**UNITED STATES SECURITIES 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 JULY 1, 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)****                                   | **** **** | ****(Zip Code)****          |
|                                                                               |           |                        |
| **(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

 

As of the close of business on August 11, 2005, there were 32,215,669 shares outstanding of the registrant’s common stock, no par value.

 

 

----

 

**TABLE OFCONTENTS**

 
|               |           | ****PART I – FINANCIAL INFORMATION****                                                                                                     |           | ****1****  |
|--------------------|----------------|------------------------------------------------------------------------------------------------------------------------------------------------------|----------------|------------|
|               |           |                                                                                                                                                 |           |       |
| ****Item 1.****    | **** **** | ****Financial Statements****                                                                                                                         |           | ****1****  |
|               |           |                                                                                                                                                 |           |       |
| **** ****     | **** **** | ****Unaudited Condensed Consolidated Balance Sheets as of July 1, 2005 and December 31, 2004****                                           |           | ****1****  |
| **** ****     | **** **** | ****Unaudited Condensed Consolidated Statements of Operations for the Three Months and Six Months Ended July 1, 2005 and June 25, 2004**** |           | ****2****  |
| **** ****     | **** **** | ****Unaudited Condensed Consolidated Statement of Stockholders’ Equity for the Six Months Ended July 1, 2005****                           |           | ****3****  |
| **** ****     | **** **** | ****Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended July 1, 2005 and June 25, 2004****                  |           | ****4****  |
| **** ****     | **** **** | ****Notes to Unaudited Condensed Consolidated Financial Statements****                                                                               |           | ****5****  |
| ****Item 2.****    | **** **** | ****Management’s Discussions and Analysis of Financial Condition and Results of Operations****                                                  | **** **** | ****12**** |
| ****Item 3.****    | **** **** | ****Quantitative and Qualitative Disclosures about Market Risk****                                                                                   | **** **** | ****19**** |
| ****Item 4.****    | **** **** | ****Controls and Procedures****                                                                                                                      | **** **** | ****20**** |
|               |           |                                                                                                                                                 |           |       |
|               |           | ****PART II — OTHER INFORMATION****                                                                                                        |           | ****20**** |
|               |           |                                                                                                                                                 |           |       |
| ****Item 1.****    | **** **** | ****Legal Proceedings****                                                                                                                            | **** **** | ****20**** |
| ****Item 2.****    | **** **** | ****Changes In Securities, Use Of Proceeds, And Issuer Purchases Of Equity Securities****                                                            |           | ****20**** |
| ****Item 3.****    | **** **** | ****Defaults Upon Senior Securities****                                                                                                              |           | ****20**** |
| ****Item 4.****    |           | Submission Of Matters To A Vote Of Security Holders                                                                                                  |           | ****20**** |
| Item 5.            |           | Other Information                                                                                                                                    |           | 20         |
| ****Item 6.****    | **** **** | ****Exhibits****                                                                                                                                     | **** **** | ****20**** |
|               |           |                                                                                                                                                 |           |       |
| ****SIGNATURES**** |           |                                                                                                                                                 |

 

----

 

**PART I. FINANCIAL INFORMATION**

 

ITEM 1. FINANCIAL STATEMENTS.

 

**INTERLINE BRANDS, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATEDBALANCE SHEETS (UNAUDITED)AS OF JULY 1, 2005 AND DECEMBER 31, 2004(in thousands except share data)**

 
| ** **                                                                                                                                                      | ** ** | **July 1, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------------------|------------|
| ** **                                                                                                                                                      | ** ** | ** **            | ** ** | ** **                 | ** ** |
| **ASSETS**                                                                                                                                                      |       |                  |       |                       |       |
| CURRENT  ASSETS:                                                                                                                                                |       |                  |       |                       |       |
| Cash and  cash equivalents                                                                                                                                      |       | $                     | 253        |                       | $          | 69,178 |   |
| Accounts receivable  - trade (net of allowance for doubtful accounts of $7,277 and $6,929)                                                                      |       | 116,039               |       | 98,511                     |       |
| Accounts  receivable - other                                                                                                                                    |       | 11,976                |       | 17,828                     |       |
| Inventory                                                                                                                                                       |       | 149,939               |       | 145,532                    |       |
| Prepaid  expenses and other current assets                                                                                                                      |       | 4,606                 |       | 3,204                      |       |
| Deferred  income taxes                                                                                                                                          |       | 11,991                |       | 12,084                     |       |
| Total  current assets                                                                                                                                           |       | 294,804               |       | 346,337                    |       |
|                                                                                                                                                            |       |                  |       |                       |       |
| PROPERTY AND  EQUIPMENT, net                                                                                                                                    |       | 28,333                |       | 28,767                     |       |
|                                                                                                                                                            |       |                  |       |                       |       |
| GOODWILL                                                                                                                                                        |       | 204,381               |       | 203,848                    |       |
|                                                                                                                                                            |       |                  |       |                       |       |
| OTHER  INTANGIBLE ASSETS, net                                                                                                                                   |       | 80,334                |       | 85,361                     |       |
|                                                                                                                                                            |       |                  |       |                       |       |
| OTHER ASSETS                                                                                                                                                    |       | 9,350                 |       | 9,067                      |       |
| TOTAL ASSETS                                                                                                                                                    |       | $                     | 617,202    |                       | $          | 673,380 |   |
| ** **                                                                                                                                                      |       |                  |       |                       |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                  |       |                  |       |                       |       |
| CURRENT  LIABILITIES:                                                                                                                                           |       |                  |       |                       |       |
| Current  portion of long-term debt                                                                                                                              |       | $                     | 1,000      |                       | $          | 1,000 |   |
| Accounts  payable                                                                                                                                               |       | 62,455                |       | 53,260                     |       |
| Accrued  expenses and other current liabilities                                                                                                                 |       | 20,085                |       | 22,180                     |       |
| Accrued  interest payable                                                                                                                                       |       | 2,007                 |       | 3,042                      |       |
| Accrued  merger expenses                                                                                                                                        |       | 5,900                 |       | 6,131                      |       |
| Accrued  income taxes payable                                                                                                                                   |       | 4,650                 |       | 7,372                      |       |
| Total  current liabilities                                                                                                                                      |       | 96,097                |       | 92,985                     |       |
|                                                                                                                                                            |       |                  |       |                       |       |
| LONG TERM  LIABILITIES:                                                                                                                                         |       |                  |       |                       |       |
| Deferred  income taxes                                                                                                                                          |       | 24,273                |       | 25,221                     |       |
| Long-term  debt, net of current portion                                                                                                                         |       | 231,775               |       | 302,275                    |       |
|                                                                                                                                                            |       |                  |       |                       |       |
| TOTAL  LIABILITIES                                                                                                                                              |       | 352,145               |       | 420,481                    |       |
|                                                                                                                                                            |       |                  |       |                       |       |
| COMMITMENTS  AND CONTINGENCIES                                                                                                                                  |       |                  |       |                       |       |
| SENIOR  PREFERRED STOCK, $0.01 par value, 20,000,000 shares authorized, no shares  outstanding as of July 1, 2005 and December 31, 2004               |       | —                |       | —                     |       |
| STOCKHOLDERS’  EQUITY:                                                                                                                                     |       |                  |       |                       |       |
| Common  stock; $0.01 par value, 100,000,000 authorized; 32,215,669 issued and  outstanding as of July 1, 2005 and 32,102,820 as of December 31,  2004 |       | 322                   |       | 321                        |       |
| Accumulated  deficit                                                                                                                                            |       | (291,878              | )          | (301,836                   | )          |
| Additional  paid-in capital                                                                                                                                     |       | 558,136               |       | 556,346                    |       |
| Deferred  compensation                                                                                                                                          |       | (2,310                | )          | (2,787                     | )          |
| Accumulated  other comprehensive income                                                                                                                         |       | 787                   |       | 855                        |       |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                                                                                |       | 265,057               |       | 252,899                    |       |
| TOTAL LIABILITIES &  STOCKHOLDERS’ EQUITY                                                                                                         |       | $                     | 617,202    |                       | $          | 673,380 |   |

 

*See accompanying notes to unaudited condensedconsolidated financial statements.*

 

1

----

 

**INTERLINE BRANDS, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS (UNAUDITED)THREE MONTHS AND SIX MONTHS ENDED JULY 1, 2005 AND JUNE 25, 2004****(inthousands, except share and per share data)**

