ITEM 1. Business
Our Company
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"); plumbing; hardware, tools and fixtures; 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 fourteen 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®, JanPakSM , 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®, SunStar®, 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 sales force of approximately 800 field sales representatives, and approximately 400 inside sales and customer service representatives, a direct marketing program consisting of catalogs and promotional flyers, brand-specific websites, a national accounts sales program, and other supply chain programs, such as vendor managed inventory.
We deliver our products through our network of 70 distribution centers and 21 professional contractor showrooms located throughout the United States, Canada and Puerto Rico, 59 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.
In this document, unless otherwise indicated, "we," "us," "our" and the "Company" refer to Interline Brands, Inc., a Delaware corporation incorporated in 2004, and its consolidated subsidiaries, and "Interline New Jersey" refers to Interline Brands, Inc., a New Jersey corporation incorporated in 1978, through which we conduct our business.
Merger Transaction
On September 7, 2012 (the "Merger Date"), pursuant to an Agreement and Plan of Merger (the "Merger Agreement") dated as of May 29, 2012, Isabelle Holding Company Inc., a Delaware corporation (“Parent”), Isabelle Acquisition Sub Inc., a Delaware corporation and a wholly-owned subsidiary of Parent (“Merger Sub”), merged with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly-owned subsidiary of Parent. Immediately following the effective time of the Merger, Parent was merged with and into the Company with the Company surviving (the "Second Merger"). Under the Merger Agreement, stockholders of the Company received $25.50 in cash for each share of Company common stock. The Merger was unanimously approved by Interline's Board of Directors and a majority of Interline's stockholders holding the outstanding shares of the common stock. See Note 3. Transactions to our audited consolidated financial statements included in this annual report for further information about the Merger Agreement. Prior to the Merger Date, the Company operated as a public company with its common stock traded on the New York Stock Exchange. As a result of the Merger, Interline's common stock became privately-held.
Our primary business activities remain unchanged after the Merger. As a result of the Merger, we applied the acquisition method of accounting and established a new accounting basis on September 8, 2012. Although the Company continued as the same legal entity after the Merger, since the financial statements are not comparable as a result of acquisition accounting, the results of operations and related cash flows are presented for two periods: the period prior to the Merger ("Predecessor") and the period subsequent to the Merger ("Successor").
In connection with the Merger, we incurred significant indebtedness and became more leveraged. In addition, the purchase price paid in connection with the Merger has been allocated to recognize the acquired assets and liabilities at fair value. The purchase accounting adjustments have been recorded to: (i) establish intangible assets for our trademarks and customer relationships, and (ii) revalue our OpCo Notes (as defined below) to fair value. Subsequent to the Merger, interest expense and non-cash amortization charges have significantly increased. As a result, our Successor financial statements subsequent to the Merger are not comparable to our Predecessor financial statements.
Acquisitions
On December 11, 2012, Interline New Jersey acquired all of the outstanding stock of JanPak, Inc. ("JanPak") for $82.5 million in cash, subject to working capital and other closing adjustments. JanPak, which is headquartered in Davidson, North Carolina, is a large regional distributor of janitorial and sanitation supplies and packaging products, primarily serving property management and building service contractors as well as manufacturing, health care and educational facilities through 16 distribution centers across the Southeast and South Central United States. This acquisition represents an expansion of the Company's offering of JanSan products in the Southeastern, Mid-Atlantic, and South Central United States.
On January 28, 2011, Interline New Jersey acquired substantially all of the assets and a portion of the liabilities of Northern Colorado Paper, Inc. (“NCP”) for $9.5 million in cash and an earn-out of up to $0.3 million in cash over two years. NCP, which is headquartered in Greeley, Colorado, is a regional distributor of JanSan supplies, primarily serving institutional facilities in the health care, education and food service industries. This acquisition represents an expansion of the Company's offering of JanSan products in the western United States.
On October 29, 2010, Interline New Jersey acquired substantially all of the assets and a portion of the liabilities of CleanSource, Inc. (“CleanSource”) for $54.6 million in cash and an earn-out of up to $5.5 million in cash over two years. CleanSource, which is headquartered in San Jose, California, is a large regional distributor of JanSan supplies. CleanSource primarily serves health care and educational facilities, as well as building services contractors. This acquisition represents a geographical expansion of the Company's offering of JanSan products to the West Coast of the United States.
