all years presented in the accompanying financialstatements to reflect the conversion of the shares.

 

On August 9, 2005,certain of the Company’s stockholders sold 7,750,000 shares of the Company’scommon stock in an underwritten offering pursuant to a registration statementon Form S-1 filed with the SEC (Commission File No. 333-126515). Theunderwriters of this offering elected to exercise their over-allotment optionwith respect to additional shares held by the selling stockholders.  As a result, on August 22, 2005, certain ofthe selling stockholders sold an additional 1,162,500 shares of our commonstock in a second closing pursuant to the same underwritten offering.  In connection with this offering, the Companydid not receive any proceeds and incurred approximately $923,000 of expensesfor the three months ended September 30, 2005, which amounts were recorded byus as an expense.

 

*SegmentInformation*—TheCompany is in one industry, the distribution of maintenance, repair andoperations, or MRO, products. In accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 131, “Disclosure about Segments of anEnterprise and Related Information”, the Company has one operating segment. Ournet sales for the three and nine-month periods ended September 30, 2005 and September24, 2004 by product category were approximately (in millions):

 

5

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| ** **                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **September 30,**      | ** ** | **September 24,**     | ** ** | **September 30,** | ** ** | **September 24,** | ** ** |
| **Product Category**                      | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Plumbing                                  |       | $                      | 91.0       |                  | $          | 82.6 |   | $ | 269.0 |   | $ | 242.2 |   |
| Electrical                                |       | 31.2                   |       | 28.4                  |       | 90.4 |   | 83.4 |   |
| Heating, Ventilation and Air Conditioning |       | 29.9                   |       | 12.9                  |       | 64.5 |   | 40.2 |   |
| Security Hardware                         |       | 14.0                   |       | 13.3                  |       | 41.2 |   | 38.2 |   |
| Appliances                                |       | 14.2                   |       | 12.6                  |       | 38.5 |   | 33.7 |   |
| Hardware                                  |       | 12.9                   |       | 12.6                  |       | 37.9 |   | 35.2 |   |
| Other                                     |       | 32.6                   |       | 28.0                  |       | 84.5 |   | 75.4 |   |
| Total                                     |       | $                      | 225.8      |                  | $          | 190.4 |   | $ | 626.0 |   | $ | 548.3 |   |

 

 

*Stock-based Compensation*—The Company accounted for option plansin accordance with APB Opinion No. 25, under which no compensation cost hasbeen recognized for stock option awards. While the Company does not recognizecompensation costs for stock options, the Company does determine what thesecosts would have been using the method prescribed by SFAS No, 123 fordisclosure purposes.

 

The fair value of each option was estimated on thedate of grant using the Black-Scholes option pricing model with the followingassumptions used for options granted in 2005 under the 2004 Equity IncentivePlan: dividend yield of 0%, volatility of 33%, risk-free interest rate of 4.01%and expected life of 5 years. The following assumptions were used for optionsgranted in 2004 under the 2000 Stock Award Plan: dividend yield of 0%, expectedvolatility of 0%, risk-free interest rate of 3.48%, and expected life of 5years.  The fair value of these awardsapproximated zero.

 

The following table illustrates the effect on netearnings (loss) and earnings (loss) per share for the three and nine monthsended September 30, 2005 and September 24, 2004 as if the Company had appliedthe fair value recognition provisions of SFAS No. 123, “Accounting forStock-Based Compensation,” to stock-based employee compensation (in thousands,except per share amounts):

 

6

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| ** **                                                                                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                   | ** ** | **September 30,**      | ** ** | **September 24,**     | ** ** | **September 30,** | ** ** | **September 24,** | ** ** |
| ** **                                                                                                                   | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                         |       |                   |       |                  |       |   |   |   |   |
| Net income as reported                                                                                                       |       | $                      | 9,718      |                  | $          | 6,927 |   | $ | 19,676 |   | $ | 17,135 |   |
|                                                                                                                         |       |                   |       |                  |       |   |   |   |   |
| Add: Stock-based employee compensation expense included in reported  net income, net of related tax effects                  |       | 142                    |       | —                |       | 435 |   | — |   |
|                                                                                                                         |       |                   |       |                  |       |   |   |   |   |
| Deduct: Total stock-based employee compensation expense determined  under fair value based method for all awards, net of tax |       | (304                   | )          | —                |       | (698 | ) | — |   |
|                                                                                                                         |       |                   |       |                  |       |   |   |   |   |
| Pro forma net income                                                                                                         |       | 9,556                  |       | 6,927                 |       | 19,413 |   | 17,135 |   |
|                                                                                                                         |       |                   |       |                  |       |   |   |   |   |
| Preferred stock dividends                                                                                                    |       | —                 |       | (14,170               | )          | — |   | (41,155 | ) |
|                                                                                                                         |       |                   |       |                  |       |   |   |   |   |
| Net income (loss) applicable to common stockholders                                                                          |       | $                      | 9,556      |                  | $          | (7,243 | ) | $ | 19,413 |   | $ | (24,020 | ) |
|                                                                                                                         |       |                   |       |                  |       |   |   |   |   |
| Earnings per share:                                                                                                          |       |                   |       |                  |       |   |   |   |   |
| Basic - as reported                                                                                                          |       | $                      | 0.30       |                  | $          | (110.13 | ) | $ | 0.62 |   | $ | (365.22 | ) |
| Basic - pro forma                                                                                                            |       | $                      | 0.30       |                  | $          | (110.13 | ) | $ | 0.61 |   | $ | (365.22 | ) |
|                                                                                                                         |       |                   |       |                  |       |   |   |   |   |
| Diluted - as reported                                                                                                        |       | $                      | 0.30       |                  | $          | (110.13 | ) | $ | 0.61 |   | $ | (365.22 | ) |
| Diluted - pro forma                                                                                                          |       | $                      | 0.29       |                  | $          | (110.13 | ) | $ | 0.60 |   | $ | (365.22 | ) |

 

 

 

*New Accounting Pronouncements*—On December 16, 2004, the FASBissued SFAS No. 123 (revised 2004), “Share-Based Payment,” which is arevision of FASB No. 123, “Accounting for Stock-Based Compensation.” SFASNo. 123R supersedes APB Opinion No. 25, “Accounting for Stock Issuedto Employees” and amends SFAS No. 95, “Statement of Cash Flows.” Generally, theapproach in SFAS No. 123R is similar to the approach described in SFASNo. 123; however, this Statement requires all share-based payments toemployees, including grants of employee stock options, be recognized in theincome statement based on their fair values. Pro forma disclosure will nolonger be an alternative to financial statement recognition.

 

On April 14, 2005, the Securities and ExchangeCommission (“SEC”) announced that it would provide for a phased-inimplementation process for SFAS No. 123R. The SEC now requires thatregistrants that are not small business issuers adopt SFAS No. 123R’s fairvalue method of accounting for share-based payments to employees not later thanthe beginning of the first fiscal quarter in the year beginning afterJune 15, 2005. As a result, the Company will not be required to adopt SFASNo. 123R until December 31, 2005, the first day of the company’s 2006fiscal year. The Company is continuing to evaluate the provisions of thisStatement, the impact on its consolidated financial statements and the timingand approach to adoption of this Statement.

 

In March 2004, the FASB issued InterpretationNo. 46(R)-5 (“FIN 46(R)-5”), “Implicit Variable Interests under FASBInterpretation No. 46 (revised December 2003), Consolidation ofVariable Interest Entities.” FIN 46 (R)-5 is effective for the first reportingperiod beginning after March 3, 2005; however, earlier application ispermitted for periods for which financial statements have not yet been issued. TheCompany has evaluated the impact of FIN 46(R)-5 and determined that the impactis immaterial to the consolidated financial statements.

 

        In November 2004, the FASB issued SFAS No. 151, *Amendment of ARB No. 43, Chapter 4*(“SFAS151”). This statement amends the guidance in Accounting Research BulletinNo. 43, Chapter 4, *Inventory Pricing*,to clarify the accounting for abnormal amounts of idle facility expense,freight, handling costs, and wasted material (spoilage). This statementrequires that those items be recognized as current-period charges regardless ofwhether they meet the criterion of “so abnormal.” In addition, this statementrequires that allocation of fixed production overhead to the costs ofconversion be based on the normal capacity of the production facilities. 