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                           | ** ** | **July 1, 2005**  | ** ** | **June 25, 2004** | ** ** | **July 1, 2005** | ** ** | **June 25, 2004** | ** ** |
| NET SALES                                            |       | $                      | 203,666    |                   | $          | 185,379 |   | $ | 400,157 |   | $ | 357,983 |   |
| COST OF  SALES                                       |       | 126,411                |       | 114,434                |       | 247,416 |   | 221,315 |   |
| Gross Profit                                         |       | 77,255                 |       | 70,945                 |       | 152,741 |   | 136,668 |   |
| OPERATING  EXPENSES :                                |       |                   |       |                   |       |   |   |   |   |
| Selling,  general and administrative expenses        |       | 54,516                 |       | 50,081                 |       | 108,256 |   | 98,338 |   |
| Depreciation  and amortization                       |       | 3,222                  |       | 3,443                  |       | 6,338 |   | 6,426 |   |
| Total  Operating Expense                             |       | 57,738                 |       | 53,524                 |       | 114,594 |   | 104,764 |   |
| OPERATING  INCOME                                    |       | 19,517                 |       | 17,421                 |       | 38,147 |   | 31,904 |   |
| CHANGE IN  FAIR VALUE OF INTEREST RATE SWAPS         |       | —                 |       | 3,594                  |       | — |   | 4,698 |   |
| LOSS ON  EXTINGUISHMENT OF DEBT                      |       | —                 |       | —                 |       | (10,340 | ) | — |   |
| INTEREST  EXPENSE                                    |       | (5,746                 | )          | (10,100                | )          | (12,015 | ) | (20,294 | ) |
| INTEREST  INCOME                                     |       | 6                      |       | 25                     |       | 126 |   | 33 |   |
| OTHER INCOME                                         |       | 119                    |       | 45                     |       | 286 |   | 181 |   |
| Income  before income taxes                          |       | 13,896                 |       | 10,985                 |       | 16,204 |   | 16,522 |   |
| PROVISION  FOR INCOME TAXES                          |       | 5,331                  |       | 4,028                  |       | 6,246 |   | 6,314 |   |
| NET INCOME                                           |       | 8,565                  |       | 6,957                  |       | 9,958 |   | 10,208 |   |
| PREFERRED  STOCK DIVIDENDS                           |       | —                 |       | (13,723                | )          | — |   | (26,984 | ) |
| NET INCOME  (LOSS) APPLICABLE TO COMMON STOCKHOLDERS |       | $                      | 8,565      |                   | $          | (6,766 | ) | $ | 9,958 |   | $ | (16,776 | ) |
| INCOME  (LOSS) PER COMMON SHARE - BASIC              |       | $                      | 0.27       |                   | $          | (102.88 | ) | $ | 0.31 |   | $ | (255.74 | ) |
| INCOME  (LOSS) PER COMMON SHARE - DILUTED            |       | $                      | 0.26       |                   | $          | (102.88 | ) | $ | 0.31 |   | $ | (255.74 | ) |
|                                                 |       |                   |       |                   |       |   |   |   |   |
| WEIGHTED  AVERAGE SHARES OUTSTANDING - BASIC         |       | 31,959,119             |       | 65,769                 |       | 31,938,147 |   | 65,597 |   |
| WEIGHTED  AVERAGE SHARES OUTSTANDING - DILUTED       |       | 32,364,012             |       | 65,769                 |       | 32,328,273 |   | 65,597 |   |

 

*See accompanying notes to unaudited condensedconsolidated financial statements*

 

2

----

 

**INTERLINE BRANDS, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)SIX MONTHS ENDED JULY 1, 2005(in thousands, except share data)**

 
| ** **                                | ** ** | ** **       | ** ** | ** **       | ** ** | ** **   | ** ** | ** **     | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------------|------------|------------------|------------|--------------|------------|----------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                                | ** ** | ** **       | ** ** | ** **       | ** ** | ** **   | ** ** | **Additional** | ** ** | ** **        | ** ** | **Other**              | ** ** | **Total**  | ** ** |
| ** **                                | ** ** | **Common Stock** | ** ** | **(Accumulated** | ** ** | **Paid In**  | ** ** | **Deferred**   | ** ** | **Comprehensive** | ** ** | **Stockholders’** | ** ** |
| ** **                                | ** ** | **Shares**       | ** ** | **Amount**       | ** ** | **Deficit)** | ** ** | **Capital**    | ** ** | **Compensation**  | ** ** | **Income (Loss)**      | ** ** | **Equity** | ** ** |
| ** **                                | ** ** | ** **       | ** ** | ** **       | ** ** | ** **   | ** ** | ** **     | ** ** | ** **        | ** ** | ** **             | ** ** | ** ** | ** ** |
| BALANCE, DECEMBER 31,  2004          |       | 32,102,820       |       | $                | 321        |         | $          | (301,836       | )          | $                 | 556,346    |                   | $          | (2,787     | )          | $ | 855 |   | $ | 252,899 |   |
|                                      |       |             |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Stock based compensation                  |       |             |       |             |       |         |       |           |       | 477               |       |                   |       | 477        |       |
|                                      |       |             |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Offering costs                            |       |             |       |             |       |         |       | (116           | )          |              |       |                   |       | (116       | )          |
|                                      |       |             |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Common stock issued through stock options |       | 112,849          |       | 1                |       |         |       | 1,906          |       |              |       |                   |       | 1,907      |       |
|                                      |       |             |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Comprehensive income:                     |       |             |       |             |       |         |       |           |       |              |       |                   |       | —     |       |
|                                      |       |             |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Net income                                |       |             |       |             |       | 9,958        |       |           |       |              |       |                   |       |       |       |
|                                      |       |             |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Foreign currency translation              |       | —           |       |             |       |         |       |           |       |              |       | (68                    | )          |       |       |
|                                      |       |             |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| Total comprehensive income                |       | —           |       | —           |       | —       |       | —         |       | —            |       | —                 |       | 9,890      |       |
|                                      |       |             |       |             |       |         |       |           |       |              |       |                   |       |       |       |
| BALANCE, JULY 1, 2005                |       | 32,215,669       |       | $                | 322        |         | $          | (291,878       | )          | $                 | 558,136    |                   | $          | (2,310     | )          | $ | 787 |   | $ | 265,057 |   |

 

*See accompanying notes to unaudited condensedconsolidated financial statements.*

 

3

----

 

**INTERLINE BRANDS, INC AND SUBSIDIARIESCONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS (UNAUDITED)SIX MONTHS ENDED JULY 1, 2005 AND JUNE 25, 2004(in thousands)**

 
| ** **                                                                         | ** ** | **July 1, 2005** | ** ** | **June 25, 2004** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| OPERATING  ACTIVITIES :                                                            |       |                  |       |                   |       |
| Net Income                                                                         |       | $                     | 9,958      |                   | $          | 10,208 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                  |       |                   |       |
| Depreciation  and amortization                                                     |       | 6,338                 |       | 6,426                  |       |
| Amortization  and write-off of debt issuance costs                                 |       | 3,064                 |       | 957                    |       |
| Redemption  premium on 11.5% senior subordinated notes                             |       | 8,050                 |       | —                 |       |
| Stock based  compensation                                                          |       | 477                   |       | —                 |       |
| Change in  fair value of interest rate swaps                                       |       | —                |       | (4,697                 | )          |
| Interest  income on shareholder notes                                              |       | —                |       | (6                     | )          |
| Deferred  income taxes                                                             |       | (855                  | )          | 4,294                  |       |
| Income tax  effect from exercise of stock options                                  |       | 215                   |       | —                 |       |
|                                                                               |       |                  |       |                   |       |
| Changes in  assets and liabilities:                                                |       |                  |       |                   |       |
| Accounts  receivable - trade                                                       |       | (17,529               | )          | (20,339                | )          |
| Accounts  receivable - other                                                       |       | 3,519                 |       | 3,646                  |       |
| Inventory                                                                          |       | (4,407                | )          | (14,618                | )          |
| Prepaid  expenses and other current assets                                         |       | (1,401                | )          | 141                    |       |
| Other assets                                                                       |       | (281                  | )          | (100                   | )          |
| Accrued  interest payable                                                          |       | (1,035                | )          | (334                   | )          |
| Accounts  payable                                                                  |       | 9,194                 |       | 18,304                 |       |
| Accrued  expenses and other current liabilities                                    |       | (594                  | )          | 1,369                  |       |
| Accrued  merger expenses                                                           |       | (206                  | )          | (183                   | )          |
| Accrued  income taxes payable                                                      |       | (2,722                | )          | 742                    |       |
|                                                                               |       |                  |       |                   |       |
| Net cash  provided by operating activities                                         |       | 11,785                |       | 5,810                  |       |
|                                                                               |       |                  |       |                   |       |
| INVESTING  ACTIVITIES :                                                            |       |                  |       |                   |       |
| Purchase of  property and equipment, net                                           |       | (3,900                | )          | (3,692                 | )          |
| Purchase of  business, net of cash acquired                                        |       | (1,602                | )          | (459                   | )          |
|                                                                               |       |                  |       |                   |       |
| Net cash  used in investing activities                                             |       | (5,502                | )          | (4,151                 | )          |
|                                                                               |       |                  |       |                   |       |
| FINANCING  ACTIVITIES :                                                            |       |                  |       |                   |       |
| Increase in  revolver and swingline, net                                           |       | —                |       | 4,500                  |       |
| Repayment of  long-term debt                                                       |       | (70,500               | )          | (3,500                 | )          |
| Payment of redemption  premium on 11.5% senior subordinated notes                  |       | (8,050                | )          | —                 |       |
| Payment of  debt issuance costs                                                    |       | —                |       | (307                   | )          |
| Initial  public offering costs                                                     |       | (616                  | )          | —                 |       |
| Proceeds  from stock options exercised                                             |       | 1,693                 |       | —                 |       |
| Proceeds  from exercise of underwriters over-allotment options                     |       | 2,333                 |       | —                 |       |
|                                                                               |       |                  |       |                   |       |
| Net cash  (used in) provided by financing activities                               |       | (75,140               | )          | 693                    |       |
|                                                                               |       |                  |       |                   |       |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS                      |       | (68                   | )          | (93                    | )          |
| NET  (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                              |       | (68,925               | )          | 2,259                  |       |
| CASH AND  CASH EQUIVALENTS, BEGINNING OF PERIOD                                    |       | 69,178                |       | 1,612                  |       |
| CASH AND  CASH EQUIVALENTS, END OF PERIOD                                          |       | $                     | 253        |                   | $          | 3,871 |   |
| ** **                                                                         | ** ** | ** **            | ** ** | ** **             | ** ** |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION                                  |       |                  |       |                   |       |
| Cash paid  during the period for :                                                 |       |                  |       |                   |       |
| Interest                                                                           |       | $                     | 10,842     |                   | $          | 19,444 |   |
| Income taxes  (net of refunds)                                                     |       | $                     | 9,708      |                   | $          | 424 |   |
|                                                                               |       |                  |       |                   |       |
| SCHEDULE OF  NON-CASH INVESTING AND FINANCING ACTIVITIES                      |       |                  |       |                   |       |
| Dividends on  preferred stock                                                      |       | $                     | —     |                   | $          | 26,984 |   |
| Adjustment  to goodwill on business acquired                                       |       | $                     | (16        | )                      | $          | — |   |

