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INTERLINE BRANDS, INC./DE - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) References to "us" and "we" are to the Company. You should read the following discussion in conjunction with our unaudited consolidated financial statements and related notes included in this quarterly report, and our audited consolidated financial statements and related notes and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC"). Forward-Looking Statements This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act") that are subject to risks and uncertainties. You should not place undue reliance on those statements because they are subject to numerous uncertainties 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 or assumed future results of operations, including descriptions of our business strategy, the impact of the Merger, as defined in "Recent Developments" below, and amounts that may be paid for resolution of legal matters. These statements often include words such as "may," "believe," "expect," "anticipate," "intend," "plan," "estimate" or similar expressions, including, without limitation, certain statements in "Results of Operations", "Liquidity and Capital Resources", and Item 3. Quantitative and Qualitative Disclosures About Market Risk. These statements are based on assumptions that we have made in light of our experience in the industry as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. As you read and consider this report, you should understand that these statements are not guarantees of performance or results. They involve risks, uncertainties and assumptions. Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual financial results or results of operations and could cause actual results to differ materially from those in the forward-looking statements. These factors include: • our level of indebtedness, • future cash flows, • the highly competitive nature of the maintenance, repair and operations distribution industry, • general market conditions, • apartment vacancy rates and effective rents, • governmental and educational budget constraints, • work stoppages or other business interruptions at transportation centers or shipping ports, • our ability to accurately predict market trends, • adverse publicity, • the impact of the resolution of current or future legal claims, • labor and benefit costs, • the loss of significant customers, • adverse changes in trends in the home improvement and remodeling and home building markets, • health care costs, • product cost and price fluctuations due to inflation and currency exchange rates, • inability to identify, acquire and successfully integrate acquisition candidates, • our ability to purchase products from suppliers on favorable terms, • fluctuations in the cost of commodity-based products and raw materials (such as copper) and fuel prices, • our customers' ability to pay us, • inability to realize expected benefits from acquisitions, • consumer spending and debt levels, • interest rate fluctuations, • weather conditions and catastrophic weather events, • material facilities and systems disruptions and shutdowns, • the length of our supply chains, • dependence on key employees, • credit market contractions, • changes to tariffs between the countries in which we operate, • our ability to protect trademarks, • changes in governmental regulations related to our product offerings, and • changes in consumer preferences. 16 -------------------------------------------------------------------------------- Table of Contents Any forward-looking statements made by us in this report, or elsewhere, speak only as of the date on which we make them. New risks and uncertainties arise from time to time, and it is impossible for us to predict these events or how they may affect us. In light of these risks and uncertainties, any forward-looking statements made in this report or elsewhere might not occur. Overview We are a leading national distributor and direct marketer of broad-line maintenance, repair and operations ("MRO") products. We have one operating segment, the distribution of MRO products into the facilities maintenance end-market. We stock approximately 100,000 MRO products in the following categories: janitorial and sanitation ("JanSan"); hardware, tools and fixtures; plumbing; heating, ventilation and air conditioning ("HVAC"); electrical and lighting; appliances and parts; security and safety; and other miscellaneous maintenance products. Our products are primarily used for the repair, maintenance, remodeling, and refurbishment of non-industrial and residential facilities. Our diverse facilities maintenance customer base includes institutions, such as educational, lodging, health care, and government facilities; multi-family housing, such as apartment complexes; and residential, such as professional contractors, and plumbing and hardware retailers. Our customers range in size from individual contractors and independent hardware stores to apartment management companies and national purchasing groups. We market and sell our products primarily through thirteen distinct and targeted brands, each of which is recognized in the facilities maintenance markets they serve for providing quality products at competitive prices with reliable same-day or next-day delivery. The AmSan®, JanPak®, CleanSource®, Sexauer®, and Trayco® brands generally serve our institutional facilities customers; the Wilmar® and Maintenance USA® brands generally serve our multi-family housing facilities customers; and the Barnett®, Copperfield®, U.S. Lock®, Hardware Express®, LeranSM and AF Lighting® brands generally serve our residential facilities customers. Our multi-brand operating model, which we believe is unique in the industry, allows us to use a single platform to deliver tailored products and services to meet the individual needs of each respective customer group served. We reach our markets using a variety of sales channels, including a field sales force of approximately 1,140 associates, which includes sales management and related associates, approximately 470 inside sales and customer service and support associates, a direct marketing program consisting of catalogs and promotional flyers, brandspecific websites, a national accounts sales program, and other supply chain programs, such