 

7

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SFAS 151 is effective for inventory costs incurredduring fiscal years beginning after June 15, 2005. The Company iscurrently evaluating the requirements of SFAS 151.

 

 

In March 2005, the FASB issued InterpretationNo. 47 (FIN 47), *Accounting forConditional Asset Retirement Obligations*. This interpretation statesthat the term “conditional asset retirement obligation” as used in paragraphA23 of SFAS No. 143 refers to a legal obligation to perform an assetretirement in which the timing and (or) method of settlement are conditional ona future event that may or may not be within the control of the entity. Theobligation to perform the asset retirement obligation is unconditional eventhough uncertainty exists about the timing and (or) method of settlement. Theeffective date for adopting this interpretation is no later than the end offiscal years ending after December 15, 2005. The Company’s financialcondition, results of operations and cash flows were not impacted by theadoption of FIN 47 in the third quarter of 2005.

 

In May 2005, the FASB issued Statement No. 154*, “*Accounting Changes and ErrorCorrections—a replacement of APB Opinion No. 20 and FASB StatementNo. 3” (“SFAS 154”). SFAS 154 replaces APB Opinion No. 20, “AccountingChanges,” and FASB Statement No. 3, “Reporting Accounting Changes inInterim Financial Statements,” and changes the requirements for the accountingfor and reporting of a change in accounting principle. SFAS 154 requiresretrospective application to prior periods’ financial statements of changes inaccounting principle, unless it is impracticable to do so, in which case otheralternatives are required. SFAS 154 is effective for accounting changesand corrections of errors made in fiscal years beginning afterDecember 15, 2005, or for the Company’s fiscal 2006 year end. TheCompany has evaluated the requirements of SFAS 154 and have determinedthat there is no impact on the consolidated financial statements.

 

*Reclassifications*—Certain prior year amounts in thefinancial statements and the notes have been reclassified to conform to the2005 presentation. The reclassifications had no effect on total stockholders’equity or net income (loss).

 

**2.     EARNINGS PER SHARE**

 

        Net income (loss) per share for allperiods has been computed in accordance with SFAS No. 128, “Earnings per Share”.Basic net income (loss) per share is computed by dividing net income (loss)applicable to common stockholders by the weighted-average number of sharesoutstanding during the year. Diluted net income per share is computed based on theweighted-average number of shares of common stock as adjusted for the potentialdilutive effect of stock options stock for the period.

 

 

Theamounts used in calculating net income (loss) per share data are as follows:

 
| ** **                                    | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **September 30,**      | ** ** | **September 24,**     | ** ** | **September 30,** | ** ** | **September 24,** | ** ** |
| ** **                                    | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                          |       |                   |       |                  |       |   |   |   |   |
| Net income                                    |       | $                      | 9,718      |                  | $          | 6,927 |   | $ | 19,676 |   | $ | 17,135 |   |
| Preferred stock dividends                     |       | —                 |       | (14,170               | )          | — |   | (41,155 | ) |
| Net loss applicable to common stockholders    |       | $                      | 9,718      |                  | $          | (7,243 | ) | $ | 19,676 |   | $ | (24,020 | ) |
|                                          |       |                   |       |                  |       |   |   |   |   |
| Weighted average shares outstanding - basic   |       | 32,061,828             |       | 65,769                |       | 31,979,374 |   | 65,769 |   |
| Effect of dilutive stock options              |       | 459,980                |       | —                |       | 420,296 |   | — |   |
|                                          |       |                   |       |                  |       |   |   |   |   |
| Weighted average shares outstanding - diluted |       | 32,521,808             |       | 65,769                |       | 32,399,670 |   | 65,769 |   |

 

Options to purchase 471,456 shares and 517,956 shares ofcommon stock which were outstanding at three and nine months ended September 30,2005, respectively, and 2,327 shares of common stock which were outstanding forthe three and nine months ended September 24, 2004 were not included in thecomputation of weighted average shares outstanding-diluted because the exerciseprices of the options are greater than the average fair market value of commonstock and the effect would be anti-dilutive.

 

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**3.     DEBT**

 

Long-term debt at September 30, 2005 and December 31, 2004 consists ofthe following:

 
| ** **                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                       | ** ** | **2005**          | ** ** | **2004**         | ** ** |
|                             |       |              |       |             |       |
| Term loans                       |       | $                 | 149,150    |             | $          | 100,000 |   |
| Note payable                     |       | 3,275             |       | 3,275            |       |
| 11.5% senior subordinated  notes |       | 130,000           |       | 200,000          |       |
|                             |       |              |       |             |       |
|                             |       | 282,425           |       | 303,275          |       |
| Less current portion             |       | (1,400            | )          | (1,000           | )          |
|                             |       |              |       |             |       |
|                             |       | $                 | 281,025    |             | $          | 302,275 |   |

 

 

In May 2003, Interline New Jersey completed an offeringof $200 million of 11.5% senior subordinated notes due 2011 and entered into a$205.0 million senior secured credit facility which consisted of a $140.0million term loan facility and a $65.0 million revolving loan facility, aportion of which is available in the form of letters of credit. The netproceeds from the offering of senior subordinated notes and the refinancing ofthe former credit facility with the new credit facility were used to: (1) repayall outstanding indebtedness under the Company’s former credit facility, (2)redeem all of the 16% senior subordinated notes, (3) pay accrued interest andrelated redemption premiums on Interline New Jersey’s former debt, and (4) paytransaction fees and expenses related to the foregoing transactions, which we referto as the “Refinancing Transactions”. Debt issuance costs capitalized inconnection with the Refinancing Transactions were approximately $13.1 million.An expense of approximately $14.9 million in May 2003 for the earlyextinguishment of debt resulted from the write-off of the unamortized loan feesand loan discount relating to Interline New Jersey’s former credit facility andthe redemption premium incurred upon redemption of the 16% senior subordinated notes.

 

The senior subordinated notes pay interest each May 15and November 15, with the first payment made on November 15, 2003.  Priorto May 15, 2006, Interline New Jersey had the option to redeem up to 35% of thenotes using proceeds of certain equity offerings and Interline New Jersey mayredeem all of the notes after May 15, 2007, subject to redemption premiumsunless redeemed after May 15, 2009.  InterlineNew Jersey elected to redeem $70.0 million of the 11.5% senior subordinatednotes using proceeds from the Company’s IPO and gave the 30-day notice,required by the indenture, on December 20, 2004.  In January 2005, the Company recorded a losson extinguishment of debt of $10.3 million, consisting of the write-off ofdeferred financing costs of $2.3 million and the premium of $8.1 million on the$70.0 million redemption of 11.5% senior subordinated notes.

 

In December 2004, Interline New Jersey amended itsterm loan facility and revolving loan facility.  The term loan was reduced to $100.0 millionfrom $140.0 million and the revolving loan facility was increased to $100.0million from $65.0 million.  As part ofthe amendment in December 2004, Interline New Jersey paid down $31.3 million ofthe term loan using proceeds from the Company’s IPO.  Interline New Jersey also amended its credit facilityon July 7, 2005, to permit the incurrence of an additional $50.0 million termloan, having substantially the same terms as the existing term loan inconnection with the Copperfield acquisition, discussed below.  On August 8, 2005, Interline New Jersey againamended its credit facility to lower the interest rate spreads applicable tothe additional $50.0 million term loan. The amended credit facility provides for aggregate commitments of$250.0 million, consisting of (1) a revolving loan facility of$100.0 million, of which a portion not exceeding $20.0 million will beavailable in the form of letters of credit, and (2) a term loan facility of$150.0 million.

 

Borrowings under the amended term loan facility andrevolving loan facility bear interest, at Interline New Jersey’s option, ateither LIBOR or at the alternate base rate plus a spread.  The indebtedness under the amended creditfacility is guaranteed by the Company and by the domestic subsidiaries ofInterline New Jersey.  Interest rates ineffect on borrowings under the term loan facilities at September 30, 2005ranged from 6.27% for LIBOR based borrowings and 8.0% for prime basedborrowings under the $100.0 million tranche B-1 term 

 

9

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loan and 5.45% for LIBOR based borrowings and 7.75%for prime based borrowings under the $50.0 million tranche B-2 term loan .  Outstanding letters of credit under therevolving loan facility are subject to a per annum fee equal to the applicablespread over the adjusted LIBOR for revolving loans.  The term loan facility matures on December 31,2010 and the revolving loan facility matures on May 31, 2008.  Debt issuance costs capitalized in connectionwith the amended credit facility were approximately $0.8 million.