 

*See accompanying notes to unaudited condensedconsolidated financial statements.*

 

4

----

 

**INTERLINE BRANDS, INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(in thousands, except share data)**

 

**1.**              BASISOF PRESENTATION

 

Theaccompanying unaudited interim financial statements of Interline Brands, Inc.,a Delaware corporation, and its subsidiaries (“Interline” or the “Company”)have been prepared in accordance with accounting principles generally acceptedin the United States of America and the rules and regulations of theSecurities and Exchange Commission, which apply to interim financialstatements.  These unaudited condensedconsolidated financial statements do not include all disclosures provided inthe annual financial statements and should be read in conjunction with thefinancial statements and notes thereto contained in the Annual Report on Form 10-Kfor Interline Brands, Inc. for the year ended December 31, 2004 asfiled with the Securities and Exchange Commission on March 31, 2005 andamended by a report on Form 10-K/A filed on April 15, 2005.

 

Alladjustments which are in the opinion of management, necessary for a fairstatement of the results for the interim periods presented have beenrecorded.  The results of operations forthe interim periods presented are not necessarily indicative of the results tobe expected for the full year.

 

During December 2004, the Company completed itsinitial public offering (the “IPO”). Immediately prior to the closing of the IPO, a reincorporation mergeroccurred and the Company became the parent company of its principal operatingsubsidiary, Interline Brands, Inc., a New Jersey corporation (“InterlineNew Jersey”).  In the reincorporationmerger, the holders of the preferred stock of Interline New Jersey received anaggregate of $55 million in cash and 19,183,321 shares of the Company’s commonstock and the holders of the common stock of Interline New Jersey received0.01218 shares of the Company’s common stock per share of Interline New Jerseycommon stock, or 66,667 shares of the Company’s 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 the Company’s common stock.  The Company restated earnings per share andshares outstanding for all years presented in the accompanying financialstatements to reflect the conversion of the shares.

 

*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 six-month periods ended July 1, 2005 and June 25,2004 by product category were approximately (in millions):

 
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **Product Category**                      | ** ** | **July 1, 2005**       | ** ** | **June 25, 2004**    | ** ** | **July 1, 2005** | ** ** | **June 25, 2004** | ** ** |
| Plumbing                                  |       | $                      | 87.6       |                 | $          | 80.1 |   | $ | 178.0 |   | $ | 159.5 |   |
| Electrical                                |       | 29.7                   |       | 27.4                 |       | 59.2 |   | 55.0 |   |
| Heating, Ventilation and Air Conditioning |       | 21.0                   |       | 17.1                 |       | 34.6 |   | 27.3 |   |
| Security Hardware                         |       | 13.5                   |       | 12.8                 |       | 27.2 |   | 24.9 |   |
| Hardware                                  |       | 13.2                   |       | 12.2                 |       | 25.0 |   | 22.6 |   |
| Appliances                                |       | 12.5                   |       | 10.8                 |       | 24.3 |   | 21.2 |   |
| Other                                     |       | 26.2                   |       | 25.0                 |       | 51.9 |   | 47.5 |   |
| Total                                     |       | $                      | 203.7      |                 | $          | 185.4 |   | $ | 400.2 |   | $ | 358.0 |   |

 

*Stock-basedCompensation*—TheCompany accounted for option plans in accordance with APB Opinion No. 25,under which no compensation cost has been recognized for stock optionawards.  While the

 

5

----

 

Companydoes not recognize compensation costs for stock options, the Company doesdetermine what these costs would have been using the method prescribed by SFASNo, 123 for disclosure purposes.

 

Thefair value of each option was estimated on the date of grant using theBlack-Scholes option pricing model with the following assumptions used foroptions granted in 2005 under the 2004 Equity Incentive Plan: dividend yield of0%, volatility of 22%, risk-free interest rate of 3.85% and expected life of 5years.  The following assumptions wereused for options granted in 2004 under the 2000 Stock Award Plan: dividendyield of 0%, expected volatility of 0%, risk-free interest rate of 4.05%, andexpected life of 5 years.   The fairvalue of these awards approximated zero.

 

Thefollowing table illustrates the effect on net earnings (loss) and earnings(loss) per share for the three and six months ended July 1, 2005 and June 25,2004 as if the Company had applied the fair value recognition provisions ofSFAS No. 123, “Accounting for Stock-Based Compensation,” to stock-basedemployee compensation (in thousands, except per share amounts):

 
| ** **                                                                                                                    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**    | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                                                                                                                    | ** ** | **July 1,  2005** | ** ** | **June 25,  2004** | ** ** | **July 1,  2005** | ** ** | **June 25,  2004** | ** ** |
|                                                                                                                          |       |                   |       |                    |       |   |   |   |   |
| Net income  as reported                                                                                                       |       | $                      | 8,565      |                    | $          | 6,957 |   | $ | 9,958 |   | $ | 10,208 |   |
|                                                                                                                          |       |                   |       |                    |       |   |   |   |   |
| Add:  Stock-based employee compensation expense included in reported net income,  net of related tax effects                  |       | 147                    |       | —                  |       | 293 |   | — |   |
|                                                                                                                          |       |                   |       |                    |       |   |   |   |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value  based method for all awards, net of tax |       | (246                   | )          | —                  |       | (392 | ) | — |   |
|                                                                                                                          |       |                   |       |                    |       |   |   |   |   |
| Pro forma  net income                                                                                                         |       | 8,466                  |       | 6,957                   |       | 9,859 |   | 10,208 |   |
|                                                                                                                          |       |                   |       |                    |       |   |   |   |   |
| Preferred  stock dividends                                                                                                    |       | —                 |       | (13,723                 | )          | — |   | (26,984 | ) |
|                                                                                                                          |       |                   |       |                    |       |   |   |   |   |
| Net income  (loss) applicable to common shareholders                                                                          |       | $                      | 8,466      |                    | $          | (6,766 | ) | $ | 9,859 |   | $ | (16,776 | ) |
|                                                                                                                          |       |                   |       |                    |       |   |   |   |   |
| Earnings per  share:                                                                                                          |       |                   |       |                    |       |   |   |   |   |
| Basic - as  reported                                                                                                          |       | $                      | 0.27       |                    | $          | (102.88 | ) | $ | 0.31 |   | $ | (255.74 | ) |
| Basic - pro  forma                                                                                                            |       | $                      | 0.26       |                    | $          | (102.88 | ) | $ | 0.31 |   | $ | (255.74 | ) |
|                                                                                                                          |       |                   |       |                    |       |   |   |   |   |
| Diluted - as  reported                                                                                                        |       | $                      | 0.26       |                    | $          | (102.88 | ) | $ | 0.31 |   | $ | (255.74 | ) |
| Diluted -  pro forma                                                                                                          |       | $                      | 0.26       |                    | $          | (102.88 | ) | $ | 0.30 |   | $ | (255.74 | ) |

 

*NewAccounting Pronouncements*—On December 16, 2004, the FASB issued SFAS No. 123 (revised2004), “Share-Based Payment,” which is a revision of FASB No. 123, “Accountingfor Stock-Based Compensation.” SFAS No. 123R supersedes APB Opinion No. 25,“Accounting for Stock Issued to Employees” and amends SFAS No. 95, “Statementof Cash Flows.” Generally, the approach in SFAS No. 123R is similar to theapproach described in SFAS No. 123; however, this Statement requires allshare-based payments to employees, including grants of employee stock options,be recognized in the income statement based on their fair values. Pro formadisclosure will no longer be an alternative to financial statement recognition.