as vendor managed inventory. We deliver our products through our network of 67 distribution centers, 22 professional contractor showrooms located throughout the United States, Canada, and Puerto Rico, 72 vendor-managed inventory locations at large customer locations and a dedicated fleet of trucks and third party carriers. Our broad distribution network enables us to provide reliable, next-day delivery service to approximately 98% of the U.S. population and same-day delivery service to most major metropolitan markets in the U.S. Our information technology and logistics platforms support our major business functions, allowing us to market and sell our products at varying price points depending on the customer's service requirements. While we market our products under a variety of brands, generally our brands draw from the same inventory within common distribution centers and share associated employee and transportation costs. In addition, we have centralized marketing, purchasing and catalog production operations to support our brands. We believe that our information technology and logistics platforms also benefit our customers by allowing us to offer a broad product selection at highly competitive prices while maintaining the unique customer appeal of each of our targeted brands. Overall, we believe that our common operating platforms have enabled us to improve customer service, maintain lower operating costs, efficiently manage working capital and support our growth initiatives. Recent Developments On March 17, 2014, Interline New Jersey completed the following financing transactions: • entered into a first lien term loan under which Interline New Jersey incurred a term loan in an aggregate principal amount of $350.0 million (the "Term Loan Facility"); and • amended the asset-based senior secured revolving credit facility, dated as of September 7, 2012 (the "ABL Facility"), by entering into the First Amendment to Credit Agreement to permit the incurrence of the Term Loan Facility and make other changes in connection with the refinancing (the "First ABL Facility Amendment"). 17-------------------------------------------------------------------------------- Table of Contents The proceeds from the Term Loan Facility were used to finance the redemption of Interline New Jersey's outstanding 7.50% Notes due 2018 (the "OpCo Notes"), the repayment of a portion of amounts outstanding under the ABL Facility and the payment of related fees, costs and expenses. In connection with the redemption of the OpCo Notes, the Company recorded a loss on early extinguishment of debt in the amount of $4.2 million. The loss was comprised of $18.5 million in consent solicitation, tender premium, call premium and related transaction costs less a non-cash benefit of $14.3 million associated with the write-off of the unamortized fair value premium of $17.8 million less the write-off of the unamortized deferred debt financing costs of $3.5 million. On April 8, 2014, Interline New Jersey further amended the ABL Facility by entering into the Second Amendment to Credit Agreement to amend certain pricing terms applicable to the ABL Facility and extend the maturity date of the ABL Facility to April 8, 2019, at which date the principal amount outstanding under the ABL Facility will be due and payable in full (the "Second ABL Facility Amendment"). See "-Liquidity and Capital Resources" for further information regarding the financing transactions. Results of Operations The following table presents information derived from the consolidated statements of operations expressed as a percentage of net sales for the three months ended March 28, 2014 and March 29, 2013: % of Net Sales Three Months Ended % Increase March 28, 2014 March 29, 2013 (Decrease)(1) Net sales 100.0% 100.0% 3.1% Cost of sales 65.4 65.4 3.1 Gross profit 34.6 34.6 3.1 Operating Expenses: Selling, general and administrative expenses 29.0 28.7 4.4 Depreciation and amortization 3.2 3.2 2.0 Merger related expenses - 0.2 (87.0) Total operating expenses 32.3 32.1 3.6 Operating income 2.3 2.5 (2.8) Loss on extinguishment of debt, net (1.1) - - Interest expense (4.0) (4.2) (0.9) Interest and other income - 0.1 (63.8) Loss before income taxes (2.7) (1.6) 78.0 Income tax benefit (1.1) (1.2) 0.1 Net loss (1.6)% (0.4)% 311.8% ____________________(1) Percent increase (decrease) represents the actual change as a percentage of the prior year's result. Overview. During the three months ended March 28, 2014, our sales increased 3.1% versus the prior year period, primarily reflecting continued economic improvements across our facilities maintenance end-market, combined with our continued investments in our sales forces and our information technology. Sales to our institutional facilities customers, which comprised 51.0% of our total sales, increased 2.9% in total. Sales to our multi-family housing facilities customers, which comprised 28.8% of our total sales, increased 4.9%. Sales to our residential facilities customers, which comprised 20.2% of our total sales, increased 0.7%. We believe we are starting to more fully realize the benefits of our efforts to strengthen our business, improve our competitive position, and enhance our market capabilities. We expect these trends to continue for the remainder of 2014 as we continue our investments in our sales force and other key areas of our business. Operating income as a percentage of net sales was 2.3% for the three months ended March 28, 2014 and 2.5% for the three months ended March 29, 2013. 