Refinancing Transactions
In connection with the Merger, the Company entered into the following financing transactions:
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a new senior secured asset-based revolving credit facility totaling $275.0 million (the "ABL Facility");
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the issuance of $365.0 million aggregate principal amount of senior notes (the "HoldCo Notes"); and
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the modification of the $300.0 million senior subordinated notes due 2018 (the “OpCo Notes”).
Simultaneously with the closing of the Merger, the following occurred: the funding of the new ABL Facility, the release of the net proceeds of the $365.0 million HoldCo Notes from escrow, the termination of the Company's previous $225.0 million asset-based revolving credit facility, and the modification of the OpCo Notes. On November 16, 2010, Interline New Jersey completed a series of refinancing transactions, including an offering of the OpCo Notes. See “Management's Discussion and Analysis of Financial Condition and Results of Operations-Refinancing Transactions,” “Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources”, and Note 10. Debt to our audited consolidated financial statements included in this annual report for further information regarding our outstanding indebtedness.
Strategy
Our objective is to become the leading supplier of MRO products to the facilities maintenance end-market, which is comprised of our institutional, multi-family housing, and residential facilities customers. In pursuing this objective, we plan to increase our net sales, earnings and return on invested capital by capitalizing on our size and scale, sales force, supply chain programs, information technology and logistics platforms to successfully execute our organic growth, operating efficiency and strategic acquisition initiatives.
• Organic Growth Initiatives. We seek to further penetrate the markets we serve, and to expand into new product and geographic areas, by adding sales professionals, and utilizing and increasing our already successful new product and marketing strategies, including: growing web-based sales capabilities; targeting new customer acquisition; expanding our national accounts program; increasing customer use of our supply chain management services; continuing to develop proprietary products under our exclusive brands; and selectively adding new products and new categories to our various brand offerings.
• Increased Operating Efficiencies. We will continue to focus on enhancing our operating efficiency, which will increase profitability, improve our cash conversion cycle and increase our return on capital.
• Acquisitions. We will continue to maintain a disciplined acquisition strategy of adding new customers and/or product offerings in currently served markets and pursuing acquisitions of established brands in new or existing markets in an effort to further leverage our operating infrastructure.
Industry and Market Overview
The MRO distribution industry in the U.S. and Canada is over $560 billion in size according to MRO market analyses by Modern Distribution Management ("MDM"), a trade company specializing in wholesale distribution, and Industrial Marketing Information, Inc. ("IMI"), a market research company specializing in quantification of the industrial business-to-business markets. The MRO distribution industry encompasses the supply of a wide range of products, including plumbing and electrical supplies, hand-tools, janitorial supplies, safety equipment and many other categories. Customers served by the MRO distribution industry include heavy industrial manufacturers that use MRO supplies for the repair and overhaul of production equipment and machinery; owners and managers of facilities such as apartment complexes, office buildings, schools, hotels and hospitals that use MRO supplies largely for maintenance, repair and refurbishment; and professional contractors.
Within the MRO distribution industry, we focus on serving customers in the facilities maintenance end-market. Our customers are primarily engaged in the repair, maintenance, remodeling, refurbishment and, to a lesser extent, construction of non-industrial and residential facilities, as opposed to the maintenance of heavy industrial facilities and machinery. According to the MDM/IMI MRO market analyses, the size of our addressable end-markets, which generally exclude new commercial and residential construction and heavy industrial manufacturing, is approximately $85 billion, including $21 billion from the JanSan market.
Our Brands
We market and sell our products primarily through fourteen 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 Wilmar®, AmSan®, JanPakSM , CleanSource®, Sexauer®, Maintenance USA® and Trayco® brands generally serve our multi-family housing and institutional facilities customers; the Barnett®, Copperfield®, U.S. Lock®, SunStar®, Hardware Express®, LeranSM and AF Lighting® brands generally serve our residential facilities customers. Our brands are distinguished not only by the type of products offered, but also by the levels of service provided to customers. We have brands that provide complementary services to our customers, including inventory management and technical assistance, as well as brands that offer products without support services. We believe that our brand-based business model effectively allows us to offer a deep product offering to very targeted customers in our facilities maintenance end-market. We have core competencies in our sales channels, including national accounts sales professionals, field sales representatives, outbound and inbound telesales and customer service representatives, direct marketing via catalogs and flyers, professional contractor showrooms, vendor-managed inventory locations, and internet-based sales and service capabilities. This allows us to effectively compete for a broad range of customers across our industry by offering our customers the service and delivery platform they prefer and often require.