 

On April 14,2005, the Securities and Exchange Commission (“SEC”) announced that it wouldprovide for a phased-in implementation process for SFAS No. 123R. The SECnow requires that registrants that are not small business issuers adopt SFAS No. 123R’sfair value method of accounting for share-based payments to

 

6

----

 

employeesnot later than the beginning of the first fiscal quarter in the year beginningafter June 15, 2005. As a result, the Company will not be required toadopt SFAS No. 123R until December 31, 2005, the first day of thecompany’s 2006 fiscal year. The Company is continuing to evaluate theprovisions of this Statement, the impact on its consolidated financialstatements and the timing and approach to adoption of this Statement.

 

In March 2004, theFASB issued Interpretation No. 46(R)-5 (“FIN 46(R)-5”), “Implicit VariableInterests under FASB Interpretation No. 46 (revised December 2003),Consolidation of Variable Interest Entities.” FIN 46(R)-5 is effective for thefirst reporting period beginning after March 3, 2005; however, earlierapplication is permitted for periods for which financial statements have notyet been issued. The Company has evaluated the impact of FIN 46(R)-5 anddetermined that the impact is immaterial to the consolidated financialstatements.

 

In May 2005,the FASB issued Statement No. 154*, “*AccountingChanges and Error Corrections—a replacement of APB Opinion No. 20 and FASBStatement No. 3” (“SFAS 154”). SFAS 154 replaces APB Opinion No. 20,“Accounting Changes,” and FASB Statement No. 3, “Reporting AccountingChanges in Interim Financial Statements,” and changes the requirements for theaccounting for and reporting of a change in accounting principle. SFAS 154requires retrospective application to prior periods’ financial statements ofchanges in accounting principle, unless it is impracticable to do so, in whichcase other alternatives are required. SFAS 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15,2005, or for the Company’s fiscal 2006 year end. We have evaluated therequirements of SFAS 154 and have determined that there is no impact onthe consolidated financial statements.

 

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

 

**2.**              EARNINGSPER SHARE

** **

Netincome (loss) per share for all periods has been computed in accordance withSFAS 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 ofshares outstanding during the year. Diluted net income per share is computed based on the weighted-averagenumber of shares of common stock as adjusted for the potential dilutive effectof stock options and non-vested stock for the period.

 

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

 
| ** **                                     | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                     | ** ** | **July, 1**            | ** ** | **June 25,**    | ** ** | **July, 1** | ** ** | **June 25,** | ** ** |
| ** **                                     | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                           |       |                   |       |                 |       |   |   |   |   |
| Net income                                     |       | $                      | 8,565      |                 | $          | 6,957 |   | $ | 9,958 |   | $ | 10,208 |   |
| Preferred  stock dividends                     |       | —                 |       | (13,723              | )          | — |   | (26,984 | ) |
| Net loss  applicable to common stockholders    |       | $                      | 8,565      |                 | $          | (6,766 | ) | $ | 9,958 |   | $ | (16,776 | ) |
|                                           |       |                   |       |                 |       |   |   |   |   |
| Weighted  average shares outstanding - basic   |       | 31,959,119             |       | 65,769               |       | 31,938,147 |   | 65,597 |   |
| Effect of  dilutive stock options              |       | 404,893                |       | —               |       | 390,126 |   | — |   |
|                                           |       |                   |       |                 |       |   |   |   |   |
| Weighted  average shares outstanding - diluted |       | 32,364,012             |       | 65,769               |       | 32,328,273 |   | 65,597 |   |

 

7

----

 

Optionsto purchase 479,456 and 2,327 shares of common stock which were outstanding at July 1,2005 and June 25, 2004, respectively, were not included in the computationof weighted average shares outstanding-diluted because the exercise prices ofthe options are greater than the average fair market value of common stock andthe effect would be antidilutive.

 

**3.**              DEBT

 

Long-term debt at July 1, 2005 and December 31,2004 consists of the following:

 
| ** **                       | ** ** | **July 1,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------------|------------|
|                             |       |                   |       |                        |       |
| Term loan                        |       | $                      | 99,500     |                        | $          | 100,000 |   |
| Note payable                     |       | 3,275                  |       | 3,275                       |       |
| 11.5% senior  subordinated notes |       | 130,000                |       | 200,000                     |       |
|                             |       |                   |       |                        |       |
|                             |       | 232,775                |       | 303,275                     |       |
| Less current  portion            |       | (1,000                 | )          | (1,000                      | )          |
|                             |       |                   |       |                        |       |
|                             |       | $                      | 231,775    |                        | $          | 302,275 |   |

 

In May 2003,Interline New Jersey completed an offering of $200 million of 11.5% seniorsubordinated notes due 2011 and entered into a $205.0 million senior securedcredit facility which consisted of a $140.0 million term loan facility and a$65.0 million revolving loan facility, a portion of which is available in theform 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) redeemall 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 transactionsare referred to as the “Refinancing Transactions”.  Debt issuance costs capitalized in connectionwith the Refinancing Transactions were approximately $13.1 million. An expenseof approximately $14.9 million for the early extinguishment of debt resultedfrom the write-off of the unamortized loan fees and loan discount relating toInterline New Jersey’s former credit facility and the redemption premiumincurred upon redemption of the 16% senior subordinated notes.

 

Thesenior subordinated notes pay interest each May 15 and November 15,with the first payment made on November 15, 2003.  Prior to May 15, 2006, Interline NewJersey may redeem up to 35% of the notes using proceeds of certain equityofferings and Interline New Jersey may redeem all of the notes after May 15,2007, subject to redemption premiums unless redeemed after May 15,2009.  Interline New Jersey elected toredeem $70.0 million of the 11.5% senior subordinated notes using proceeds fromthe Company’s IPO and gave the 30-day notice, required by the indenture, on December 20,2004.  In January 2005, the Companyrecorded a loss on extinguishment of debt of $10.3 million, consisting of thewrite-off of deferred financing costs of $2.3 million and the premium of $8.1million on the $70.0 million redemption of 11.5% senior subordinated notes.

 

In December 2004,Interline New Jersey amended its term loan facility and revolving loanfacility.  The term loan was reduced to$100.0 million from $140.0 million and the revolving loan facility wasincreased to $100.0 million from $65.0 million. As part of the amendment in December 2004, Interline New Jerseypaid down $31.3 million of the term loan using proceeds from the IPOtransaction.  Borrowings under theamended term loan facility and revolving loan facility bear interest, atInterline New Jersey’s option, at either LIBOR plus a spread or at thealternate base rate plus a spread. Interest rates in effect on borrowings underthe term loan facility at July 1, 2005 ranged from 5.78% for LIBOR basedborrowings and 7.5% for

 

8

----

 

primebased borrowings.  Outstanding letters ofcredit under the revolving loan facility are subject to a per annum fee equalto the applicable spread 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 $1.1 million.

 

As of July 1,2005, Interline New Jersey had $92.1 million available under its revolving loanfacility.  Total letters of credit issuedunder this facility as of July 1, 2005 were $7.9 million.  There were no borrowings under the revolvingloan facility at July 1, 2005. The credit facility is secured bysubstantially all of the assets of Interline New Jersey.

 

Inconjunction with the IPO and the amended credit facility, the Company recordedan expense of approximately $0.7 million for early extinguishments of debtresulting from the write-off of the unamortized loan fees relating to theCompany’s former credit facility in December 2004.  In January 2005, the Company recognizeda charge 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 derivative financial instruments, includinginterest rate exchange agreements, to manage its exposure to fluctuations ininterest rates on its debt.  All interestrate swap agreements were terminated as of December 2004.

 

Thecredit facility contains customary affirmative and negative covenants thatlimit Interline New Jersey’s ability to incur additional indebtedness, paydividends on its common stock or redeem, repurchase or retire its common stockor subordinated indebtedness, make certain investments, sell assets, andconsolidate, merge or transfer assets, and that require Interline New Jersey tomaintain a maximum debt to cash flow ratio and a minimum interest expensecoverage ratio. The Company and Interline New Jersey were in compliance with allcovenants at July 1, 2005.

 

We are a holding company whose only asset isthe stock of our subsidiaries. We conduct virtually all of our businessoperations through Interline New Jersey. Accordingly, our only material sourcesof cash are dividends and distributions with respect to our ownership interestsin Interline New Jersey that are derived from the earnings and cash flowgenerated by Interline New Jersey. The debt instruments of Interline NewJersey, primarily the credit facility and the indenture governing the terms ofthe 11.5% notes, contain significant restrictions on the payment of dividendsand distributions to us by Interline New Jersey. In particular, Interline NewJersey’s credit facility prevents it from paying dividends, making distributionsto 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 indenturefor the 11.5% notes restricts the ability of Interline New Jersey to paydistributions or dividends to us and to make advances to, or investments in,us. Dividends, distributions and investments are permitted in an amountgenerally limited to 50% of the net income of Interline New Jersey, plus anamount equal to the net proceeds from certain equity issuances if Interline NewJersey is in compliance with a leverage ratio and is not in default. Inaddition, there are certain other permitted payments, includingan ability to make distributions of up to $10 million.