18 -------------------------------------------------------------------------------- Table of Contents Net loss as a percentage of net sales was 1.6% for the three months ended March 28, 2014 compared to 0.4% in the comparable prior year period due to the loss on extinguishment of debt, net as a result of the redemption of the OpCo Notes and the related financing transactions that were completed during the first quarter of 2014, as more fully discussed in the "-Liquidity and Capital Resources" section below. Three Months Ended March 28, 2014 Compared to the Three Months Ended March 29, 2013 Net Sales. Net sales increased by $11.7 million, or 3.1%, to $392.5 million for the three months ended March 28, 2014 from $380.8 million for the three months ended March 29, 2013. Sales to our institutional facilities customers increased by $5.7 million, sales to our multi-family housing facilities customers increased by $5.3 million, and sales to our residential facilities customers increased by $0.5 million. There were 64 shipping days in both the three months ended March 28, 2014 and the three months ended March 29, 2013. Gross Profit. Gross profit increased by $4.1 million, or 3.1%, to $135.8 million for the three months ended March 28, 2014 from $131.7 million for the three months ended March 29, 2013. Our gross profit margin was 34.6% in both the three months ended March 28, 2014 and the three months ended March 29, 2013. Selling, General and Administrative Expenses ("SG&A"). SG&A expenses increased by $4.8 million, or 4.4%, to $114.0 million for the three months ended March 28, 2014 from $109.2 million for the three months ended March 29, 2013. As a percentage of net sales, SG&A expenses increased 30 basis points to 29.0% for the three months ended March 28, 2014 compared to 28.7% for the three months ended March 29, 2013. The increase in SG&A expenses as a percentage of net sales was primarily due to higher distribution center consolidation and restructuring costs, higher payroll and fringe benefit costs, and higher delivery costs, partially offset by lower share based compensation expense and other variable SG&A expenses as a percentage of net sales. Depreciation and Amortization. Depreciation and amortization expense increased by $0.2 million, or 2.0%, to $12.6 million for the three months ended March 28, 2014 from $12.4 million for the three months ended March 29, 2013. As a percentage of net sales, depreciation and amortization was 3.2% for both the three months ended March 28, 2014 and the three months ended March 29, 2013. The increase was primarily driven by the amortization of definite-lived intangible assets as these assets are being amortized on an accelerated basis. Merger related expenses. Merger related expenses incurred during the three months ended March 28, 2014 of $0.1 million was comprised of transaction related compensation incurred as a result of the Merger. Merger related expenses incurred for the three months ended March 29, 2013 of $0.8 million consisted of transaction related compensation of $0.6 million and professional fees of $0.1 million, and other costs of $0.2 million, all incurred as a direct result of the Merger. Operating income. As a result of the foregoing, operating income changed by $0.3 million, or 2.8%, to $9.1 million for the three months ended March 28, 2014 from $9.4 million for the three months ended March 29, 2013. Loss on extinguishment of debt. In connection with the redemption of the OpCo Notes and the related refinancing transactions, we recorded a loss on extinguishment of debt, net of $4.2 million which consisted of $18.5 million in consent solicitation, tender premium, call premium and related transaction costs less a non-cash benefit of $14.3 million associated with the write-off of the unamortized fair value premium of $17.8 million less the write-off of the unamortized deferred debt financing costs of $3.5 million. There was no extinguishment of debt that occurred during the same period in the prior year. Interest Expense. Interest expense decreased $0.1 million, or 0.9%, to $15.7 million for the three months ended March 28, 2014 from $15.8 million in the combined three months ended March 29, 2013. The decrease in interest expense was directly attributable to interest expense savings realized as a result of the financing transactions that occurred in the first quarter of 2014. Income tax benefit. Income taxes were relatively consistent year-over-year with a benefit of $4.4 million for the three months ended March 28, 2014 and March 29, 2013, respectively. The effective tax rate for the three months ended March 28, 2014 and March 29, 2013 was 42.2% and 75.0%, respectively. The change in the effective tax rate during the first quarter of 2014 compared to the comparable prior year period is due to a refinement in the deferred state tax rates estimated in the first quarter of 2013. 19 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Overview We are a holding company whose only asset is the stock of Interline New Jersey. We conduct virtually all of our business operations through Interline New Jersey. Accordingly, our only material sources of cash are dividends and distributions with respect to our ownership interests in Interline New Jersey that are derived from the earnings and cash flow generated by Interline New Jersey. On March 17, 2014, Interline New Jersey completed the following refinancing transactions: • entered into a first lien term loan agreement under which Interline New Jersey incurred a term loan in an aggregate principal amount of $350.0 million (the "Term Loan Facility"); and • amended the asset-based senior secured revolving credit facility, dated as of September 7, 2012 (the "ABL Facility"), by entering into the First Amendment to Credit Agreement to permit the incurrence of the Term Loan Facility and make other changes in connection with the refinancing (the "First ABL Facility Amendment"). The proceeds from the Term Loan Facility were used to finance the redemption of Interline New Jersey's outstanding 7.50% Notes due 2018 (the "OpCo Notes"), the repayment of a portion of amounts outstanding under the ABL Facility and the payment of related fees, costs and expenses. In connection with the redemption of the OpCo Notes, the Company recorded a loss on early extinguishment of debt in the amount of $4.2 million. The loss was comprised of $18.5 million in consent solicitation, tender premium, call premium and related transaction costs less a non-cash benefit of $14.3 million associated with the unamortized fair value premium of $17.8 million less unamortized deferred financing costs of $3.5 million. In addition to making changes that were required in order to permit the incurrence of the Term Loan Facility and the redemption of the OpCo Notes, the First ABL Facility Amendment also made various changes to the ABL Facility that were intended to conform certain covenant baskets and related terms with those contained in the Term Loan Facility (the terms of which are disclosed below under "-Term Loan Facility"). The First ABL Facility Amendment also released the security interest previously granted by the