Institutional and Multi-Family Housing Facilities Maintenance Brands
We serve our institutional and multi-family housing facilities customers primarily through our Wilmar, AmSan, JanPak, CleanSource, Sexauer, Maintenance USA and Trayco brands. These customers buy our products for the maintenance, repair and remodeling of many types of facilities, and often need to obtain products with minimal delay. In many cases, our institutional and multi-family housing facilities customers also look to us for support services such as inventory management, technical advice and assistance, drop ship products and equipment servicing and training.
Wilmar. Our Wilmar brand markets and sells maintenance products to our multi-family housing customers. Through its master catalog, Wilmar is able to act as a one-stop shopping resource for multi-family housing maintenance managers by offering one of the industry’s most extensive selections of standard and specialty plumbing, hardware, electrical, janitorial and related products. Wilmar provides same-day or next-day delivery in local markets on our own trucks served by our distribution centers, and ships by parcel delivery services or other carriers to other areas. The Wilmar brand sells primarily through field sales representatives, as well as through its website, direct marketing and telesales. We also have a successful national accounts program at Wilmar where national account managers market to senior officers at real estate investment trusts and other property management companies. Through this program, we assist large multi-location customers in reducing total supply chain costs.
AmSan. Our AmSan brand markets and sells a comprehensive range of JanSan and MRO products to institutional facilities, such as schools and universities, health care sites, lodging and government facilities and building services contractors. We sell JanSan products primarily through field sales representatives supported by a full line catalog and website, which includes national brand product offerings as well as our exclusive brand product lines such as Renown and Appeal. In addition, AmSan provides customers with reliable technical support, equipment repair services, and customized training programs, all of which make AmSan an important supplier to our customers. AmSan provides same-day or next-day delivery in local markets on our own trucks served by our distribution centers and ships by parcel delivery services or other carriers to other areas.
JanPak. Our JanPak brand markets and sells a comprehensive range of cleaning and packaging solutions to building services contractors, property management, health care, education and manufacturing customers. These solutions are sold through a team of field sales professionals with subject matter and market segment expertise to address the most critical needs facing these customers. In addition, JanPak provides a number of after sales service and support capabilities, like technical training, equipment service and repair, and certification platforms, to meet the unique and on-going needs of our customers. Customers are served through a dedicated customer support team, a robust e-commerce platform, and a fleet of delivery vehicles and local distribution centers.
CleanSource. Our CleanSource brand markets and sells a comprehensive range of JanSan and MRO products to institutional facilities, such as schools, health care sites, lodging and government facilities and building services contractors. CleanSource sells JanSan products primarily through field sales representatives supported by a catalog and website, which include national brand product offerings as well as our exclusive brand product lines Renown and Appeal. CleanSource field sales representatives are trained and experienced in developing customer-focused solutions based on a careful analysis of each customer’s unique facility, providing better results and total value.
Sexauer. Our Sexauer brand markets and sells specialty plumbing and facility maintenance products to institutional customers, including education, lodging, health care and other facilities maintenance customers. The Sexuaer brand sells primarily through field sales representatives. We believe that the catalog of Sexauer products is well known in the industry as a comprehensive source of specialty plumbing and facility maintenance products. In addition to a broad product portfolio, Sexauer offers customers an extensive selection of service and procurement solutions, through its catalog and website, drawing upon our product and supply management expertise.
Maintenance USA. Our Maintenance USA brand markets and sells a broad portfolio of MRO products to facilities, including multi-family housing, lodging and institutional customers. Maintenance USA sells our products primarily through telesales and direct marketing supplemented by its website, representing a low-cost supply alternative to property managers and customers requiring a reduced level of support services.
Trayco. Our Trayco brand markets and sells an extensive inventory of specialty plumbing items as well as a wide array of other facilities maintenance products. Trayco specializes in hard-to-find items and provides access to hundreds of manufacturers. Trayco sells its products through the use of a catalog and field sales personnel, supplemented by its website.
Residential Facilities Maintenance Brands
Our residential facilities maintenance customers are comprised of professional contractor customers that are primarily served by our Barnett, Copperfield, U.S. Lock, SunStar, Hardware Express, Leran, and AF Lighting brands. Residential facilities customers generally purchase our products for specific job assignments and/or to resell the product to end-customers to be used in many types of facilities.