 

In April 2003, the Company 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% per annum, with principal due in full in April 2010.

 

The maturities of long-termdebt subsequent to July 1, 2005 are as follows:

 
| 2005       |   | $       | 500     |   |
|------------|--------|---------|---------|--------|
| 2006       |   | 1,000   |    |
| 2007       |   | 1,000   |    |
| 2008       |   | 1,000   |    |
| 2009       |   | 1,000   |    |
| Thereafter |   | 228,275 |    |
|       |   | $       | 232,775 |   |

 

**4.**              STOCKOPTION PLANS

** **

During 2000,Interline New Jersey established a Stock Award Plan, (the “2000 Plan”), underwhich Interline New Jersey may award a total of 6,395 shares of common stock inthe form of incentive stock options (which may be awarded to key employeesonly), nonqualified stock options, stock appreciation rights, or SARs, andrestricted stock awards, all of which may be awarded to directors, officers,key employees and consultants.  Theexercise price per share for an incentive stock option may not be less than100% of the fair market value of a share of common stock on the grantdate.  The exercise price per share foran incentive stock option granted to a person owning stock possessing more than10% of the total combined voting power of all classes of stock may not be lessthan 110% of the fair market value of a share of common stock on the grantdate, and may not be exercisable after the expiration of ten years from thedate of grant.  The Company’scompensation committee will determine in its sole discretion whether a SAR issettled in cash, shares or a combination of cash and shares.

 

9

----

 

During 2004, theCompany adopted the 2004 Equity Incentive Plan, (the “2004 Plan”), under whichthe Company 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.  Under the terms of the 2004 plan and unlessthe compensation committee of the Company determines otherwise, the exerciseprice of the options will not be less than the fair market value of the commonstock at the time of grant.

 

Uponcompletion of the Company’s IPO in December 2004, 175,820 shares ofrestricted stock were issued to senior management.  The restricted stock awards will vest on anaccelerated basis contingent upon the executive’s continued employment inone-third installments over three years provided that certain pre-establishedannual percentage increases in our earnings 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.  Such awards 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 twodirectors also each received 20,000 non-qualified stock options with anexercise price equal to the IPO price of $15.00 per share.  In addition, the Company issued to management1,835,218 non-qualified stock options with an exercise price equal to the IPOprice of $15.00 per share and 590,465 non-qualified stock options with aweighted average exercise price of $24.00 per share.  All of these options were fully vested andexercisable when granted.  However,management will only be permitted to sell shares acquired upon the exercise ofthe options in 25% increments over four years.

 

Asummary of the status of 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                                |       | 30,000        |       | $19.43              |       | $                    | 19.43      |   |
| Exercised                              |       | (112,849      | )          | $15.00              |       | $                    | 15.00      |   |
| Cancelled                              |       | (151,835      | )          | $15.00 -  $1,669.13 |       | $                    | 30.73      |   |
|                                   |       |          |       |                |       |                 |       |
| Outstanding  at July 1, 2005      |       | 2,233,325     |       | $15.00 -  $41.05    |       | $                    | 16.88      |   |

 

10

----

 

**5.**              SUBSEQUENTEVENTS

 

*Acquisition*

OnJuly 7, 2005, the Company acquired all of the common stock of CCSEnterprises, Inc., known as Copperfield, a national distributor and directmarketer of specialty ventilation and chimney maintenance products.  Headquartered in Fairfield, Iowa, Copperfield’sannual sales for the year ended November 30, 2004 were $41.0 million.  The transaction was valued at$70.0 million and funded with borrowings under the Company’s creditfacility.  This acquisition represents anexpansion of the Company’s professional contractors and specialty distributorbusiness.

 

Copperfieldoffers more than 5,000 brand name and private label repair and replacementitems including chimney replacement and relining products, specialtyventilation components, hearth products and gas and electrical appliances.

 

The Company has not completed the process of performing its allocationof the purchase price.

 

*Secondary Offering of Common Stock*

On August 3, 2005, the Company priced a secondaryoffering of 7,750,000 shares of common stock at an offering price of $19.00 pershare.  The transaction closed on August 9,2005.  Because the shares were sold byselling stockholders, the company did not receive any proceeds from thisoffering.  The selling stockholders havealso granted the underwriters a 30 day over-allotment option to purchase1,162,500 shares.

 

*Credit Facility*

In connection with theCopperfield acquisition, Interline New Jersey amended its credit facility onJuly 22, 2005, to permit the incurrence of an additional $50.0 million termloan. On August 8, 2005, Interline New Jersey again amended its credit facilityto lower the interest rate spreads applicable to the additional $50.0 millionterm loan.

 

11

----

 

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

 

*References to “us” and “we” are to theCompany.  You should read the followingdiscussion in conjunction with our unaudited consolidated financial statementsand related notes included in this quarterly report, and our auditedconsolidated financial statements and related notes included  in**our Annual Report on Form 10-K filed with the SEC.*

 

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

 

This quarterly report contains forward-lookingstatements that are subject to risks and uncertainties. You should not placeundue reliance on those statements because they are subject to numerousuncertainties and factors relating to our operations and business environment,all of which are difficult to predict and many of which are beyond our control.Forward-looking statements include information concerning our possible orassumed future results of operations, including descriptions of our businessstrategy. These statements often include words such as “may,” “believe,” “expect,”“anticipate,” “intend,” “plan,” “estimate” or similar expressions. Thesestatements are based on assumptions that we have made in light of our experiencein the industry as well as our perceptions of historical trends, currentconditions, expected future developments and other factors we believe areappropriate under the circumstances. As you read and consider this quarterlyreport, you should understand that these statements are not guarantees ofperformance or results. They involve risks, uncertainties and assumptions.Although we believe that these forward-looking statements are based onreasonable assumptions, you should be aware that many factors could affect ouractual financial results or results of operations and could cause actualresults to differ materially from those in the forward-looking statements.These factors include:

 

•                  materialfacilities and systems disruptions and shutdowns,

•                  ourability to purchase products from suppliers on favorable terms,

•                  ourability to accurately predict market trends,

•                  productcost and price fluctuations due to market conditions or foreign currencyfluctuations,

•                  failureto locate and acquire acquisition candidates,

•                  failureto successfully integrate acquired businesses,

•                  dependenceon key employees,

•                  ourlevel of debt,

•                  interestrate fluctuations,

•                  futurecash flows,

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

•                  generalmarket conditions,

•                  changesin consumer preferences,

•                  adversepublicity and litigation,

•                  laborand benefit costs, and

•                  theother factors listed under “Risk Factors” in our Annual Report on Form 10-Kfiled with the SEC.

 

All information contained in this quarterlyreport is materially accurate as of the date of this report.   New risks and uncertainties arise from timeto time, and it is impossible for us to predict these events or how they mayaffect us. In light of these risks and uncertainties, you should keep in mindthat any forward-looking statement made in this quarterly report might notoccur.  We assume no obligation to updateany forward-looking statements after the date of this quarterly report as aresult of new information, future events or developments, except as required byfederal securities law.

 

Overview

 

As a leading national distributor and directmarketer of over 45,000 specialty MRO products, we sell to approximately150,000 active customer accounts. Our highly diverse customer base includesfacilities maintenance customers, professional contractors and specialtydistributors. Our customers range in size from individual contractors andindependent specialty distributors or hardware stores to apartment management companiesand national purchasing groups.

 

12

----

 

We market and sell our products primarily througheight 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 products and services to meet the individual needs of eachrespective customer group served. We reach our markets using a variety of saleschannels, including a direct sales force of field sales representatives,telesales representatives, a direct marketing program, brand-specifice-commerce websites and a national accounts sales program.

 

CriticalAccounting Policies

 

In preparing the consolidated financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America, management is required to make certain estimates, judgmentsand assumptions. These estimates, judgments and assumptions affect the reportedamounts of assets and liabilities, including the disclosure of contingentassets and liabilities, at the date of the financial statements and thereported amounts of revenues and expenses during the periods presented. On anongoing basis, management evaluates these estimates and assumptions. Managementbases its estimates and assumptions on historical experience and on variousother factors that are believed to be reasonable at the time the estimates andassumptions are made. Actual results may differ from these estimates andassumptions under different circumstances or conditions. The significantaccounting policies that management believes are the most critical in order tofully understand and evaluate our financial position and results of operationsinclude the following policies.

 

*Revenue Recognition*

 

While ourrecognition of revenue is predominantly derived from routine transactions anddoes not involve significant judgment, revenue recognition represents animportant accounting policy for us.  Werecognize a sale when the product has been shipped and risk of loss has passedto the customer, collection of the resulting receivable is probable, persuasiveevidence of an arrangement exists, and the price is fixed or determinable.  Sales are recorded net of estimated discounts,rebates and returns.  A portion of oursales is delivered direct from the manufacturer.  These direct-shipment sales are recorded on agross basis, with the corresponding cost of goods sold, in accordance with theguidance in EITF 99-19, *Reporting Revenues Grossas a Principal verses Net as an Agent*.  We provide limited product return andprotection rights to certain customers. We accrue product return reserves and warranty obligations.  A provision is made for estimated productreturns based on sales volumes and our experience.  Actual returns have not varied materiallyfrom amounts provided historically.