 

As of September 30, 2005,Interline New Jersey had $85.9 million available under its revolving loanfacility.  Total letters of credit issuedunder this facility as of September 30, 2005 were $9.1 million.  There were $5.0 million of borrowings underthe revolving loan facility at September 30, 2005.  The credit facility is secured bysubstantially all of the assets of Interline New Jersey.

 

In conjunction with the IPO and the amended creditfacility, the Company recorded an expense of approximately $0.7 million forearly extinguishments of debt resulting from the write-off of the unamortizedloan fees relating to the Company’s former credit facility in December 2004.  In January 2005, the Company recognized acharge of $2.3 million of unamortized loan fees related to the earlyextinguishment of $70.0 million of the 11.5% senior subordinated notes.

 

Periodically, the Company has entered into derivativefinancial instruments, including interest rate exchange agreements, to manageits exposure to fluctuations in interest rates on its debt.  All interest rate swap agreements wereterminated as of December 2004.

 

The credit facility contains customary affirmative andnegative covenants that limit Interline New Jersey’s ability to incuradditional indebtedness, pay dividends on its common stock or redeem,repurchase or retire its common stock or subordinated indebtedness, makecertain investments, sell assets, and consolidate, merge or transfer assets,and that require Interline New Jersey to maintain a maximum debt to cash flowratio and a minimum interest expense coverage ratio.  The Company and Interline New Jersey were incompliance with all covenants at September 30, 2005.

 

        We are a holding company whose onlyasset is the stock of our subsidiaries.  Weconduct virtually all of our business operations through Interline New Jersey.Accordingly, our only material sources of cash are dividends and distributionswith respect to our ownership interests in Interline New Jersey that arederived from the earnings and cash flow generated by Interline New Jersey. The debt instruments of Interline New Jersey, primarily the credit facility andthe indenture governing the terms of the 11.5% notes, contain significantrestrictions on the payment of dividends and distributions to us by InterlineNew Jersey.  In particular, Interline NewJersey’s credit facility prevents it from paying dividends, makingdistributions to us or making investments in us.  However, ordinary coursedistributions for overhead and taxes are permitted, as are (provided InterlineNew Jersey is not in default) annual payments of up to $7.5 million in respectof our stock option plans and annual payments of up to $40 million depending onthe pro forma net leverage ratio of the previous quarter.  In addition, the indenture for the 11.5% notesrestricts the ability of Interline New Jersey to pay distributions or dividendsto us and to make advances to, or investments in, us. Dividends, distributionsand investments are permitted in an amount generally limited to 50% of the netincome of Interline New Jersey, plus an amount equal to the net proceeds fromcertain equity issuances if Interline New Jersey is in compliance with aleverage ratio and is not in default.  Inaddition, there are certain other permitted payments, including an ability tomake distributions of up to $10 million.

 

In April 2003, the Interline New Jersey issued anon-recourse note payable in the principal amount of $3.3 million for thepurchase of an investment.  This note,which is secured only by the investment, bears interest at a rate of 4% perannum, with principal due in full in April 2010.

 

 

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The maturities of long-term debt subsequentto September 30, 2005 are as follows:

 
| 2005       |   | $       | 350     |   |
|------------|--------|---------|---------|--------|
| 2006       |   | 1,400   |    |
| 2007       |   | 1,400   |    |
| 2008       |   | 1,400   |    |
| 2009       |   | 1,400   |    |
| Thereafter |   | 276,475 |    |
|       |   | $       | 282,425 |   |

 

 

 

**4.     STOCKOPTION PLANS**

 

During 2000, InterlineNew Jersey established a Stock Award Plan, (the “2000 Plan”), under whichInterline New Jersey may award a total of 6,395 shares of common stock in theform of incentive stock options (which may be awarded to key employees only),nonqualified stock options, stock appreciation rights, or SARs, and restrictedstock awards, all of which may be awarded to directors, officers, key employeesand consultants. The exercise price per share for an incentive stock option maynot be less than 100% of the fair market value of a share of common stock onthe grant date. The exercise price per share for an incentive stock optiongranted to a person owning stock possessing more than 10% of the total combinedvoting power of all classes of stock may not be less than 110% of the fairmarket value of a share of common stock on the grant date, and may not beexercisable after the expiration of ten years from the date of grant. TheCompany’s compensation committee will determine in its sole discretion whethera SAR is settled in cash, shares or a combination of cash and shares.

 

During 2004, the Companyadopted the 2004 Equity Incentive Plan, (the “2004 Plan”), under which theCompany may award 3,175,000 shares in the form of incentive stock options,nonqualified stock options, stock appreciation rights, or SARs, restrictedshare units, restricted stock and stock bonus awards, all of which may beawarded to any employee, director, officer or consultant of the Company. Underthe terms of the 2004 plan and unless the compensation committee of the Companydetermines otherwise, the exercise price of the options will not be less than thefair market value of the common stock at the time of grant.

 

Upon completion of the Company’s IPO in December 2004,175,820 shares of restricted stock were issued to senior management. Therestricted stock awards will vest on an accelerated basis contingent upon theexecutive’s continued employment in one-third installments over three yearsprovided that certain pre-established annual percentage increases in ourearnings per share are attained. The restricted stock may also vest on theseventh anniversary of the date of grant if the executive remains in our employfor seven years.  In addition, anaggregate of 10,000 shares of restricted stock were issued to two non-employeedirectors who are not affiliated with any of our principal stockholders. Suchawards will vest over two years. As a result of these restricted stock awards,the Company will incur non-cash charges between $0.4 million and $0.9 millionin each of the next three to seven years depending upon the acceleration ofvesting of restricted stock. These two directors also each received 20,000non-qualified stock options with an exercise price equal to the IPO price of$15.00 per share. In addition, the Company issued to management 1,835,218non-qualified stock options with an exercise price equal to the IPO price of$15.00 per share and 590,465 non-qualified stock options with a weightedaverage exercise price of $24.00 per share. All of these options were fullyvested and exercisable when granted. However, management will only be permittedto sell shares acquired upon the exercise of the options in 25% increments overfour years.

 

 

11

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A summary of the statusof the Company’s stock option plans is as follows:

 
| ** **                        | ** ** | ** **    | ** ** | ** **         | ** **         | **Weighted**         | ** ** |
|-----------------------------------|------------|---------------|------------|--------------------|--------------------|----------------------|------------|
| ** **                        | ** ** | **Number**    | ** ** | **Exercise Price** | ** **         | **Average Exercise** | ** ** |
| ** **                        | ** ** | **of Shares** | ** ** | **Per Share**      | ** **         | **Price Per Share**  | ** ** |
|                              |       |          |       |               |               |                 |       |
| Outstanding at December 31, 2004  |       | 2,468,009     |       | $                  | 15.00  - $1,669.13 |                 | $          | 17.61 |   |
|                              |       |          |       |               |               |                 |       |
| 2005:                             |       |          |       |               |               |                 |       |
| Granted                           |       | 68,500        |       | $                  | 19.05  - $20.21    |                 | $          | 19.61 |   |
|                              |       |          |       |               |               |                 |       |
| Exercised                         |       | (112,849      | )          | $                  | 15.00              |                 | $          | 15.00 |   |
|                              |       |          |       |               |               |                 |       |
| Cancelled                         |       | (153,243      | )          | $                  | 15.00  - $1,669.13 |                 | $          | 30.59 |   |
|                              |       |          |       |               |               |                 |       |
|                              |       |          |       |               |               |                 |       |
| Outstanding at September 30, 2005 |       | 2,270,417     |       | $                  | 15.00  - $41.05    |                 | $          | 16.93 |   |

 

 

**5.     ACQUISITION**

 

*CCS Enterprises, Inc.*

On July 7, 2005, the Companyacquired all of the common stock of CCS Enterprises, Inc., also known as Copperfield,under a stock purchase agreement. Copperfield is a national distributor and direct marketer of specialtyventilation and chimney maintenance products and is headquartered in Fairfield,Iowa.  This acquisition represents anexpansion of the Company’s professional contractors and specialty distributorbusiness.  Copperfield had net sales of$41.0 million for the year ended November 30, 2004.