Barnett. Our Barnett brand markets and sells a broad range of MRO products to professional contractors, including plumbing, electrical, building and HVAC contractors, typically for repair, remodeling and maintenance applications. The Barnett brand also sells its products to specialty distributors, which are generally smaller and carry fewer products than Barnett. The brand sells its products through a catalog, supplemented by its website, direct marketing, telesales and field sales representatives in select markets throughout the United States. Customers can also receive technical support and assistance in selecting products by calling our customer service centers. In addition to next-day delivery, Barnett also offers customers the convenience of a network of local professional contractor showrooms, or Pro Centers, as well as on-site, vendor-managed inventory capabilities.
Hardware Express. Our Hardware Express brand markets and sells our full range of products to resellers of all types, primarily retail hardware stores, small distributors and online retailers. Hardware Express sells primarily through a catalog, supplemented by its website, direct marketing, telesales and national accounts.
Copperfield. Our Copperfield brand markets and sells specialty ventilation and chimney maintenance products to chimney professionals and hearth retailers, through its website, direct marketing, outbound telesales and field sales representatives. Copperfield offers brand name and exclusive brand repair and replacement items including chimney replacement and relining products, specialty ventilation components, hearth products, gas and electrical appliances and an assortment of gas and solid fuel burning appliances.
U.S. Lock. Our U.S. Lock brand markets and sells a broad range of security hardware products, from individual lock-sets to computerized master-key systems. U.S. Lock sells a number of brand name products from leading security hardware manufacturers, as well as a number of exclusive brand security hardware products. U.S. Lock sells primarily to Locksmiths nationwide through a catalog and a team of highly technical telesales account managers supplemented by its website.
Leran. Our Leran brand markets and sells an extensive line of propane, plumbing, HVAC, electrical and hardware products including copper tubing and brass fittings as well as appliances and water heaters to professional contractors. Leran sells its products through the use of a catalog supplemented by telesales personnel and its website.
SunStar/AF Lighting. Our SunStar and AF Lighting brands market and sell residential lighting and electrical products to electrical contractors, electrical distributors, lighting showrooms and mass merchants through direct marketing, outbound telesales and a network of manufacturer’s representatives, supplemented by each brand's website.
Our Products
Our products are primarily used for the repair, maintenance, remodeling and refurbishment of residential and non-industrial facilities. We stock approximately 100,000 standard and specialty MRO products in a number of categories, including: JanSan; plumbing; hardware, tools and fixtures; HVAC; electrical and lighting; appliances and parts; security and safety; and other miscellaneous products. We offer a broad range of brand name and exclusive brand products. We believe we benefit from stable, non-discretionary and recurring end-market demand, which is largely characterized by products that are either consumable or have regular replacement cycles.
Product Categories
The approximate percentages of our net sales for the fiscal year ended December 28, 2012 by principal product category were as follows:
The following is a discussion of our principal product categories:
Janitorial and Sanitation. Our comprehensive selection of JanSan products includes cleaning chemicals, trash can liners, paper towels, bath tissue, brooms, mops, and other products. We offer a number of products from leading JanSan manufacturers, such as Kimberly-Clark, Georgia-Pacific, 3M, GOJO and Rubbermaid. We also offer exclusive brand JanSan products under our Renown and Appeal brands.
Plumbing. We sell a broad range of plumbing products, from individual faucet parts to complete bathroom renovation kits. In addition, we sell both brand name and exclusive brand products. For example, we sell brand name products from manufacturers including Kohler, Moen and Delta. We also sell exclusive brand plumbing products under various proprietary trademarks, including Premier faucets and water heaters, DuraPro tubular products and ProPlus retail plumbing accessories.
Hardware, Tools and Fixtures. We sell a variety of hardware products, tools and fixtures, including hinges, power tools and mini blinds, and a limited selection of cabinetry, doors and windows. Our brand name products include DeWalt, Channellock, Milwaukee Tool and Sunco. Our exclusive brand hardware products include Yukon, Legend and Anvil Mark.
Heating, Ventilation and Air Conditioning. We offer a variety of HVAC products, including condensing units, thermostats, fans and motors under both name brand and exclusive brand names. Manufacturers include Goodman, Nordyne and Honeywell. We also offer specialty ventilation and chimney maintenance products through our Copperfield brand.