 

*Estimating Allowances for Doubtful Accounts*

 

We maintain allowances for doubtful accounts forestimated losses resulting from the inability to collect outstanding amountsfrom customers. The allowances include specific amounts for those accounts thatare likely to be uncollectible, such as accounts of customers in bankruptcy andgeneral allowances for those accounts that management currently believes to becollectible but later become uncollectible. Estimates are used to determine theallowances for bad debts and are based on historical collection experience,current economic trends, credit worthiness of customers and changes in customerpayment terms. Adjustments to credit limits are made based upon payment historyand our customers’ current credit worthiness. If the financial condition of ourcustomers were to deteriorate, allowances may be needed that will increaseselling, general and administrative expenses and decrease accounts receivable.  At July 1, 2005 the allowance fordoubtful accounts totaled $7.3 million.

 

*Estimating Write-Offs for Excess and Obsolete Inventory*

 

Inventories are valued at the lower of cost or market. Wedetermine inventory cost using the average cost method. We adjust inventory forexcess and obsolete inventory and for the difference by which the cost of theinventory exceeds the estimated market value. In order to determine theadjustments, management reviews inventory quantities on hand, slow movementreports and sales history reports. Management estimates the required adjustmentbased on estimated demand for products and market conditions. To the extenthistorical results are not indicative of future results and if events occurthat affect our relationships with suppliers or the salability of our products,additional write-offs may be needed that will increase our cost of sales anddecrease inventory.

 

13

----

 

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

 

Management assesses the recoverability of ourgoodwill, identifiable intangibles and other long-lived assets whenever events orchanges in circumstances indicate that the carrying value may not berecoverable. The following factors, if present, may trigger an impairmentreview: (1) significant underperformance relative to expected historicalor projected future operating results, (2) significant negative industryor economic trends, (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 course of our business, webecome involved in legal proceedings. In accordance with SFAS No. 5 “Accountingfor Contingencies,” if it is probable that, as a result of a pending legalclaim, an asset had been impaired or a liability had been incurred at the dateof the financial statements and the amount of the loss is estimable, an accrualfor the costs to resolve the claim is recorded in accrued expenses in ourbalance sheets. Professional fees related to legal claims are included ingeneral and administrative expenses in our statements of operations.Management, with the assistance of outside counsel, determines whether it isprobable that a liability from a legal claim has been incurred and estimatesthe amount of loss. The analysis is based upon potential results, assuming acombination of litigation and settlement strategies. Management does notbelieve that currently pending proceedings will have a material adverse effecton our consolidated financial position. It is possible, however, that futureresults of operations for any particular period could be materially affected bychanges in our assumptions related to these proceedings.

 

*Derivative Financial Instruments*

 

We periodically enter into derivative financialinstruments, including interest rate exchange agreements, or swaps, to manageexposure to fluctuations in interest rates on our debt. In December 2004,in conjunction with our Initial Public Offering, we terminated all interestrate exchange agreements, or swaps. Under our former swap agreements we paid a fixed rate on the notionalamount to a bank and the bank paid us a variable rate on the notional amountequal to a base LIBOR rate. These interest rate swaps did not qualify for hedgeaccounting under SFAS No. 133 “Accounting for Derivative Statementsand Hedging Activities,” and were recorded at fair value in our balance sheetwith changes in the fair value reflected in non-operating expense. The fairmarket value of these instruments was determined by quotes obtained from therelated counter parties.

 

Results of Operations

 

The following discussion includes references to theterm average daily sales. Average daily sales are defined as sales for a periodof time divided by the number of shipping days in that period of time.

 

*Overview.*  During the second quarter of 2005we achieved record revenue.  Salesincreased 9.9% to $203.7 million in the second quarter compared to $185.4million in the prior year period, with the same number of shipping days in eachperiod.  Our continued revenue growth isa reflection of improving market conditions and the success of several salesgrowth initiatives put in place over the last six quarters.  An increasing component of our top linegrowth in the second quarter came from new product initiatives, such as theexpansion of our capabilities to sell and distribute HVAC equipment.  Sales of this equipment, and including otherlarger items such as appliances and water heaters, taken as a whole, haveincreased over the prior year period at a rate exceeding 30%.  These three product groups have a higheraverage sales price than our average stock-keeping units and generally come atlower gross margins.  Our gross marginpercentage on these three specific product groups has increased compared to theprior year period.  Primarily as a resultof sales mix our consolidated gross margin percentage declined in the period by34 basis points.  We continued to benefitfrom operating expense leverage in the areas of freight, distribution centerlabor and occupancy costs which offset the

 

14

----

 

sales mix driven gross margin change.  As a result operating income increased by12.0% over the comparable prior year period.

 

*Three Months Ended July 1, 2005Compared to Three Months Ended June 25, 2004*

 

**Net Sales.**  Our net sales increased by$18.3 million, or 9.9%, to $203.7 million in the three months ended July 1,2005 from $185.4 million in the three months ended June 25,2004.  There were the same number ofshipping days in both periods.  The salesincrease was largely attributable to continued strong demand for our products,new sales and growth initiatives, and the success of new productintroductions.  Our strongest salesgrowth this quarter was 13.3% in the professional contractor market, followedby 10.5% sales growth in the facilities maintenance market and 4.0% salesgrowth in the specialty distributor market.

 

*Gross Profit.*  Gross profitincreased by $6.3 million, or 8.9%, to $77.3 million in the threemonths ended July 1, 2005 from $70.9 million in the three monthsended June 25, 2004.  Gross profitmargins decreased to 37.9% for the three months ended July 1, 2005compared to 38.3% for the three months ended June 25, 2004.  This decline in our gross profit margins is aresult of increased sales of large equipment items, such as appliances, waterheaters and HVAC equipment, which generally carry lower gross profit margins.

 

*Selling, General andAdministrative Expenses.*  SG&A expenses increased by $4.4 million, or 8.9%,to $54.5 million in the three months ended July 1, 2005 from$50.1 million in the three months ended June 25, 2004.  Certain expenses within SG&A, such as thecosts of running distribution centers, delivery expenses and selling expensesfluctuate with sales volume.  Theincrease in SG&A expenses included these increases as well as increasedinvestment in new sales and marketing initiatives.  SG&A expenses as a percentage of salesimproved approximately 20 basis points to 26.8% in the three months ended July 1,2005 from 27.0% in the three months ended June 25, 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 thebenefit of increased sales on our fixed cost infrastructure, partially offsetby our continued investment in our growth initiatives.

 

*Depreciation and Amortization.*  Depreciation andamortization expense decreased by $0.2 million, or 6.4%, to $3.2 millionin the three months ended July 1, 2005 from $3.4 million in the threemonths ended June 25, 2004.

 

*Operating Income.*  As a result of theforegoing, operating income increased by $2.1 million, or 12.0%, to$19.5 million in the three months ended July 1, 2005 from $17.4million in the three months ended June 25, 2004.  As a percent of sales, operating incomeincreased to 9.6% in the current quarter from 9.4% in the comparable prior yearperiod.

 

*Change in Fair Value of Interest RateSwaps.*  Ourinterest rate swaps were terminated at the time of our IPO in December 2004.  As such, changes in fair value of interestrate swaps were zero in the three months ended July 1, 2005 compared to again of $3.6 million in the three months ended June 25, 2004.  Theses gains are related to changes in themarket value of our interest rate swap instruments. The non-cash gains wereattributable to changes in market conditions, including but not limited tofluctuations in interest rates, general market volatility, and the remainingtenor of our instruments.

 

*Interest Expense.*  Interest expensedecreased by $4.4 million in the three months ended July 1, 2005 to$5.7 million from $10.1 million in the three months ended June 25,2004.  The net decrease was attributed tolower debt balances associated with the early extinguishment of $70.0 millionof the 11.5% senior subordinated notes of Interline New Jersey in January 2005and the pay down of $31.3 million of our term loan, as well as lower interestexpense associated with the termination of our interest rate swaps and thewrite-off of deferred financing costs – all associated with our IPO.

 

*Provision for Income Taxes.*  The provision for income taxeswas $5.3 million in the three months ended July 1, 2005 compared to aprovision of $4.0 million in the three months ended June 25, 2004.The effective tax rate for the three months ended July 1, 2005 was 38.4%compared to 36.7% in the three months ended June 25, 2004.  The increase in the effective tax rate wasdue primarily to lower state income taxes during the three months ended June 25,2004.

 

15

----

 

*Six Months Ended July 1, 2005Compared to Six Months Ended June 25, 2004*

 

**Net Sales.**  Our netsales increased by $42.2 million, or 11.8%, to $400.2 million in thesix months ended July 1, 2005 from $358.0 million in the six monthsended June 25, 2004.  During 2005 wehad one more shipping day than during the prior year period.  Average daily sales increased 10.9% to$3.1 million in the six months ended July 1, 2005 compared to$2.8 million in the six months ended June 25, 2004.  The sales increase was largely attributableto improved demand for our products, new sales and growth initiatives, and tonew product introductions.  Average dailysales growth for the six months ended July 1, 2005 was 15.9% in theprofessional contractor market, followed by 10.9% sales growth in thefacilities maintenance market and 4.4% sales growth in the specialtydistributor market.