The aggregate purchase price was$70.0 million, including costs of acquisition of $0.7 million, and was fundedby borrowings under Interline New Jersey’s credit facility.  Included in the purchase price was $4.0million deposited in an escrow account to cover the representations, warrantiesand contingencies of the parties to the purchase agreement.  The amounts are included in the preliminarypurchase price allocation as they are not considered contingent but representthe final payment of the purchase price after finalization of assets purchasedand liabilities assumed.  The amount inescrow related to contingencies is included because the amount will be eitherpaid to the seller or to a third-party claimant.  The Company has included the results ofoperations for Copperfield from the date of acquisition and applied preliminarypurchase accounting in accordance with SFAS No. 141, *BusinessCombinations*as of the date of acquisition, which resulted inrecorded estimated goodwill of $35.8 million. The allocation of the purchase price is as follows:
| Net assets             |   | $    | 7.7    |   |
|------------------------|--------|------|--------|--------|
| Customer relationships |   | 21.0 |   |
| Trademarks             |   | 5.5  |   |
| Goodwill               |   | 35.8 |   |
|                   |   | $    | 70.0   |   |

 

Goodwill recorded in connectionwith the acquisition is not expected to be deductible for tax purposes.  The intangible assets are subject toamortization and will be amortized on a straight-line basis over aweighted-average useful life of approximately 22.3 years.  We recorded an addition to goodwill of $9.5million in connection with the acquisition of CCS Enterprises, Inc. to recognizethe book to tax basis difference on non-goodwill intangibles.  The purchase price allocations for thisacquisition have not been finalized because information related to finalizingthe valuations of inventory and property, plant and equipment are still in the processof being gathered and analyzed. Supplemental pro forma information has not been provided below becauseit is immaterial.

 

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ITEM 2. MANAGEMENT’SDISCUSSIONS AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

*References to “us” and “we” are to the Company. You shouldread the following discussion in conjunction with our unaudited consolidatedfinancial statements and related notes included in this quarterly report, andour audited consolidated financial statements and related notes included  in**our AnnualReport on Form 10-K filed with the SEC.*

 

**Cautionary Statement for Purposes of the “Safe Harbor”Provisions of the Private Securities Litigation Reform Act of 1995**

 

                Thisquarterly report contains forward-looking statements that are subject torisks and uncertainties. You should not place undue reliance on thosestatements because they are subject to numerous uncertainties and factorsrelating to our operations and business environment, all of which are difficultto predict and many of which are beyond our control. Forward-lookingstatements include information concerning our possible or assumed futureresults of operations, including descriptions of our business strategy. Thesestatements often include words such as “may,” “believe,” “expect,” “anticipate,”“intend,” “plan,” “estimate” or similar expressions. These statements are basedon assumptions that we have made in light of our experience in the industry aswell as our perceptions of historical trends, current conditions, expectedfuture developments and other factors we believe are appropriate under thecircumstances. As you read and consider this quarterly report, you shouldunderstand that these statements are not guarantees of performance or results.They involve risks, uncertainties and assumptions. Although we believe thatthese forward-looking statements are based on reasonable assumptions, youshould be aware that many factors could affect our actual financial results orresults of operations and could cause actual results to differ materially fromthose in the forward-looking statements. These factors include:

 

•      material facilities and systemsdisruptions and shutdowns,

•      our ability to purchase products fromsuppliers on favorable terms,

•      our ability to accurately predict markettrends,

•      product cost and price fluctuations due tomarket conditions or foreign currency fluctuations,

•      failure to locate and acquire acquisitioncandidates,

•      failure to successfully integrate acquiredbusinesses,

•      dependence on key employees,

•      our level of debt,

•      interest rate fluctuations,

•      future cash flows,

•      the highly competitive nature of themaintenance, repair and operations distribution industry,

•      general market conditions,

•      changes in consumer preferences,

•      adverse publicity and litigation,

•      labor and benefit costs, and

•      the other factors listed under “RiskFactors” in our Annual Report on Form 10-K filed with the SEC.

 

                Allinformation contained in this quarterly report is materially accurate as of thedate of this report.  New risks anduncertainties arise from time to time, and it is impossible for us to predictthese events or how they may affect us. In light of these risks anduncertainties, you should keep in mind that any forward-looking statementmade in this quarterly report might not occur. We assume no obligation toupdate any forward-looking statements after the date of this quarterly reportas a result of new information, future events or developments, except asrequired by federal securities law.

 

Overview

 

                As a leading national distributor and direct marketerof over 45,000 specialty MRO products, we sell to approximately 150,000 activecustomer accounts. Our highly diversecustomer base includes facilities maintenance customers, professionalcontractors and specialty distributors. Our customers range in size fromindividual contractors and independent specialty distributors or hardwarestores to apartment management companies and national purchasing groups.

 

                We market and sell our productsprimarily through nine distinct and targeted brands. Our multi-brand operating model, which webelieve is unique in the industry, allows us to use a single platform todeliver tailored 

 

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products and services tomeet the individual needs of each respective customer group served. We reachour markets using a variety of sales channels, including a direct sales forceof field sales representatives, telesales representatives, a direct marketing program,brand-specific e-commerce websites and a national accounts sales program.

 

CriticalAccounting Policies

 

                In preparing the consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States of America, management is required to makecertain estimates, judgments and assumptions. These estimates, judgments andassumptions affect the reported amounts of assets and liabilities, includingthe disclosure of contingent assets and liabilities, at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe periods presented. On an ongoing basis, management evaluates theseestimates and assumptions. Management bases its estimates and assumptions onhistorical experience and on various other factors that are believed to bereasonable at the time the estimates and assumptions are made. Actual resultsmay differ from these estimates and assumptions under different circumstancesor conditions. The significant accounting policies that management believes arethe most critical in order to fully understand and evaluate our financialposition and results of operations include the following policies.

 

*Revenue Recognition*

 

          While our recognitionof revenue is predominantly derived from routine transactions and does notinvolve significant judgment, revenue recognition represents an importantaccounting policy for us. We recognize a sale when the product has been shippedand risk of loss has passed to the customer, collection of the resultingreceivable is probable, persuasive evidence of an arrangement exists, and the priceis fixed or determinable. Sales are recorded net of estimated discounts,rebates and returns. A portion of our sales is delivered direct from the manufacturer.These direct-shipment sales are recorded on a gross basis, with thecorresponding cost of goods sold, in accordance with the guidance in EITF99-19, *Reporting Revenues Gross as a Principal verses Netas an Agent*. We provide limited product return and protection rightsto certain customers. We accrue product return reserves and warrantyobligations. A provision is made for estimated product returns based on salesvolumes and our experience. Actual returns have not varied materially fromamounts provided historically.

 

*Estimating Allowances for Doubtful Accounts*

 

                We maintain allowances fordoubtful accounts for estimated losses resulting from the inability to collectoutstanding amounts from customers. The allowances include specific amounts forthose accounts that are likely to be uncollectible, such as accounts ofcustomers in bankruptcy and general allowances for those accounts thatmanagement currently believes to be collectible but later become uncollectible.Estimates are used to determine the allowances for bad debts and are based onhistorical collection experience, current economic trends, credit worthiness ofcustomers and changes in customer payment terms. Adjustments to credit limitsare made based upon payment history and our customers’ current creditworthiness. If the financial condition of our customers were to deteriorate,allowances may be needed that will increase selling, general and administrativeexpenses and decrease accounts receivable. At September 30, 2005 the allowancefor doubtful accounts totaled $7.8 million.

 

*Estimating Write-Offs for Excess and Obsolete Inventory*

 

                Inventoriesare valued at the lower of cost or market. We determine inventory cost usingthe average cost method. We adjust inventory for excess and obsolete inventoryand for the difference by which the cost of the inventory exceeds the estimatedmarket value. In order to determine the adjustments, management reviewsinventory quantities on hand, slow movement reports and sales history reports.Management estimates the required adjustment based on estimated demand forproducts and market conditions. To the extent historical results are not indicative of futureresults and if events occur that affect our relationships with suppliers or thesalability of our products, additional write-offs may be needed that willincrease our cost of sales and decrease inventory.