Electrical and Lighting. Our comprehensive selection of electrical and lighting products ranges from electrical wire and breakers to light fixtures and light bulbs. We offer brand name products from leading electrical supply manufacturers, including Eaton, Sylvania and Leviton, as well as a number of exclusive brand electrical products, such as Preferred Industries.
Appliances and Parts. Our comprehensive range of appliances and parts includes stoves, washer/dryer components, garbage disposers, refrigerators and range hoods. We sell a number of brand name products of leading appliance manufacturers, including General Electric. We also sell a number of high-quality replacement parts from a number of different suppliers.
Security and Safety. We sell a broad range of security hardware products, from individual lock-sets to computerized master-key systems. We sell a number of brand name products of leading security hardware manufacturers, including Kwikset and Schlage. We also sell a number of exclusive brand security hardware products, such as U.S. Lock hardware, Legend locks and Rx master keyways. We sell a variety of safety products, ranging from safety detection devices, such as smoke detectors, to personal protection items, including gloves and masks.
Exclusive Brand Products
Our size and reputation have enabled us to develop and market various lines of exclusive brand products, which we believe offer our customers high-quality, low-cost alternatives to the brand name products we sell. Third-party manufacturers, primarily in Asia and the United States, using our proprietary branding and packaging design, manufacture our exclusive brand products. Our sales
force, catalogs, brand-specific websites and promotional flyers emphasize the comparative value of our exclusive brand products. Since our exclusive brand products are typically less expensive for us to purchase from suppliers, we are able to improve our profit margin with the sale of these products while offering lower prices to our customers. In addition, we have found that we develop strong relationships with our exclusive brand customers and generate increased repeat business, as exclusive brand customers generally return to us for future service and replacement parts on previously purchased products.
New Product Offerings
We constantly monitor and evaluate our product offerings, both to assess the sales performance of our existing products and to discontinue products that fail to meet specified sales criteria. We also create new product offerings in response to customer requirements by adjusting our product portfolio within existing product lines as well as by establishing new product line categories. These categories can either be new to Interline or new to a brand. For example, as we enhance our brand-specific websites, we are able to make available products not yet offered in our catalogs. Through these efforts, we are able to sell more products to existing customers as well as address our customers’ changing product needs and thereby retain and attract customers. Further, by introducing new product lines, we provide our customers with additional opportunities for cost savings and a one-stop shopping outlet with broad product offerings. We believe that introducing new products in existing product lines and creating new product lines are both strategies which enable us to increase penetration of existing customer accounts, as well as attract new customers to our brands.
Sales and Marketing
We market our products through a variety of channels. The majority of sales to our facilities maintenance customers are made through field sales and telesales representatives, which are all supported by catalogs and promotional mailings. We also serve our customers with brand-specific websites.
As MRO customers grow in size, their supply chains often become increasingly complex and difficult to manage. In many cases, customers have a limited view into or control over their product spend, inventory shrinkage, and indirect MRO personnel costs. To meet these needs, we offer a range of sophisticated supply chain management solutions designed to solve the unique problems of each of our customers. By offering customers services beyond fulfillment such as product standardization, vendor consolidation, inventory management, product training, and electronic invoicing, we provide a suite of services that can be utilized either individually or as a group based upon the customer’s size and supply chain complexity. Our customers rely upon us as a supply chain partner rather than a vendor, and in turn realize significant benefits by reducing overall product cost, improving inventory management, and lowering their indirect MRO spend. As supply chain partners, we seek to become our customers’ single source for MRO supplies and knowledge.
Our marketing strategy involves targeting our marketing channels and efforts to specific customer groups. As a result of our long-standing relationships with customers, we have been able to assemble a database of customer purchasing information, such as purchasing trends, product and pricing preferences, and support service requirements. In addition, we are able to track information such as customer retention and reactivation as well as new account acquisitions. We are also able to track the success of a particular marketing effort by analyzing the purchases of the customers targeted by that effort. Our information technology allows us to use this data to develop more effective sales and marketing programs. For example, our understanding of the preferences of our large, multi-family housing customers led to our development of a national accounts program through which field sales representatives focus on developing contacts with national accounts. We will continue to leverage our customer knowledge and shared brand information technology to develop successful print and website-based sales and marketing strategies.
Field Sales Representatives
Our direct sales force markets and sells to all levels of the customer’s organization, including senior property management executives, local and regional property managers, on-site maintenance managers, and owners and managers of professional plumbing, electrical and HVAC contractors. Our direct sales force marketing efforts are designed to establish and solidify customer relationships through frequent contact, while emphasizing our broad product selection, e-commerce capabilities, reliable delivery of our products, high level of customer service and competitive pricing.