Company to secure the ABL Facility, subject to a requirement that the Company re-pledge its assets to secure the ABL Facility in the event that the Company's 10.00% / 10.75% Senior Notes due 2018 (the "HoldCo Notes") are no longer outstanding. Accordingly, while the Company will guaranty both the Term Loan Facility and the ABL Facility, its assets will not be pledged to secure either such facility so long as the HoldCo Notes remain outstanding. On April 8, 2014, Interline New Jersey further amended the ABL Facility by entering into the Second Amendment to Credit Agreement to amend certain pricing terms applicable to the ABL Facility and extend the maturity date of the ABL Facility to April 8, 2019 (the "Second ABL Facility Amendment"). The debt instruments of Interline New Jersey, primarily the ABL Facility and the Term Loan, contain significant restrictions on the payment of dividends and distributions to the Company by Interline New Jersey. See "-ABL Facility" and "-Term Loan Facility" for more information on the ABL Facility and the Term Loan Facility, respectively. Interline New Jersey and the Company were in compliance with all covenants contained in the ABL Facility, the Term Loan Facility, and HoldCo Notes as of March 28, 2014. Liquidity Historically, our capital requirements have been for debt service obligations, working capital requirements, including inventories, accounts receivable and accounts payable, acquisitions, the expansion and maintenance of our distribution network and upgrades of our information systems. We expect this to continue in the foreseeable future. Historically, we have funded these requirements through cash flow generated from operating activities and funds borrowed under our credit facility. We expect our cash on hand, cash flow from operations and availability under our ABL Facility to be our primary source of funds in the future. From time to time, based on market conditions and other factors, we may repay or refinance all or any of our existing indebtedness, including repurchasing or redeeming our bonds, or incur additional indebtedness. Letters of credit, which are issued under our ABL Facility, are used to support payment obligations incurred for our general corporate purposes. As of March 28, 2014, we had $154.9 million of availability under our ABL Facility, net of $10.1 million in letters of credit. We believe that cash and cash equivalents on hand, cash flow from operations and available borrowing capacity under our ABL Facility will be adequate to finance our ongoing operational cash flow needs and debt service obligations for the foreseeable future. 20 -------------------------------------------------------------------------------- Table of Contents Financial Condition Working capital increased by $28.1 million to $331.8 million as of March 28, 2014 from $303.7 million as of December 27, 2013. The increase in working capital was primarily driven by an increase in accounts receivable-trade due to the increase in net sales and a reduction of interest accrued on the Company's outstanding debt as a result of the early redemption of the OpCo Notes during the first quarter of 2014. Cash Flow Operating Activities. Net cash used in operating activities was $9.9 million and $10.7 million for the three months ended March 28, 2014 and March 29, 2013, respectively. Net cash used in operating activities of $9.9 million for the three months ended March 28, 2014 primarily consisted of net loss of $6.1 million, adjustments to reconcile net loss to net cash used in operating activities of $24.2 million and net cash used by working capital items of $27.9 million. The adjustments of $24.2 million primarily consisted of $12.6 million in depreciation and amortization of property and equipment and intangible assets, which includes increased amortization of definite-lived intangible assets as these assets are being amortized on an accelerated basis, $6.0 million in deferred income taxes, and loss on early extinguishment of debt in the amount of $4.2 million, which consisted of $18.5 million in consent solicitation, tender premium, call premium and related transaction costs less a non-cash benefit of $14.3 million associated with the write-off of the unamortized fair value premium of $17.8 million less the write-off of the unamortized deferred debt financing costs of $3.5 million. These amounts were partially offset by $0.5 million in amortization of the fair value adjustment recorded to the OpCo Notes in connection with the Merger and $0.2 million of amortization of deferred lease incentive obligations. The cash used by working capital items primarily consisted of $12.2 million from increased trade receivables, net of changes in provision for doubtful accounts, resulting from increased sales in the current year as compared to the prior year, an $11.6 million change in accrued interest due to the early redemption of the OpCo Notes, $8.7 million from reduced trade payables balances as a result of the timing of purchases and related payments, $2.4 million from a decrease in accrued expenses and other current liabilities as a result of lower accrued salaries and wages due to the timing of payrolls, and $2.6 million from changes in income taxes. The cash used by working capital items was partially offset by an $8.3 million decrease in prepaid expenses and other current assets primarily as a result of timing of collections of rebates from our vendors and $1.4 million from decreased inventory levels. Net cash used in operating activities of $10.7 million for the three months ended March 29, 2013 primarily consisted of net loss of $1.5 million, adjustments for non-cash items of $9.5 million and cash used by working capital items of $18.8 million. Adjustments for non-cash items primarily consisted of $12.4 million in depreciation and amortization of property and equipment and intangible assets, which includes increased amortization on the incremental step-up in customer relationships recorded in connection with purchase accounting for the Merger as well as amortization of the acquired JanPak customer relationships, $1.2 million in share-based compensation associated with options issued during the period, $0.9 million in amortization of debt financing costs, and $0.6 million in provisions for doubtful accounts. These amounts were partially offset by $4.3 million in deferred income taxes, $0.8 million in amortization of the fair value adjustment recorded to the OpCo Notes in connection with the Merger transactions, $0.2 million of amortization of deferred lease incentive obligations, and $0.4 million of other items. The cash used in working capital items primarily consisted of $8.7 million from increased inventory levels primarily related to seasonal build-up combined with opportunistic purchases, from a decrease in accrued expenses and other current liabilities as a result of payment of costs associated with the JanPak acquisition as well as the Merger, lower payroll and incentive compensation accruals as compared to prior year-end due to timing of payments, and timing of other miscellaneous accrual and payment activity, $6.3 million from increased trade receivables, net of changes in provision for doubtful accounts, resulting from increased sales in the current year as compared to the prior year, and a $1.9 million decrease in accrued interest due to the normal timing of accrual and payment activity. The cash used in working capital items was partially offset by $4.1 million from increased trade payables balances as a result of the timing of purchases and related payments, $1.8 million in decreased prepaid expenses and other current assets primarily as a result of timing of collections of rebates from our vendors, and $0.6 million from changes in income taxes. Investing Activities. Net cash used in investing activities was $4.4 million and $4.5 million for the three months ended March 28, 2014 and March 29, 2013, respectively. The respective cash outflows for each period relate to capital expenditures made in the ordinary course of business. Financing Activities. Net cash provided by financing activities totaled $18.2 million and $7.8 million for the three months ended March 28, 2014 and March 29, 2013, respectively. 21 -------------------------------------------------------------------------------- Table of Contents Net cash provided by financing activities for the three months ended March 28, 2014 was attributable to $349.1 million in net proceeds from the issuance of Term Loan Facility offset by $300.0 million used to finance the redemption of the OpCo Notes, $18.5 million in the payment of tender premiums and expenses on the OpCo Notes, $7.1 million of payments for debt issuance costs, and $5.0 million in net payments on the ABL Facility. Net cash provided by financing activities for the three months ended March 29, 2013 was attributable to $54.0 million in proceeds from the ABL Facility, and $0.8 million in proceeds from the issuance of common stock, offset in part by $46.5 million in payments on the ABL Facility, a $0.2 million net decrease in purchase card payable, and $0.2 million of payments on capital lease obligations. Capital Expenditures Capital expenditures were $4.4 million during the three months ended March 28, 2014, compared to $4.5 million for the three months ended March 29, 2013. Capital expenditures as a percentage of net sales were 1.1% for the three months ended March 28, 2014, and 1.2% for the three months ended March 29, 2013. Capital expenditures during 2014 and 2013 were driven primarily by the continued consolidation of our distribution center network, including the investments in larger, more efficient distribution centers and enhancements to our information technology systems. We expect our capital expenditures during the remainder of 2014 to be comparable with our historical capital expenditures as a percentage of sales. ABL Facility On September 7, 2012, Interline New Jersey entered into an asset-based senior secured revolving credit facility with a syndicate of lenders that permits revolving borrowings in an aggregate principal amount of up to $275.0 million. The ABL Facility also provides for a sub-limit of borrowings on same-day notice referred to as swingline loans up to $30.0 million and a sub-limit for the issuance of letters of credit up to $45.0 million. Subject to certain conditions, the principal amount of the ABL Facility may be increased from time to time up to an amount which, in the aggregate for all such increases, does not exceed $100.0 million, in $25.0 million increments. There are no scheduled amortization payments due under the ABL Facility. The Second ABL Facility Amendment extended the maturity date of the ABL Facility to April 8, 2019, at which date the principal amount outstanding under the ABL Facility will be due and payable in full. Advances under the ABL Facility are limited to the lesser of (a) the aggregate commitments under the ABL Facility and (b) the sum of the following: • 85% of the book value of eligible accounts receivable; plus • the lesser of (i) 70% of the lower of cost (net of rebates and discounts) or market value of eligible inventory; and (ii) 85% of the appraised net orderly liquidation value of eligible inventory; • minus certain reserves as may be established under the ABL Facility. Future borrowings under the ABL Facility are subject to the Company's representation and warranty that no event, change or condition has occurred that has had, or could reasonably be expected to have, a material adverse effect on the Company (as defined in the ABL Facility). Obligations under the ABL Facility are guaranteed by the Company and each of the wholly-owned material subsidiaries of the co-borrowers under the ABL Facility. These obligations are primarily secured, subject to certain exceptions, by a security interest in substantially all of the assets of Interline New Jersey and each of its wholly-owned material U.S. subsidiaries. This security interest is comprised of a first-priority lien on generally all of the current assets (including accounts receivable and inventory) of Interline New Jersey and the other grantors, which assets secure the Term Loan on a second-priority basis, and a second-priority lien on generally all of the fixed assets of Interline New Jersey and the other grantors, which assets secure the Term Loan on a first-priority basis. The assets held directly by the Company will not secure the ABL Facility, except that the Company will be required to grant a security interest in these assets in the event that the HoldCo Notes are no longer outstanding. From the date of the Second ABL Facility Amendment through the end of Interline New Jersey's current fiscal quarter, borrowings will bear interest at a rate equal to LIBOR plus 1.50% in the case of Eurodollar revolving loans, and an applicable base rate plus 0.50% in the case of Alternate Base Rate ("ABR") loans. 