 

*Impairment of Goodwill, Intangibles and Other Long-Lived Assets*

 

                Management assesses therecoverability of our goodwill, identifiable intangibles and other long-livedassets whenever events or changes in circumstances indicate that the carryingvalue may not be recoverable. The following factors, if present, may trigger animpairment review: (1) significant underperformance relative to expectedhistorical or 

 

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projectedfuture operating results, (2) significant negative industry or economictrends, (3) a significant increase in competition, and (4) asignificant increase in interest rates on debt. If the recoverability of theseassets is unlikely because of the existence of one or more of the above-mentionedfactors, an impairment analysis is performed using a projected discounted cashflow method. Management must make assumptions regarding estimated future cashflows and other factors to determine the fair value of these respective assets.If these estimates or related assumptions change in the future, we may berequired to record an impairment charge. Impairment charges would be includedin selling, general and administrative expenses in our statements ofoperations, and would result in reduced carrying amounts of the related assetsin our balance sheets.

 

*Legal Contingencies*

 

                From time to time, in the courseof our business, we become involved in legal proceedings. In accordance withSFAS No. 5 “Accounting for Contingencies,” if it is probable that, as aresult of a pending legal claim, an asset had been impaired or a liability hadbeen incurred at the date of the financial statements and the amount of theloss is estimable, an accrual for the costs to resolve the claim is recorded inaccrued expenses in our balance sheets. Professional fees related to legalclaims are included in general and administrative expenses in our statements ofoperations. Management, with the assistance of outside counsel, determineswhether it is probable that a liability from a legal claim has been incurredand estimates the amount of loss. The analysis is based upon potential results,assuming a combination of litigation and settlement strategies. Management doesnot believe that currently pending proceedings will have a material adverseeffect on our consolidated financial position. It is possible, however, thatfuture results of operations for any particular period could be materiallyaffected by changes in our assumptions related to these proceedings.

 

*Derivative Financial Instruments*

 

                We periodically enter intoderivative financial instruments, including interest rate exchange agreements,or swaps, to manage exposure to fluctuations in interest rates on our debt. InDecember 2004, in conjunction with our Initial Public Offering, we terminatedall interest rate exchange agreements, or swaps. Under our former swapagreements we paid a fixed rate on the notional amount to a bank and the bankpaid us a variable rate on the notional amount equal to a base LIBOR rate.These interest rate swaps did not qualify for hedge accounting under SFAS No.133 “Accounting for Derivative Statements and Hedging Activities,” and wererecorded at fair value in our balance sheet with changes in the fair valuereflected in non-operating expense. The fair market value of these instruments wasdetermined by quotes obtained from the related counter parties.

 

Results ofOperations

 

The following discussion includes references to the term averagedaily sales. Average daily sales are defined as sales for a period of timedivided by the number of shipping days in that period of time.

 

*Overview.*During the thirdquarter of 2005 we achieved record revenue.  Sales increased 18.6% to $225.8 million in the third quarter compared to $190.4million in the prior year period, with the same number of shipping days in eachperiod.  Our revenue growth is a result ofseveral factors, including our ability to execute on our strategy to grow salesorganically and through strategic acquisition.  The company achievedcontinued growth in our three core markets: facilities maintenance,professional contractors and specialty distributors.  Our sales growth, excluding salesassociated with our July 2005 acquisition of Copperfield, was 12.4% compared to the prior yearperiod.  Our sales growth came from the success of the numerousgrowth investments we have put into place during 2004 and 2005, as well asimproved market conditions in the professional contractor and multi-familyhousing sectors.  An increasing component ofour sales growth in the third quarter came from newproduct initiatives, such as the expansion of our capabilities to sell anddistribute HVAC equipment.  Sales of thisequipment, and other larger items such as appliances and water heaters, takenas a whole, have increased over the prior year period by 65%.  These three product groups have a higher averagesales price than our average stock-keeping units and generally carry lowergross margins.  Primarily as a result of salesmix, our consolidated gross margin percentage declined in the period by 30basis points.    We continued to benefitfrom operating expense leverage in the areas of freight, distribution center laborand occupancy costs.  Operating incomeincreased by 12.1% over the comparable prior yearperiod.

 

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*Three Months Ended September 30, 2005 Compared to ThreeMonths Ended September 24, 2004*

 

                *Net Sales.* Our net sales increased by $35.4 million, or18.6%, to $225.8 million in the three months ended September 30, 2005 from$190.4 million in the three months ended September 24, 2004, with the samenumber of shipping days in both periods. The sales increase was attributable to$11.7 million from our Copperfield acquisition and the remaining increaseresulted from continued strong demand for our products, new sales and growthinitiatives, and the success of new product introductions. Our strongest salesgrowth this quarter, excluding the impact of our Copperfield acquisition, was 19.2%in the professional contractor market, followed by 9.7% sales growth in thefacilities maintenance market and 10.3% sales growth in the specialtydistributor market.

 

*                GrossProfit.*Grossprofit increased by $12.9 million, or 17.7%, to $86.1 million in the threemonths ended September 30, 2005 from $73.2 million in the three monthsended September 24, 2004.  Gross profitmargins decreased to 38.1% for the three months ended September 30, 2005 comparedto 38.4% for the three months ended September 24, 2004.  This decline in our gross profit margins is primarilya result of a change in sales mix related to a 65% increase in the sale oflarge equipment items, specifically appliances, water heaters and HVACequipment, which generally carry lower gross profit margins.

 

*                Selling, General andAdministrative Expenses.*SG&A expenses increased by $9.2 million, or 18.4%, to $58.9 millionin the three months ended September 30, 2005 from $49.7 million in the threemonths ended September 24, 2004.  Increased SG&A expenses related to ourCopperfield acquisition accounted for $3.0 million of the $9.2 millionincrease.  Excluding these expenses,SG&A expenses increased 14.2% in the three months ended September 30,2005.  Certain expenses within SG&A,such as the costs of running regional distribution centers, delivery expensesand selling expenses fluctuate with sales volume.  The increase in SG&A expenses included theseincreases as well as increased investment in new sales and marketinginitiatives, higher health care costs, and Sarbanes-Oxley compliance costs.  SG&A expenses as a percentage of sales remainedthe same at 26.1% in the three months ended September 30, 2005 and in the threemonths ended September 24, 2004. Excluding Sarbanes-Oxley compliance costs of $0.4 million incurredduring the three months ended September 30, 2005, SG&A expenses as apercentage of sales decreased 20 basis points to 25.9%.  There were no Sarbanes-Oxley compliance costsin the comparable prior year period.

 

*                Depreciationand Amortization.*Depreciation and amortization expense increased by $0.4 million,or 12.5%, to $3.4 million in the three months ended September 30, 2005 from $3.0 millionin the three months ended September 24, 2004. This increase was due to our Copperfield acquisition.  Copperfield depreciation and amortization was$0.4 million for the three months ended September 30, 2005.  This represents the depreciation andamortization on property, plant and equipment as well as amortization of theintangibles valued in the purchase.

 

*                Secondaryoffering related expenses.*We incurred secondary offeringrelated expenses of $0.9 million during the three months ended September 30,2005.  There were no secondary offeringrelated expenses in the three months ended September 24, 2004.  During the three months ended September 30, 2005, certain ofthe Company’s stockholders sold 7,750,000 shares of the Company’s common stockin an underwritten offering pursuant to a registration statement on Form S-1filed with the SEC (Commission File No. 333-126515).  The underwriters of this offering elected toexercise their over-allotment option with respect to additional shares held bythe selling stockholders.  As a result,on August 22, 2005, certain of the selling stockholders sold an additional1,162,500 shares of our common stock in a second closing pursuant to the sameunderwritten offering.  In connectionwith this offering, the Company did not receive any proceeds and incurredapproximately $0.9 of expenses for the three months ended September 30, 2005,which amounts were recorded by us as an expense.

 

*            Operating Income.*As a result of the foregoing, operating income increased by $2.5million, or 12.0%, to $22.9 million in the three months ended September 30,2005 from $20.5 million in the three months ended September 24, 2004.  As a percent of sales, operating income decreasedto 10.2% in the current quarter from 10.8% in the comparable prior year period.  This decrease was primarily due to $0.9million in secondary offering costs incurred during the three months endedSeptember 30, 2005.