We maintain one of the largest direct sales forces in our industry, with approximately 800 field sales representatives covering markets throughout the United States, Canada and Central America. We have found that we obtain a greater percentage of our customers’ overall spending on MRO products in markets serviced by local sales representatives, particularly in regions where these representatives are supported by a nearby distribution center that enables same-day or next-day delivery of our products.
Our field sales representatives are expected not only to generate orders, but also to act as problem-solving customer service representatives. Our field sales representatives are trained and qualified to assist customers in shop organization, special orders, part
identification and complaint resolution. We compensate the majority of our field sales representatives based on a commission program or on a combination of salary and bonus program. We will continue to seek additional opportunities where we can leverage the strength of our field sales force to generate additional sales from our customers.
Telesales
Our telesales operation has been designed to make ordering our products as convenient and efficient as possible. We divide our telesales staff into outbound and inbound groups. Our outbound telesales representatives are responsible for maintaining relationships with existing customers and prospecting for new customers. These representatives are assigned individual accounts in specified territories and have frequent contact with existing and prospective customers in order to make telesales presentations, notify customers of current promotions and encourage additional purchases. Our inbound telesales representatives are trained to process orders quickly from existing customers, provide technical support and expedite and process new customer applications, as well as handle all other customer service requests. We offer our customers nationwide toll-free telephone numbers and brand-specific telesales representatives who are familiar with a particular brand’s markets, products and customers. Our call centers are staffed by approximately 400 telesales, customer service and technical support personnel, who utilize our proprietary, on-line order processing system. This sophisticated software provides the telesales staff with detailed customer profiles and information about products, pricing, promotions and competition.
Catalogs and Direct Mail Marketing
Our catalogs and direct mail marketing promotional flyers are key marketing tools that allow us to communicate our product offerings to both existing and potential customers. We create catalogs for most of our brands and mail or deliver them generally on an annual or semi-annual basis to our existing customers. We often supplement these catalog mailings by sending our customers promotional flyers. Most of our branded catalogs have been distributed for over three decades and we believe that these catalog titles have achieved a high degree of recognition among our customers.
In targeting potential direct marketing customers, we sometimes make our initial contact through promotional flyers, rather than by sending a complete catalog. We obtain mailing lists of prospective customers from outside marketing information services and other sources. We are able to gauge the effectiveness of our promotional flyer mailings through the use of proprietary database analysis methods, as well as through our telesales operations. Once customers begin to place orders with us, we typically send an initial catalog and include the customer on our periodic mailing list for updated catalogs and promotional materials. We believe that this approach is a cost-effective way for us to contact large numbers of potential customers and to determine which customers should be targeted for continuous marketing.
We produce the design and layout for our catalogs and promotional mailings using a sophisticated catalog content database and software system. Our catalogs are indexed and illustrated to provide simplified pricing information and to highlight new product offerings. Our promotional mailings introduce new product offerings, sale-promotion items and other periodic offerings. Illustrations, photographs and copy are shared among brand catalogs and mailings or customized for a specific brand, allowing for fast and efficient production of multi-branded media. In addition, we frequently build custom catalogs designed specifically for the needs of our larger customers.
E-commerce
Our websites play a significant role in meeting the needs of our customers. Whether the customer shops online, references a catalog, uses a virtual catalog, or prefers to interact directly with a representative, our brand websites are an information resource for our customers. Through our user friendly search engine, customers can access detailed product information, see customer-specific pricing, view real-time product availability, and see how the product will be shipped to their location. Customers can view their entire order history, regardless if placed on the web or through other channels. We offer an extended product assortment online over and above what is in the published catalog.
We offer our customers a variety of online methods for supply chain spending controls. Customized and shared favorites lists assist our customers for ease of placing orders. Additionally, usage reports are available online. Where budgetary considerations are a concern, customers can control spending through a workflow-enabled budget management and approval tool. The flexible budget management tool tracks our customers' spending and generates invoices to the customers' general ledger codes. We also offer product standardization and customized product assortments. Each method allows the customer the ability to tailor their online shopping experience to their business needs. We handle a variety of customer’s unique needs, such as consignment, multi-family and single owner operator requirements, all operating on one single web platform. Our field sales force plays a significant role in educating our customers on how to utilize and leverage our e-commerce platform. Our field sales force can assist our customers with registering on the site, setting up favorites lists, and helping customers place their first orders.