22 -------------------------------------------------------------------------------- Table of Contents As of the end of the quarter following the closing of the Second ABL Facility Amendment, the interest rates applicable to obligations under the ABL Facility will be determined as of the end of each fiscal quarter in accordance with applicable rates set forth in the grid below, which interest rates are generally 0.25% lower than the rates in effect prior to the Second ABL Facility Amendment: Revolver Eurodollar Availability Revolver ABR Spread Spread Category 1 Greater than $150.0 million 0.25% 1.25% Category 2 Greater than $75.0 million but less than or equal to $150.0 million 0.50% 1.50% Category 3 Less than or equal to $75.0 million 0.75% 1.75% The applicable rates for Category 1 will not be available after the first quarter ending on or about March 31, 2015. The applicable rates for Category 3 and, after March 31, 2015, Category 2, described above will be subject to a 0.25% step-down from the spread described above if the fixed charge coverage ratio for the period of four consecutive fiscal quarters ending on the last day of the fiscal quarter most recently ended is greater than 1.75:1.00. As of March 28, 2014, the interest rate in effect with respect to the ABL Facility was 1.69% for the Eurodollar revolving loans and 3.75% for the ABR revolving loans. The Second ABL Facility Amendment also revised the terms of the commitment fee payable by Interline New Jersey in respect of unutilized commitments, which will be equal to 0.375% per annum for the ABL Facility if utilization is less than 25.0% of the aggregate commitments and 0.25% per annum if the utilization of the ABL Facility exceeds 25.0% of the aggregate commitments. The ABL Facility requires the Company and its restricted subsidiaries, on a consolidated basis, to maintain a fixed charge coverage ratio (defined as the ratio of EBITDA, as defined in the credit agreement, to the sum of cash interest, principal payments on indebtedness and accrued income taxes, dividends or distributions and repurchases, redemptions or retirement of the equity interest of the Company) of at least 1.00:1.00 when the excess availability is less than or equal to the greater of: (i) 10% of the total commitments under the ABL Facility; and (ii) $25.0 million. The ABL Facility also contains restrictive covenants (in each case, subject to exclusions) that limit, among other things the ability of Interline New Jersey and its restricted subsidiaries to: • create, incur, assume or suffer to exist, any liens, • create, incur, assume or permit to exist, directly or indirectly, any additional indebtedness, • consolidate, merge, amalgamate, liquidate, wind up or dissolve themselves, • convey, sell, lease, license, assign, transfer or otherwise dispose of their assets, • make certain restricted payments, • make certain investments, • amend or otherwise alter the terms of documents related to certain subordinated indebtedness, • enter into transactions with affiliates, and • prepay certain indebtedness. The ABL Facility provides that Interline New Jersey and its restricted subsidiaries may incur secured or unsecured indebtedness so long as (i) in the event that the proceeds thereof are used to redeem HoldCo Notes, the pro forma interest coverage ratio of Interline New Jersey and its restricted subsidiaries is at least 2.00:1.00 or (ii) in the event the proceeds thereof are used for another purpose, (A) if such indebtedness is secured on a second-lien or other junior basis or is unsecured, the pro forma total leverage ratio of Interline New Jersey and its restricted subsidiaries is less than or equal to 6.50:1.00 or (B) if such indebtedness is secured on a first-lien basis, the pro forma ratio of (x) consolidated first lien indebtedness of Interline New Jersey and its restricted subsidiaries and (y) consolidated EBITDA of Interline New Jersey and its restricted subsidiaries (such ratio, the "First Lien Leverage Ratio") is less than or equal to 3.75:1.00. The ABL Facility contains certain customary representations and warranties, affirmative and other covenants and events of default, including, among other things, payment defaults, breach of representations and warranties, covenant defaults, cross-defaults to certain indebtedness bankruptcy, certain events under the Employee Retirement Income Security Act ("ERISA"), judgment defaults, actual or asserted failure of any material guaranty or security document supporting the ABL Facility to be in force and effect and a change of control. If such an event of default occurs the agent under the ABL Facility is entitled to take various actions, including the 23 -------------------------------------------------------------------------------- Table of Contents acceleration of amounts due under the ABL Facility, the termination of all revolver commitments and all other actions that a secured creditor is permitted to take following a default. Term Loan Facility On March 17, 2014, Interline New Jersey entered into a first lien term loan agreement under which Interline New Jersey incurred a term loan in an aggregate principal amount of $350.0 million. The initial aggregate principal amount of the Term Loan is equal to $350.0 million. The Term Loan Facility allows for incremental increases in an aggregate principal amount of up to (i) $100.0 million plus (ii) the amount as of the date of incurrence that would not cause the First Lien Leverage Ratio to exceed 3.75:1.00. The Term Loan Facility will mature on the earlier of (A) March 17, 2021 and (B) the date which is 91 days prior to the maturity date of the HoldCo Notes. Obligations under the Term Loan Facility are guaranteed by the Company and each of the wholly-owned material U.S. subsidiaries of Interline New Jersey. These obligations are primarily secured, subject to certain exceptions, by a security interest in substantially all of the assets of Interline New Jersey and each of its wholly-owned material U.S. subsidiaries. This security interest is comprised of a first-priority lien on generally all of the fixed