 

*Gross Profit.*  Gross profitincreased by $16.1 million, or 11.8%, to $152.7 million in the sixmonths ended July 1, 2005 from $136.7 million in the six months endedJune 25, 2004.  Gross profit marginsremained steady at 38.2% for the six months ended July 1, 2005 and June 25,2004.  Gross profit margins in certainproduct categories improved due to the success of our private label program,improved pricing from suppliers, and increased efficiencies at our nationaldistribution center.   These benefitswere offset by the increase in sales of lower margin products such as appliances,water heaters and HVAC equipment.

 

*Selling, General andAdministrative Expenses.*  SG&A expenses increased by $9.9 million, or 10.1%,to $108.3 million in the six months ended July 1, 2005 from$98.3 million in the six months ended June 25, 2004.  Certain expenses within SG&A, such as thecosts of running distribution centers, delivery expenses and selling expensesfluctuate with sales volume.  Theincrease in SG&A expenses included these increases as well as continuinginvestments in new sales and marketing initiatives.  SG&A expenses as a percentage of salesimproved 40 basis points to 27.1% in the six months ended July 1, 2005from 27.5% in the six months ended June 25, 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 thebenefit of increased sales on our fixed cost infrastructure, partially offsetby our continued investment in our growth initiatives.

 

*Depreciation and Amortization.*  Depreciation andamortization expense decreased by $0.1 million, or 1.4%, to $6.3 millionin the six months ended July 1, 2005 from $6.4 million in the sixmonths ended June 25, 2004.

 

*Operating Income.*  As a result of theforegoing, operating income increased by $6.2 million, or 19.6%, to$38.1 million in the six months ended July 1, 2005 from$31.9 million in the six months ended June 25, 2004.  As a percent of sales, operating incomeincreased to 9.5% in the first six months from 8.9% in the comparable prioryear period.

 

*Change in Fair Value of Interest RateSwaps.*  Ourinterest rate swaps were terminated at the time of our IPO in December 2004.  As such, changes in fair value of interestrate swaps were zero in the six months ended July 1, 2005 compared to again of $4.7 million in the six months ended June 25, 2004.  Theses gains are related to changes in themarket value of our interest rate swap instruments. The non-cash gains wereattributable to changes in market conditions, including but not limited tofluctuations in interest rates, general market volatility, and the remainingtenor of our instruments.

 

*Interest Expense.*  Interest expensedecreased by $8.3 million in the six months ended July 1, 2005 to$12.0 million from $20.3 million in the six months ended June 25,2004.  The net decrease was attributed tolower debt balances associated with the early extinguishment of $70.0 millionof the 11.5% senior subordinated notes of Interline New Jersey in January 2005and the pay down of $31.5 million of our term loan, as well as lower interestexpense associated with the termination of our interest rate swaps and thewrite-off of deferred financing costs – all associated with our IPO.

 

*Loss on Extinguishment of Debt*.  Aspart of our IPO, we redeemed $70.0 million of the 11.5% senior subordinatednotes 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 connection with the

 

16

----

 

redemption,we recorded a $10.3 million loss on the early extinguishment of debt in thefirst quarter of 2005, consisting ofan $8.1 million redemption premium and $2.3 million write-off of deferredfinancing costs.

 

*Provision for Income Taxes.*  The provision for income taxeswas $6.2 million in the fiscal six months ended July 1, 2005 comparedto a provision of $6.3 million in the six months ended June 25, 2004.The effective tax rate for the six months ended July 1, 2005 was 38.5%compared to 38.2% in the six months ended June 25, 2004. The increase inthe effective tax rate was due primarily to a decrease in our state incometaxes and foreign income taxes partially offset by an increase innon-deductible expenses.

 

**Liquidity and Capital Resources**

 

As of July 1,2005, we had approximately $92.1 million of availability under InterlineNew 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 the revolving loan facilityunder our credit facility, are used to support payment obligations incurred forour general corporate purposes.  As of July 1,2005, we had $7.9 million of letters of credit issued under the creditfacility.  Interest on Interline NewJersey’s 11.5% senior subordinated notes due 2011 is payable each May 15and November 15.  With respect toborrowings under our credit facility, we have the option to borrow at anadjusted LIBOR or an alternative base rate. Interest on the credit facility is generally payable quarterly, and withrespect to any LIBOR borrowings, on the last day of the interest periodapplicable to the term of the borrowing.

 

We are a holding company whose only asset is the stockof our subsidiaries.  We conductvirtually 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 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 New Jersey’s credit facility prevents it frompaying dividends, making distributions 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%notes restricts the ability of Interline New Jersey to pay distributions ordividends to 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 operating activities was$11.8 million for the six months ended July 1, 2005 compared to netcash provided by operating activities of $5.8 million in the six monthsended June 25, 2004.  Net cashprovided by operating activities for the six months ended July 1, 2005 washigher than the prior year period primarily as a result of our increase inoperating income of $6.2 million and changes in our core working capital of$3.9 million.  This was partially offsetby the changes in all other assets and liabilities.  In addition, we had lower cash interestexpense of $8.6 million, resulting from our lower average debt balances, whichwere reduced using proceeds from our IPO transaction, and higher cash taxes of$9.3 million, due to timing of income tax payments.

 

Net cash used in investing activities was$5.5 million in the six months ended July 1, 2005 compared to $4.2million in the six months ended June 25, 2004.  Net cash used in investing activities in thesix months ended July 1, 2005 and the six months ended June 25, 2004were primarily attributable to capital expenditures made in the ordinary courseof business and costs related to purchases of businesses.

 

17

----

 

Net cash used in financing activities totaled$75.1 million for the six months ended July 1, 2005 compared to netcash provided by financing activities of $0.7 million in the six monthsended June 25, 2004.  Net cash usedin financing activities for the six months ended July 1, 2005 wasprimarily attributable to our repayment of $70.0 million of our seniorsubordinated notes and $8.1 million in related redemption premiums partiallyoffset by $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 July 1, 2005, other than the redemptionof $70.0 million of Interline New Jersey’s 11.5% senior subordinated notes asdescribed above, our contractual obligations and other contractual commitmentshave not changed materially outside the ordinary course of business since December 31,2004.

 

*Our Initial Public Offering and Related Transactions*

 

In December 2004, we successfully completed ourinitial public offering, or IPO, and amended Interline New Jersey’s seniorcredit facility.  A total of 14,375,000shares of our common stock were sold, of which 12,667,000 were sold by us and1,708,000 were sold by our shareholders. We sold 12,500,000 shares of ourcommon stock in December 2004 and 167,000 shares in January 2005following the exercise of the underwriters’ over-allotment option.  We received $171.8 million in net proceedsincluding the exercise of the underwriters’ over-allotment option, representing$176.9 million of proceeds from the sale of stock net of underwriting discountsand commissions, less $4.1 million of initial public offering costs and $1.1million of debt issuance costs.

 

Immediately prior to the closing of the IPO, areincorporation merger occurred and we became the holding company of theInterline group of businesses with Interline New Jersey as our wholly owned operatingsubsidiary.  In the reincorporationmerger, the holders of the preferred stock of Interline New Jersey received anaggregate of $55 million in cash and 19,183,321 shares of our common stock andthe holders of the common stock of Interline New Jersey received 0.01218 sharesof our common stock per share of Interline New Jersey common stock, or 66,667shares of our common stock in total.  Inaddition, holders of options to purchase shares of the common stock ofInterline New Jersey were converted into options to purchase shares of ourcommon stock.

 

We used $31.3 million of the proceeds to partiallyrepay the term loan under Interline New Jersey’s credit facility.  We amended Interline New Jersey’s seniorcredit facility to allow for the IPO and reduce our applicable rate in respectto 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 toterminate certain interest rate swap agreements.  In January 2005 we used $70.0 million ofthe proceeds from the IPO transaction to partially redeem Interline New Jersey’s11.5% senior subordinated notes.  Inconnection with the redemption, in January 2005 we paid $8.1 million ofpremiums for early redemption of the 11.5% senior subordinated notes andrecorded a $10.3 million loss on the early extinguishment of debt, whichincluded a charge for write-off of unamortized debt issuance costs in theamount of $2.3 million.

 

We refer to the transactions described in this section collectivelyas the “IPO Transactions”.

 

*Capital Expenditures*

 

Capital expenditures were $3.9 million in the sixmonths ended July 1, 2005 compared to $3.7 million in the six months endedJune 25, 2004.  Capital expendituresas a percentage of sales were 1.0% in both periods.

 

*Liquidity*

 

Our principal working capital need is for inventoryand trade accounts receivable, which have generally increased with the growthin our business.  Our principal sourcesof cash to fund our working capital needs are cash generated from operatingactivities and borrowings under our revolving credit facility.