Operations and Logistics
Distribution Network
We have a network strategically located to serve the largest metropolitan areas throughout the United States and Canada comprised of 70 distribution centers and 21 professional contractor showrooms. We also maintain a dedicated fleet of trucks to assist in the local delivery of products. The geographic scope of our distribution network and the efficiency of our information technology enable 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 distribution centers are central to our operations and range in size from approximately 6,000 square feet to approximately 317,100 square feet. Our distribution centers are typically maintained under operating leases in commercial or industrial centers, and primarily consist of warehouse and shipping facilities. We have professional contractor showrooms in certain existing distribution centers and in freestanding locations, which allow customers to obtain products from a fixed location without ordering in advance.
Inbound Logistics
Our Regional Replenishment Centers ("RRCs") in Jacksonville, Florida; Philadelphia, Pennsylvania; Nashville, Tennessee; and Salt Lake City, Utah are distribution centers that receive the majority of our supplier shipments, efficiently re-distribute products to our other distribution centers and also deliver directly to customers in their local regions. Some over-sized or seasonal products are directly shipped to distribution centers other than the RRCs by our suppliers. Our use of RRCs has significantly reduced distribution center replenishment lead times while simultaneously improving our customer fill rates.
Outbound Logistics
Once an order is entered into our computer system, the order is usually picked and processed in the distribution center nearest to the customer. For customers located within the local delivery radius of a distribution center, our own trucks or third-party carriers will deliver the products directly to the customer the next business day (or same day, if needed). For customers located outside the local delivery radius of a distribution center, we deliver products via parcel delivery companies, such as UPS. Large orders, or orders that cannot be delivered via parcel delivery, are delivered by common carriers. In addition, portions of our sales are delivered direct from the supplier.
Suppliers and Purchasing
Our suppliers play an important role in our success. We work closely with our supplier base to ensure product merchandising and costs are managed effectively. Wherever possible, we seek to develop long-standing relationships with our suppliers. We also manage sourcing risk by developing multiple sources of competitive product supply for many key products. Due to our high volume of purchases, we are able to obtain purchase terms we believe to be more favorable than those available to most local suppliers of MRO products.
We buy our products from approximately 3,700 suppliers located in the United States and throughout the world. A majority of our purchases are primarily from domestic supplier partners with the remainder from foreign-based suppliers located primarily throughout Asia and South America. No individual supplier represented more than 7% of our total purchases during the fiscal year ended December 28, 2012.
With regard to inventory, our customer-centric strategy balances the need for high fill rates with the aggressive management of inventory levels. Our goals are to continue to increase our inventory efficiency over the long term as we grow, further optimize our distribution network, manage stock keeping unit complexity and leverage our common information technology and logistics platforms. We also balance inventory efficiency with global sourcing opportunities, which have longer supply lead times than domestic relationships.
In addition to our inventory management team, our purchasing process is managed through an inventory management system which forecasts demand based on customer ordering patterns. This system monitors our inventory and alerts our purchasing managers of items approaching low levels of stock. We balance ordering and carrying costs in an effort to minimize total inventory costs. Demand forecasting is automated and is primarily based on historical sales, taking into account seasonally adjusted demand and supply lead times, which in turn are key inputs into setting safety stock levels.
Information Technology
We operate a customer service and inventory management system that allows us to manage customer relationships and to administer and distribute thousands of products. Our systems encompass all major business functions for each of our brands and enable us to receive and process orders, manage inventory, verify credit and payment history, generate customer invoices, receive payments and manage our proprietary customer information. We have consistently invested in our information technology, and we will continue to do so, as we believe that the efficiency and flexibility of our information technology are critical to the success of our business.
We constantly seek new ways to generate additional efficiencies, such as by utilizing e-commerce. For most of our brands, our customers can browse brand-specific product offerings online and use the internet to send electronic purchase orders to our order entry system. Additionally, we integrate with industry-leading business-to-business portals that allow customers to receive real-time inventory visibility and order product. Our customers can integrate these systems into their own purchase order systems, thereby making the supply chain operate more seamlessly. In addition, we offer our customers the option of receiving invoices electronically. For customers that place frequent orders and have the ability to receive electronic invoices, this program can dramatically reduce ordering costs by eliminating invoice handling, and by automating the matching and payment process. We believe that by offering services like electronic purchasing and invoicing, which remove transaction costs from the supply chain, we help our customers realize significant cost savings.