assets of Interline New Jersey and the other grantors, which assets secure the ABL Facility on a second-priority basis, and a second-priority lien on generally all of the current assets (including accounts receivable and inventory) of Interline New Jersey and the other grantors, which assets secure the ABL Facility on a first-priority basis. The assets held directly by the Company will not secure the Term Loan Facility, except that the Company will be required to grant a security interest in these assets in the event that the HoldCo Notes are no longer outstanding. The Term Loan Facility will bear interest, at the borrower's option, at (i) LIBOR subject to a minimum floor of 1.0%, plus 300 basis points ("LIBO Rate") or (ii) an ABR subject to a minimum floor of 2.0%, plus 200 basis points. In addition, at the closing of the Term Loan Facility, Interline New Jersey paid (in addition to customary fees) an upfront fee equal to 0.25% of the principal amount thereof. As of March 28, 2014, the interest rate in effect with respect to the Term Loan Facility was 4.00% for LIBO Rate borrowings and 5.25% for ABR borrowings. Under the Term Loan Facility, Interline New Jersey may voluntarily prepay principal at any time and from time to time without penalty or premium, other than a 1.0% premium during the first six months following the closing date for re-pricing transactions only. The Term Loan Facility is due and payable in quarterly installments equal to 0.25% of the original principal amount, with the balance payable in one final installment at the maturity date. Additional provisions include the requirement to repay the Term Loan Facility with certain asset sale and insurance proceeds, certain debt proceeds and 50% of excess cash flow (reducing to 25% if the First Lien Leverage Ratio is no more than 3.00:1.00 and 0% if the First Lien Leverage Ratio is no more than 2.75:1.00). The Term Loan Facility does not include any financial covenants; however, it does contain certain restrictive covenants (in each case, subject to exclusions) that limit, among other things, the ability of Interline and the restricted subsidiaries to: • create, incur, assume or suffer to exist, any liens, • create, incur, assume or permit to exist, directly or indirectly, any additional indebtedness, • consolidate, merge, amalgamate, liquidate, wind up or dissolve themselves, • convey, sell, lease, license, assign, transfer or otherwise dispose of their assets, • make certain restricted payments, • make certain investments, • amend or otherwise alter the terms of documents related to certain subordinated indebtedness, • enter into transactions with affiliates, and • prepay certain indebtedness. The covenants are subject to various baskets and materiality thresholds, with certain of the baskets to the restrictions on the repayment of subordinated indebtedness, restricted payments and investments being available only when the pro forma interest coverage ratio of Interline New Jersey and its restricted subsidiaries is at least 2.00:1.00. The Term Loan Facility provides that Interline New Jersey and its restricted subsidiaries may incur secured or unsecured indebtedness so long as (i) (A) in the event that the proceeds thereof are used to redeem HoldCo Notes, the pro forma interest coverage ratio of Interline New Jersey and its restricted subsidiaries is at least 2.00:1.00 or (B) in the event the proceeds thereof are used for another purpose, the pro forma total leverage ratio of Interline New Jersey and its restricted subsidiaries is less than or equal to 6.50:1.00 and (ii) in the event any of such indebtedness is secured on a first-lien basis, the First Lien Leverage Ratio is less than or equal to 3.75:1.00. 24 -------------------------------------------------------------------------------- Table of Contents The Term Loan Facility contains certain customary representations and warranties, affirmative covenants and events of default, including, among other things, payment defaults, breach of representations and warranties, covenant defaults, cross-defaults to certain indebtedness (subject to certain restrictions on cross-defaults to the financial covenant contained in the ABL Facility), certain events of bankruptcy, certain events under ERISA, judgment defaults, actual or asserted failure of any material guaranty or security documents supporting the Term Loan Facility to be in full force and effect and change of control. If such an event of default occurs, the Agent under the Term Loan Facility is entitled to take various actions, including the acceleration of amounts due and all other actions that a secured creditor is permitted to take following a default. HoldCo Notes In connection with the Merger, Interline Delaware issued $365.0 million in aggregate principal amount of the HoldCo Notes due November 15, 2018. Debt financing costs capitalized in connection with the HoldCo Notes were $16.7 million. The HoldCo Notes are the Company's general senior unsecured obligations; rank pari passu in right of payment with all existing and future indebtedness of the Company, other than subordinated obligations; are senior in right of payment to any future subordinated obligations of the Company; are not guaranteed by any subsidiary of the Company; are effectively subordinated to any existing or future obligations of the Company that are secured by liens on assets of the Company (including the Company's guarantee of the ABL Facility, which is secured by a pledge of the stock of Interline New Jersey) to the extent of the value of such assets, unless the HoldCo Notes are equally and ratably secured by such assets; are structurally subordinated to all existing and future indebtedness (including the OpCo Notes and indebtedness under the ABL Facility) of, and other claims and obligations (including preferred stock) of, the subsidiaries of the Company, except to the extent a subsidiary of the Company executes a guaranty agreement in the future. The HoldCo Notes are not guaranteed by any of the Company's subsidiaries. The HoldCo Notes bear interest at a rate of 10.00% per annum with respect to cash interest and 10.75% per annum with respect to any paid-in-kind ("PIK") interest, payable semi-annually on January 15 and July 15. The Company is required to pay interest on the HoldCo Notes in cash, unless its subsidiaries are