 

18

----

 

*Credit Facility*

 

Interline New Jersey entered into a credit facilityon May 29, 2003, which was amended as of December 19, 2003, andamended again on December 21, 2004 in connection with the IPOTransactions.  Interline New Jersey alsoamended its credit facility on July 7, 2005, to permit the incurrence ofan additional $50.0 million term loan, having substantially the same terms asthe existing 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 a portion not exceeding $20.0 million will beavailable in the form of letters of credit, and (2) a term loan facilityof $150.0 million.  Borrowings underthe amended term loan facility and revolving loan facility bear interest, atInterline New Jersey’s option, at either adjusted LIBOR or at the alternatebase rate plus a spread.  Outstandingletters of credit under the revolving loan facility are subject to a per annumfee equal to the applicable spread over 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 the proceeds from theadditional $50.0 million term loan and $20.0 million of borrowings under therevolving loan facility to fund the Copperfield acquisition.  As of July 1, 2005, after giving effectto the Copperfield acquisition as if it occurred on that date, Interline NewJersey had $149.5 million aggregate principal outstanding under the term loanfacility.

 

During the six months ended July 1, 2005 weborrowed periodically on our revolving credit facility to accommodate our dailyworking capital needs. The weighted average daily outstanding balance duringthe six-month period was $10.2 million, with ordinary course borrowingsranging from $0.0 million to $22.0 million. As of July 1, 2005,Interline New Jersey had $7.9 million of letters of credit issued underthe revolving loan facility and $99.5 million aggregate principaloutstanding under the term loan facility.

 

We believe that cash flow from operations andavailable borrowing capacity under our new credit facility will be adequate tofinance our ongoing operational cash flow needs and debt service obligationsfor the next twelve months.

 

ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET 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 hashistorically been moderate the company and its markets have been impacted overthe past year by rising raw material prices and resulting supplier costincreases.  These increases havegenerally served to increase sales results.

 

The majority of our purchases from foreign-basedsuppliers are from China and other countries in Asia and are transacted in U.S.dollars.  On July 21, 2005, thePeople’s Bank of China announced that the yuan will no longer be pegged to theU.S. dollar, but will be allowed to float in a band (and to a limited extent,increase in value) against a basket of foreign currencies, a move thatincreases the risk that Chinese-sourced products could become more expensivefor us.

 

*Derivative Financial Instruments*

 

Periodically, the company had entered into derivativefinancial instruments, including interest rate exchange agreements, or swaps,to manage our exposure to fluctuations in interest rates on our debt.  As of July 1, 2005, we did not have anyinterest rate swap exchange agreements, or swaps.  Under our former swap agreements, we pay afixed rate on the notional amount to our banks and the banks pay us a variablerate on the notional amount equal to a base LIBOR rate.  Our derivative activities, all of which arefor purposes other than trading, are initiated within the guidelines ofcorporate risk-management policies.

 

We periodically evaluate the costs and benefits of anychanges in our interest rate risk.  Basedon such evaluation, we may enter into new interest rate swaps to manage ourinterest rate exposure.

 

19

----

 

ITEM 4.CONTROLS AND PROCEDURES.

 

Our management, with the participation of ourChief Executive Officer and Chief Financial Officer (our principal executiveofficer and principal financial officer), evaluated the effectiveness of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act) as of July 1, 2005. Based on thisevaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of July 1, 2005, ourdisclosure controls and procedures were: (1) designed to ensure thatmaterial information relating to us, including our consolidated subsidiaries,is made known to our Chief Executive Officer and  Chief Financial Officer by others withinthose entities, particularly during the period in which this report was beingprepared, and (2) effective, in that they provide reasonable assurancethat information 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.

 

No change in our internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act) occurred during the quarter ended July 1, 2005 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**PART II. OTHER INFORMATION**

 

ITEM1. LEGAL PROCEEDINGS.

 

We are involved in various legal proceedings that have arisenin the ordinary course of our business and have not been fully adjudicated.These actions, when ultimately concluded and determined, will not, in theopinion of management, have a material effect upon our consolidated financialposition, results of operations or liquidity.

 

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

 

None

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

None

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

 

The 2005Annual Meeting of stockholders of the Company was held on Thursday, May 26,2005 (the “2005 Annual Meeting”). The matters which were submitted to theCompany’s stockholders for approval at the 2005 Annual Meeting included (1) theelection of two Class I Directors, Ernest K. Jacquet and John J. Gavin, and (2)the ratification of the selection of Deloitte & Touche LLP as theindependent registered public accounting firm of the Company for the fiscalyear ending December 30, 2005.

 

Both nomineesfor election to the board were elected to serve until the Annual Meeting in2008, and until their respective successors are elected and qualified. Theterms of the Class II Directors (Barry J. Goldstein, Charles W. Santoro andDrew T. Sawyer) and Class III Directors (Gideon Argov, Christopher C. Behrensand Michael J. Grebe) continue until the Annual Meetings in 2006 and 2007,respectively, and until their respective successors are elected and qualified.

 

As of April11, 2005, the record date for the 2005 Annual Meeting, there were 32,102,820shares issued and outstanding and entitled to vote at the 2005 Annual Meeting.There were 23,879,024 shares present in person or by proxy, which constitutesapproximately 74 percent of the shares entitled to vote at the 2005 AnnualMeeting.

 

The number ofvotes cast for, against or withheld, and the number of abstentions and brokernon-votes with respect to each proposal is set forth below:

 

DirectorElections:

 
| **Nominee**       | ** ** | **For**    | ** ** | **Against** | ** ** | **Withheld** | ** ** |
|-------------------|------------|------------|------------|-------------|------------|--------------|------------|
|              |       |       |       |        |       |         |       |
| Ernest K. Jacquet |       | 23,728,309 |       | 0           |       | 150,715      |       |
|              |       |       |       |        |       |         |       |
| John G. Gavin     |       | 23,828,544 |       | 0           |       | 50,480       |       |

 

Ratificationof the selection of Deloitte & Touche LLP as the independent registeredpublic accounting firm of the Company for the fiscal year ending December 30,2005:

 

| **For**    | ** ** | **Against** | ** ** | **Withheld** | ** ** |
|------------|------------|-------------|------------|--------------|------------|
| 23,873,620 |       | 4,404       |       | 1,000        |       |

 

ITEM 5. OTHER INFORMATION.

 

*Bonus Program*

On May 26, 2005,the Compensation Committee of the Board of Directors of the Company approved abonus program and performance measures and goals for the payment of bonuses forthe fiscal year ending December 30, 2005. All of the Company’s executiveofficers are eligible to participate in this bonus program. The key performancemeasures selected by the Compensation Committee for this 2005 bonus program are(i) earnings per share (EPS) and (ii) tangible return on invested capital(Tangible ROIC), which is a function of the Company’s adjusted EBITDA, averagecore working capital and average property and equipment. In each case theCompensation Committee retains discretion to adjust the performance measures toexclude the effects of certain events and transactions.

 

The Company’sexecutive officers are each eligible to earn a bonus under the 2005 bonusprogram, as provided in their respective employment agreements, pursuant towhich executives could earn bonuses between 30% and 120% of their annual basesalary. Under this program, the Compensation Committee retains discretion toadjust bonuses in excess of these amounts in the event of superior performanceabove the targeted performance measures with no individual bonus exceeding 200%of annual base salary.

 

*CreditFacility*

On August 8,2005, Interline New Jersey amended its credit facility to lower the interestrate spreads applicable to the additional $50.0 million term loan.

 

ITEM 6. EXHIBITS.

 

The following exhibits are being filed aspart of this Quarterly Report on Form 10-Q:

 
| 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 (furnished herewith).                                             |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                              |
| 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).                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                              |
| 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).                                                                                                                                 |

 

20

----

 
| 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). |

 

21

----

 

**Signatures**

 

Pursuant to the requirements of the Securities Exchange Actof 1934, the Registrant has duly caused this report to be signed on its behalfby the undersigned hereunto duly authorized.

 
|   |   | INTERLINE BRANDS, INC.                                             |
|--------|--------|--------------------------------------------------------------------|
|   |   |                                                               |
|   |   |                                                               |
|   |   | BY:                                                                |   /S/  MICHAEL J. GREBE |   |
|   |   |                                                               | Michael J. GrebePresident  and Chief Executive Officer |
|   |   |                                                               |
|   |   |  (Duly Authorized Signatory and Principal  Executive Officer) |

 

 

Date: August 11, 2005

 

----

 

**Signatures**

 

Pursuant to the requirements of the Securities Exchange Actof 1934, the Registrant has duly caused this report to be signed on its behalfby the undersigned hereunto duly authorized.

 
|   |   | INTERLINE BRANDS, INC.                                             |
|--------|--------|--------------------------------------------------------------------|
|   |   |                                                               |
|   |   |                                                               |
|   |   | BY:                                                                |   /S/  THOMAS J. TOSSAVAINEN |   |
|   |   |                                                               | Thomas J. TossavainenChief  Financial Officer |
|   |   |                                                               |
|   |   |  (Duly Authorized Signatory and Principal  Financial Officer) |

 

 

Date: August 11, 2005

 

----