 

*                Changein Fair Value of Interest Rate Swaps.*Our interest rate swaps were terminated atthe time of our initial public offering, or IPO, in December 2004.  As such, changes in fair value of interestrate swaps were zero in the three months ended September 30, 2005 compared to again of $1.5 million in the three months ended September 24, 2004. Theses gainsare related to changes in the market value of our interest rate swapinstruments. The non-cash gains were attributable to changes in marketconditions, including but not limited to fluctuations in interest rates,general market volatility, and the remaining tenor of those instruments.

 

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*                InterestExpense.*Interestexpense decreased by $3.6 million in the three months ended September 30, 2005to $6.7 million from $10.3 million in the three months ended September24, 2004.  The net decrease wasattributed to lower debt balances associated with the early extinguishment of$70.0 million of the 11.5% senior subordinated notes of Interline New Jersey inJanuary 2005 and the pay down of $31.3 million of our term loan, as well aslower interest expense associated with the termination of our interest rateswaps and the write-off of deferred financing costs — all associated with ourIPO.  This was partially offset by theincurrence of an additional $50.0 million term loan during the three monthsended September 30, 2005 as well as increased average borrowings under ourrevolving credit facility to fund the $70.0 million acquisition of Copperfield.

 

*                Provision for Income Taxes.*The effective tax rate for the threemonths ended September 30, 2005 was 41.0% compared to 41.6% in the three monthsended September 24, 2004.  The decreasein the effective tax rate was due primarily to lower state income taxes andlower permanent differences offset in part by non-deductible expenses associatedwith our secondary offering of stock in August 2005.

 

 

*NineMonths Ended September 30, 2005 Compared to Nine Months Ended September 24,2004*

 

**                NetSales.**Our net sales increased by $77.6 million,or 14.1%, to $626.0 million in the nine months ended September 30, 2005from $548.4 million in the nine months ended September 24, 2004.  During 2005 we had one more shipping day thanduring the prior year period.  Averagedaily sales increased 13.6% to $3.3 million in the nine months ended September30, 2005 compared to $2.9 million in the nine months ended September 24, 2004. The sales increase was attributable to $11.7 million from ourCopperfield acquisition and the remaining increase resulted from improved demand for our products, new sales and growthinitiatives, and to new product introductions.  Average daily sales growth for the nine monthsended September 30, 2005, excluding the impact of our Copperfield acquisition,was 17.0% in the professional contractor market, followed by 10.5% sales growthin the facilities maintenance market and 6.4% sales growth in the specialtydistributor market.

 

*                GrossProfit.*Grossprofit increased by $29.0 million, or 13.8%, to $238.9 million in thenine months ended September 30, 2005 from $209.9 million in the ninemonths ended September 24, 2004.  Grossprofit margins declined 10 basis points to 38.2% for the nine months ended September30, 2005 from 38.3% for the nine months ended September 24, 2004.  This decline in our gross profit margins isprimarily a result of  30% increases insales over the comparable prior year period of lower margin products such asappliances, water heaters and HVAC equipment. This was partially offset by improvement in gross profit margins incertain product categories due to the success of our private label program,improved pricing from suppliers, and increased efficiencies at our nationaldistribution center.

 

*                Selling, General andAdministrative Expenses.*SG&A expenses increased by $19.1 million, or 12.9%, to $167.1 millionin the nine months ended September 30, 2005 from $148.1 million in the ninemonths ended September 24, 2004.  Increased SG&A expenses related to ourCopperfield acquisition accounted for $3.0 million of the $19.1 millionincrease.  Excluding these expenses,SG&A expenses increased 10.9% in the nine months ended September 30,2005.  Certain expenses within SG&A,such as the costs of running distribution centers, delivery expenses andselling expenses fluctuate with sales volume.  The increase in SG&A expenses includedthese increases as well as continuing investments in new sales and marketinginitiatives, higher health care costs, and Sarbanes-Oxley compliance costs.  SG&A expenses as a percentage of salesimproved 30 basis points to 26.7% in the nine months ended September 30, 2005 from27.0% in the nine months ended September 24, 2004.  This improvement in operating leverage is aresult of improved operating efficiencies at our regional distribution centers —specifically distribution center labor and freight costs — as well as the benefitof increased sales on our fixed cost infrastructure, partially offset by ourcontinued investment in our growth initiatives. Excluding Sarbanes-Oxley compliance costs of $0.7 million incurredduring the nine months ended September 30, 2005, SG&A expenses as apercentage of sales decreased 40 basis points to 26.6%.  There were no Sarbanes-Oxley compliance costsin the comparable prior year period.

 

*                Depreciationand Amortization.*Depreciation and amortization expense increased by $0.3 million,or 3.0%, to $9.7 million in the nine months ended September 30, 2005 from $9.4 millionin the nine months ended September 24, 2004.  This increase was due to our Copperfieldacquisition.  The Copperfielddepreciation and amortization was $0.4 million for the three months endedSeptember 30, 2005.  This represents thedepreciation and amortization on property, plant and equipment as well asamortization of the intangibles valued in the purchase.

 

*                Secondaryoffering related expenses.*We incurred secondary offeringrelated expenses of $0.9 million during the nine months ended September 30,2005.  There were no secondary offeringrelated expenses in the nine months ended September 24, 2004.  During the nine months ended September 30, 2005, certain ofthe Company’s stockholders sold 7,750,000 shares of the Company’s common stockin an underwritten offering pursuant to a 

 

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registration statement on Form S-1 filed with the SEC(Commission File No. 333-126515).  Theunderwriters of this offering elected to exercise their over-allotment optionwith respect to additional shares held by the selling stockholders.  As a result, on August 22, 2005, certain ofthe selling stockholders sold an additional 1,162,500 shares of our commonstock in a second closing pursuant to the same underwritten offering.  In connection with this offering, the Companydid not receive any proceeds and incurred approximately $0.9 of expenses forthe nine months ended September 30, 2005, which amounts were recorded by us asan expense.

 

 

*            Operating Income.*As a result of the foregoing, operating income increased by $8.7million, or 16.6%, to $61.1 million in the nine months ended September 30,2005 from $52.4 million in the nine months ended September 24, 2004.  As a percent of sales, operating incomeincreased to 9.8% in the first nine months from 9.6% in the comparable prioryear period.

 

*                Changein Fair Value of Interest Rate Swaps.*Our interest rate swaps were terminated atthe time of our IPO in December 2004.  Assuch, changes in fair value of interest rate swaps were zero in the nine monthsended September 30, 2005 compared to a gain of $6.2 million in the nine monthsended September 24, 2004. Theses gains are related to changes in the marketvalue of our interest rate swap instruments.  The non-cash gains were attributable tochanges in market conditions, including but not limited to fluctuations ininterest rates, general market volatility, and the remaining tenor of ourinstruments.

 

*                InterestExpense.*Interestexpense decreased by $11.9 million in the nine months ended September 30,2005 to $18.7 million from $30.6 million in the nine months ended September24, 2004.  The net decrease wasattributed to lower debt balances associated with the early extinguishment of$70.0 million of the 11.5% senior subordinated notes of Interline New Jersey inJanuary 2005 and the pay down of $31.5 million of our term loan, as well aslower interest expense associated with the termination of our interest rateswaps and the write-off of deferred financing costs — all associated with ourIPO.  This was partially offset by theincurrence of an additional $50.0 million term loan during the three monthsended September 30, 2005 as well as increased borrowings under our revolvingcredit facility to fund the $70.0 million acquisition of Copperfield.

 

*                Loss on Extinguishment of Debt*. As part of our IPO, we redeemed$70.0 million of the 11.5% senior subordinated notes in January 2005. Thisredemption was made 30 days after the closing of our IPO, in accordance withthe redemption provision of the indenture governing the notes. In connectionwith the redemption, we recorded a $10.3 million loss on the earlyextinguishment of debt in the first quarter of 2005, consisting of an $8.1million redemption premium and $2.3 million write-off of deferred financingcosts.

 

*                Provision for Income Taxes.*The effective tax rate for the ninemonths ended September 30, 2005 was 39.8% compared to 39.6% in the nine monthsended  September 24, 2004.  The increase in the effective tax rate was dueprimarily to increased non-deductible expenses offset in part by a decrease in permanentdifferences.