restricted from dividending money to it (or have limited ability to do so), subject to certain circumstances. The Company has the option to redeem the HoldCo Notes prior to November 15, 2014 at a redemption price equal to 100% of the principal amount plus a make-whole premium and accrued and unpaid interest to the date of redemption. At any time on or after November 15, 2014, the Company may redeem some or all of the HoldCo Notes at certain fixed redemption prices expressed as percentages of the principal amount, plus accrued and unpaid interest. At any time prior to November 15, 2014, the Company may, from time to time, redeem up to 35% of the aggregate principal amount of the HoldCo Notes with any funds up to an aggregate amount equal to the net cash proceeds received by the Company from certain equity offerings at a price equal to 110.00% of the principal amount of the HoldCo Notes redeemed, plus accrued and unpaid interest and additional interest, if any, to the redemption date, provided that the redemption occurs within 90 days of the closing date of such equity offering, and at least 65% of the aggregate principal amount of the HoldCo Notes remain outstanding immediately thereafter. The Indenture governing the HoldCo Notes contains covenants limiting, among other things, the ability of the Company and its restricted subsidiaries to incur additional indebtedness, issue preferred stock, create or incur certain liens on assets, pay dividends and make other restricted payments, create restriction on dividend and other payments to the Company from certain of its subsidiaries, sell assets and subsidiary stock, engage in transactions with affiliates, consolidate, merge or transfer all or substantially all of the Company's assets and the assets of its subsidiaries and create unrestricted subsidiaries. These covenants are subject to a number of important exceptions and qualifications. The holders of the HoldCo Notes have the right to require us to repurchase their notes upon certain change of control events. Critical Accounting Policies In preparing the unaudited consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("US GAAP"), we are required to make certain estimates, judgments and assumptions. These estimates, judgments and assumptions affect the reported amounts of assets and liabilities, including the disclosure of contingent assets and liabilities, at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. On an ongoing basis, we evaluate these estimates and assumptions. We base our estimates and assumptions on historical experience and on various other factors that we believe are reasonable at the time we make the estimates and assumptions. Actual results may differ from these estimates and assumptions under different circumstances or conditions. 25 -------------------------------------------------------------------------------- Table of Contents Our critical accounting policies are included in our Annual Report on Form 10-K for the year ended December 27, 2013 filed with the SEC. During the three months ended March 28, 2014, there were no significant changes to any of our critical accounting policies. Recently Issued Accounting Guidance In March 2013, the FASB issued ASU No. 2013-05, Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity ("ASU 2013-05"). The amendments contained within this guidance clarify the applicable guidance for the release of the cumulative translation adjustment under current US GAAP when an entity ceases to have a controlling financial interest in a subsidiary or group of assets that is a business within a foreign entity. The amendments in ASU 2013-05 are effective prospectively for the first annual period beginning after December 15, 2014, and interim and annual periods thereafter, with early adoption permitted. The amendments should be applied prospectively to derecognition events occurring after the effective date, and prior periods should not be adjusted. This ASU is not expected to have a material impact on the Company's consolidated financial statements. Recently Adopted Accounting Guidance In February 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2013-04, Liabilities (Topic 405) - Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date ("ASU 2013-04"). The objective of the amendments in this update is to provide guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, except for obligations addressed within existing US GAAP. Examples of obligations within the scope of this ASU include debt arrangements, other contractual obligations, and settled litigation and judicial rulings. This guidance requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope is fixed at the reporting date, as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement amount its co-obligors, plus any additional amount the entity expects to pay on behalf of its co-obligors. The guidance also requires an entity to disclose the nature and amount of the obligations as well as other information about those obligations. The amendments in ASU 2013-04 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013, and should be retrospectively applied to all prior periods presented for those obligations resulting from joint and several liability arrangements within the ASU's scope that exist at the beginning of an entity's fiscal year of adoption. An entity may elect to use hindsight for the comparative periods, and should disclose that fact. Early adoption was permitted. Effective December 28, 2013, the Company adopted this ASU, which did not have a material impact on the Company's consolidated financial statements. In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"). The objective of this ASU is to eliminate the diversity in practice on how entities present unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASU 2013-11 will require entities to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset (with certain exceptions) for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. The amendments in ASU 2013-11 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013, with early adoption permitted. The amendments should be applied prospectively, although retrospective application was permitted. Effective December 28, 2013, the Company adopted this ASU, which did not have a material impact on the Company's consolidated financial statements. |