 

 

**Liquidity and Capital Resources**

 

                Asof September 30, 2005, we had approximately $85.9 million of availabilityunder Interline New Jersey’s $100.0 million revolving credit facility.  Historically, our capital requirements havebeen for debt service obligations, working capital requirements, acquisitions,the expansion and maintenance of our distribution network, and upgrades of ourproprietary information systems.  Weexpect this to continue in the foreseeable future.  Historically, we have funded theserequirements through internally generated cash flow and funds borrowed underour credit facility.  We expect our cashflow from operations and the loan availability under our credit facility to beour primary source of funds in the future.  Letters of credit, which are issued under therevolving loan facility under our credit facility, are used to support paymentobligations incurred for our general corporate purposes.  As of September 30, 2005, we had $9.1 millionof letters of credit issued under the credit facility.  Interest on Interline New Jersey’s 11.5%senior subordinated notes due 2011 is payable each May 15 and November 15.  With respect to borrowings under our creditfacility, we have the option to borrow at an adjusted LIBOR or an alternativebase rate.  Interest on the creditfacility is generally payable quarterly, and with respect to any LIBORborrowings, on the last day of the interest period applicable to the term ofthe borrowing.

 

                We are a holding company whoseonly asset is the stock of our subsidiaries.  We conduct virtually all of our businessoperations through Interline New Jersey.  Accordingly, our only material sources of cashare dividends 

 

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and distributionswith respect to our ownership interests in Interline New Jersey that arederived from the earnings and cash flow generated by Interline New Jersey.  The debt instruments of Interline New Jersey,primarily the credit facility and the indenture governing the terms of the11.5% notes, contain significant restrictions on the payment of dividends anddistributions to us by Interline New Jersey. In particular, Interline NewJersey’s credit facility prevents it from paying dividends, makingdistributions to us or making investments in us.  However, ordinary course distributions foroverhead and taxes are permitted, as are (provided Interline New Jersey is notin default) annual payments of up to $7.5 million in respect of our stockoption plans and annual payments of up to $40 million depending on the proforma net leverage ratio of the previous quarter.  In addition, the indenture for the 11.5% notesrestricts the ability of Interline New Jersey to pay distributions or dividendsto us and to make advances to, or investments in, us.  Dividends, distributions and investments arepermitted in an amount generally limited to 50% of the net income of InterlineNew Jersey, plus an amount equal to the net proceeds from certain equityissuances if Interline New Jersey is in compliance with a leverage ratio and isnot in default.  In addition, there arecertain other permitted payments, including an ability to make distributions ofup to $10 million.

 

                Net cash provided by operatingactivities was $30.8 million for the nine months ended September 30, 2005compared to net cash provided by operating activities of $7.5 million inthe nine months endedSeptember 24, 2004.  Net cash provided by operating activities for thenine months ended September 30, 2005 was higher than the prior yearperiod primarily as a result of our increase in operating income of $8.7million and changes in our core working capital, defined as the sum of accountsreceivable trade plus inventory less accounts payable, of $14.9 million.  This was partially offset by the changes inall other assets and liabilities.  Inaddition, we had lower cash interest expense of $10.7 million, resulting fromour lower average debt balances, which were reduced using proceeds from our IPO,and higher cash taxes of $17.2 million, due to higher pretax earnings and the timingof income tax payments.

 

Netcash used in investing activities was $77.1 million in the nine monthsended September 30, 2005 compared to $5.9 million in the nine months ended September24, 2004.  Net cash used in investingactivities in the nine months ended September 30, 2005 and the nine monthsended September 24, 2004 were primarily attributable to capital expendituresmade in the ordinary course of business and costs related to purchases ofbusinesses including the $70.0 million purchase of Copperfield.

 

                Net cash used in financingactivities totaled $21.5 million for the nine months ended September 30, 2005 compared to net cash provided by financingactivities of $1.2 million in the nine months ended  September 24, 2004.  Net cash used in financingactivities for the nine months ended September 30, 2005 was primarily attributableto our repayment of $70.0 million of our senior subordinated notes and $8.1million in related redemption premiums partially offset by the incurrence of anadditional $50.0 million term loan, which was used in our Copperfieldacquisition, $2.3 million received in January 2005 for the over-allotmentshares sold to underwriters, net of expenses, in conjunction with our IPO and$1.7 million of proceeds received from the exercise of stock options.

 

                As of September 30, 2005, otherthan the redemption of $70.0 million of Interline New Jersey’s 11.5% seniorsubordinated notes and the incurrence of an additional $50.0 million term loanand incremental revolver borrowings, as described above, our contractualobligations and other contractual commitments have not changed materiallyoutside the ordinary course of business since December 31, 2004.

 

 

 

*Our Initial Public Offering and Related Transactions*

 

                In December 2004, wesuccessfully completed our initial public offering, or IPO, and amended InterlineNew Jersey’s senior credit facility.  Atotal of 14,375,000 shares of our common stock were sold, of which 12,667,000were sold by us and 1,708,000 were sold by our shareholders.  We sold 12,500,000 shares of our common stockin December 2004 and 167,000 shares in January 2005 following the exercise ofthe underwriters’ over-allotment option. We received $171.8 million in netproceeds including the exercise of the underwriters’ over-allotment option,representing $176.9 million of proceeds from the sale of stock net ofunderwriting discounts and commissions, less $4.1 million of initial public offeringcosts and $1.1 million of debt issuance costs.

 

                Immediately prior to the closingof the IPO, a reincorporation merger occurred and we became the holding companyof the Interline group of businesses with Interline New Jersey as our wholly ownedoperating subsidiary. In 

 

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thereincorporation merger, the holders of the preferred stock of Interline NewJersey received an aggregate of $55 million in cash and 19,183,321 shares ofour common stock and the holders of the common stock of Interline New Jerseyreceived 0.01218 shares of our common stock per share of Interline New Jerseycommon stock, or 66,667 shares of our common stock in total.  In addition, holders of options to purchaseshares of the common stock of Interline New Jersey were converted into optionsto purchase shares of our common stock.

 

                We used $31.3 million of theproceeds to partially repay the term loan under Interline New Jersey’s creditfacility.  We amended Interline NewJersey’s senior credit facility to allow for the IPO and reduce our applicablerate in respect to any term loans from LIBOR plus 3.50% to LIBOR plus 2.25%.  In conjunction with this amendment, weincurred $1.1 million of debt issuance costs. In December 2004 we also used $4.6 million of the proceeds to terminate theinterest rate swap agreements.  InJanuary 2005 we used $70.0 million of the proceeds from the IPO transaction topartially redeem Interline New Jersey’s 11.5% senior subordinated notes.  In connection with the redemption, in January2005 we paid $8.1 million of premiums for early redemption of the 11.5% seniorsubordinated notes and recorded a $10.3 million loss on the earlyextinguishment of debt, which included a charge for write-off of unamortizeddebt issuance costs in the amount of $2.3 million.

 

               We refer to the transactionsdescribed in this section collectively as the “IPO Transactions”.

 

*Capital Expenditures*

 

                Capital expenditures were $5.9million in the nine months ended September 30, 2005 compared to $5.4 million inthe nine months endedSeptember 24, 2004.  Capital expenditures as a percentage of saleswere 0.9% in the nine months ended September 30, 2005 and 1.0% in the ninemonths ended September 24, 2004.

 

*Liquidity*

 

                Our principal working capitalneed is for inventory and trade accounts receivable, which have generallyincreased with the growth in our business. Our principal sources of cash tofund our working capital needs are cash generated from operating activities andborrowings under our revolving credit facility.

 

*Credit Facility*

 

                Interline New Jersey enteredinto a credit facility on May 29, 2003, which was amended as ofDecember 19, 2003, and amended again on December 21, 2004 in connectionwith the IPO.  Interline New Jersey alsoamended its credit facility on July 7, 2005, to permit the incurrence of anadditional $50.0 million term loan, having substantially the same terms as theexisting term loan in connection with the Copperfield acquisition.  On August 8, 2005, Interline New Jersey againamended its credit facility to lower the interest rate spreads applicable tothe additional $50.0 million term loan.  Theamended credit facility provides for aggregate commitments of $250.0 million,consisting of (1) a revolving loan facility of $100.0 million, of which aportion not exceeding $20.0 million will be available in the form of letters ofcredit, and (2) a term loan facility of $150.0 million.  Borrowings under the amended term loanfacility and revolving loan facility bear interest, at Interline New Jersey’soption, at either adjusted LIBOR or at the alternate base rate plus a spread.  Outstanding letters of credit under the revolvingloan facility are subject to a per annum fee equal to the applicable spreadover adjusted LIBOR for revolving loans.  The indebtedness under the amended creditfacility is guaranteed by us and by the domestic subsidiaries of Interline NewJersey.  The amended term loan facilityhas a maturity of December 31, 2010, and the revolving loan facility has amaturity of May 31, 2008.

 

                On July 7, 2005, we used theproceeds from the additional $50.0 million term loan and $20.0 million ofborrowings under the revolving loan facility to fund the Copperfieldacquisition.  As of the end of the thirdquarter the Company had paid down $15.0 million of the incremental $20.0million borrowed for the acquisition.

 

              During the nine months ended September30, 2005 we borrowed periodically on our revolving credit facility toaccommodate our daily working capital needs.  The weighted average daily outstanding balanceduring the nine-month period was $11.3 million, with ordinary courseborrowings ranging from $0.0 million to $22.5 million.  As of September 30, 2005, Interline New Jerseyhad $9.1 million of letters of credit issued under the revolving loanfacility and $149.2 million aggregate principal outstanding under the termloan facility.

 

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                We believe that cash flow fromoperations and available borrowing capacity under our new credit facility willbe adequate to finance our ongoing operational cash flow needs and debt serviceobligations for the next twelve months.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK.

 

                We are aware of the potentially unfavorable effectsinflationary pressures may create through higher asset replacement costs andrelated depreciation, higher interest rates and higher product and materialcosts.  We seek to minimize the effectsof inflation and changing prices through economies of purchasing and inventorymanagement resulting in cost reductions and productivity improvements as wellas price increases to maintain reasonable profit margins.  Management believes that while inflation has historicallybeen moderate the company and its markets have been impacted over the past yearby rising raw material prices and resulting supplier cost increases.  These increases have generally served toincrease sales results.

 

                The majority of our purchasesfrom foreign-based suppliers are from China and other countries in Asia and aretransacted in U.S. dollars.  On July 21,2005, the People’s Bank of China announced that the yuan will no longer bepegged to the U.S. dollar, but will be allowed to float in a band (and to alimited extent, increase in value) against a basket of foreign currencies, andon September 23, 2005 slightly increased the permitted movement againstnon-U.S. dollar currencies in the basket. China’s decision to remove the U.S. dollar peg for the yuan increasesthe risk that Chinese-sourced products could become more expensive for us.

 

*DerivativeFinancial Instruments*

 

                Periodically, the company had enteredinto derivative financial instruments, including interest rate exchangeagreements, or swaps, to manage our exposure to fluctuations in interest rateson our debt. As of September 30, 2005, we did not have any interest rate swapexchange agreements, or swaps. Under our former swap agreements, we pay a fixedrate on the notional amount to our banks and the banks pay us a variable rateon the notional amount equal to a base LIBOR rate. Our derivative activities,all of which are for purposes other than trading, are initiated within theguidelines of corporate risk-management policies.

 

                We periodically evaluate thecosts and benefits of any changes in our interest rate risk. Based on suchevaluation, we may enter into new interest rate swaps to manage our interest rateexposure.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

                Ourmanagement, with the participation of our Chief Executive Officer and ChiefFinancial Officer (our principal executive officer and principal financialofficer), evaluated the effectiveness of our disclosure controls and procedures(as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September30, 2005. Based on this evaluation, our Chief Executive Officer and  Chief Financial Officer concluded that, as of September30, 2005, our disclosure controls and procedures were: (1) designed to ensurethat material information relating to us, including our consolidatedsubsidiaries, is made known to our Chief Executive Officer and  Chief Financial Officer by others within thoseentities, particularly during the period in which this report was beingprepared, and (2) effective, in that they provide reasonable assurance thatinformation required to be disclosed by us in the reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms.

 

                Nochange in our internal control over financial reporting (as defined in Rules13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarterended September 30, 2005 that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

 

**PART II. OTHER INFORMATION**

 

ITEM 1. LEGAL PROCEEDINGS.

 

                We areinvolved in various legal proceedings that have arisen in the ordinary courseof our business and have not been fully adjudicated. These actions, whenultimately concluded and determined, will not, in the opinion of management,have a material effect upon our consolidated financial position, results ofoperations or liquidity.

 

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ITEM 2. CHANGES IN SECURITIES,USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

                None

 

ITEM 3. DEFAULTS UPON SENIORSECURITIES.

 

                None

 

ITEM 4. SUBMISSION OF MATTERSTO A VOTE OF SECURITY HOLDERS.

 

              None

 

ITEM 5. OTHER INFORMATION.

 

              None

 

 

ITEM 6. EXHIBITS.

 

                The following exhibits are being filed as part ofthis Quarterly Report on Form 10-Q:

 
| 1.1   |   | Underwriting Agreement dated as of August 3, 2005  among the Company, the several selling stockholders named on Schedule A  thereto and the several underwriters named on Schedule B thereto, for whom  Credit Suisse First Boston LLC and Lehman Brothers, Inc. acted as  representatives (incorporated by reference to exhibit 1.1 to the Company’s  Registration Statement on Form S-1/A filed on July 22, 2005). |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1  |   | Amendment No. 1 , dated as of August 8, 2005, to the  Amended and Restated Credit Agreement dated as of December 21, 2004, among  the Company, Interline New Jersey, the lenders party thereto and Credit  Suisse, Cayman Islands Branch, as Administrative Agent. (incorporated by  reference to exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q  filed on August 11, 2005).                            |
| 10.53 |   | Incremental Facility Amendment, dated as of July 7,  2005, among the Company, Interline New Jersey, the lenders named thereto and  Credit Suisse, Cayman Islands Branch, as Administrative Agent (incorporated  by reference to exhibit 10.53 to the Company’s Registration Statement on Form  S-1/A filed on July 22, 2005).                                                                                        |
| 10.55 |   | Employment Agreement, dated as of July 22, 2005,  between Interline New Jersey and Thomas J. Tossavainen (incorporated by  reference to exhibit 10.55 to the Company’s Registration Statement on Form  S-1/A filed on August 1, 2005).                                                                                                                                                                               |
| 10.56 |   | Amendment, dated September 9, 2005, to Employment  Agreement, dated as of December 15, 2004, between Interline New Jersey and  William R. Pray (furnished herewith).                                                                                                                                                                                                                                                      |
| 31.1  |   | Certification of Michael J. Grebe as President and  Chief Executive Officer of Interline Brands, Inc., pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 (furnished herewith).                                                                                                                                                                                                                              |
| 31.2  |   | Certification of Thomas J. Tossavainen as Vice  President and Chief Financial Officer of Interline Brands, Inc., pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 (furnished herewith).                                                                                                                                                                                                                    |
| 32.1  |   | Certification of the Chief Executive Officer  pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished  herewith).                                                                                                                                                                                                     |
| 32.2  |   | Certification of the Chief Financial Officer  pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished  herewith).                                                                                                                                                                                                     |

 

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**Signatures**

 

                Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned hereuntoduly authorized. 

 
|   | INTERLINE BRANDS, INC. |
|--------|------------------------|
|   |                   |   |
|   |                   |   |
|   | BY:               | /s/  Michael J. Grebe |
|   |                   | Michael J. Grebe |
|   |                   | President and Chief Executive Officer |
|   |                   |   |
|   |                   | (Duly Authorized Signatory and Principal Executive  Officer) |

 

Date: November 10, 2005

 

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**Signatures**

 

                Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned hereuntoduly authorized.

 
|   | INTERLINE BRANDS, INC. |
|--------|------------------------|
|   |                   |   |
|   |                   |   |
|   | BY:               | /s/  Thomas J. Tossavainen  |
|   |                   | Thomas J. Tossavainen |
|   |                   | Chief Financial Officer |
|   |                   |   |
|   |                   | (Duly Authorized Signatory and Principal Financial  Officer) |

 

Date: November 10, 2005

 

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