Competition
The MRO product distribution industry is highly competitive. Competition in our industry is primarily based upon product line breadth, product availability, technology, service capabilities and price. We face significant competition from national and regional distributors, such as HD Supply, Ferguson and Grainger. These competitors market their products through the use of direct sales forces as well as direct marketing, websites and catalogs. In addition, we face competition from traditional channels of distribution such as retail outlets, small wholesalers and large warehouse stores, including Home Depot and Lowe’s. We also compete with buying groups formed by smaller distributors, internet-based procurement service companies, auction businesses and trade exchanges.
We expect that competition in our industry will continue to be strong in the future. The MRO product distribution industry continues to consolidate as traditional MRO product distributors attempt to achieve economies of scale and increase efficiency. Furthermore, MRO product customers are continuing to seek low cost alternatives to replace traditional methods of purchasing and sources of supply. We believe that the current trend is for customers to reduce the number of suppliers and rely on lower cost alternatives such as direct marketing and/or integrated supply arrangements, which will contribute to competition in our industry.
Environmental and Health and Safety Matters
Some of the products we handle and sell, such as cleaning chemicals, are considered hazardous materials. Accordingly, we are subject to certain federal, state and local environmental laws and regulations, including those governing the transportation, management and disposal of, and exposure to, hazardous materials and the cleanup of contaminated sites. While we could incur costs as a result of liabilities under, or violations of, such environmental laws and regulations or arising out of the presence of hazardous materials in the environment, including the discovery of any such materials resulting from historical operations at our sites, we do not believe that we are subject to any such costs that are material. We are also subject to various health and safety requirements, including the Occupational, Safety and Health Act, as well as other federal, state and local laws and regulations. We believe we are in compliance in all material respects with all environmental laws and regulations and health and safety requirements applicable to our facilities and operations.
Trademarks and Other Intellectual Property
We have registered and nonregistered trade names, trademarks and service marks covering the principal brand names and product lines under which our products are marketed, including AF Lighting®, AmSan®, Appeal®, Barnett®, CleanSource®, Copperfield®, Hardware Express®, JanPakSM , LeranSM, Maintenance USA®, Premier®, ProPlus®, Renown®, Renovations Plus®, Sexauer®, SunStar Lighting®, Trayco®, U.S. Lock®, and Wilmar®. We also own several patents for products manufactured and marketed by us, primarily under our Copperfield® brand. We believe that our trademarks and other intellectual property rights are important to our success and our competitive position. Accordingly, our policy is to pursue and maintain registration of our trade names, trademarks and other intellectual property whenever appropriate and to oppose vigorously any infringement or dilution of our trade names, trademarks or other intellectual property.
Employees
As of December 28, 2012, we had approximately 4,100 employees. We believe that our employee relations are satisfactory.
Available Information
Our internet address is www.interlinebrands.com. We make available, free of charge, through our internet site, via a hyperlink to the 10KWizard.com web site, our annual reports on Form 10-K; quarterly reports on Form 10-Q; current reports on Form 8-K; and any amendments to those reports filed or furnished pursuant to the Exchange Act, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission ("SEC").
ITEM 1A.
ITEM 1A. Risk Factors
The following risk factors should be read carefully in connection with evaluating us and this Annual Report on Form 10-K. Certain statements in ‘‘Risk Factors’’ are forward-looking statements. See ‘‘Forward-Looking Statements’’ above.
Risks Relating to Our Business
We operate in a highly competitive industry, and if we are unable to compete successfully we could lose customers and our sales may decline.
The MRO product distribution industry is highly competitive. We face significant competition from national and regional distributors that market their products through the use of direct sales forces as well as direct marketing, websites and catalogs. In addition, we face competition from traditional channels of distribution such as retail outlets, small wholesalers and large warehouse stores and from buying groups formed by smaller distributors, internet-based procurement service companies, auction businesses and trade exchanges. We expect that new competitors may develop over time as internet-based enterprises become more established and reliable and refine their service capabilities.
In addition, the MRO product distribution industry is undergoing changes driven by industry consolidation and increased customer demands. Traditional MRO product distributors are consolidating operations and acquiring or merging with other MRO product distributors to achieve economies of scale and increase efficiency. This consolidation trend could cause the industry to become more competitive and make it more difficult for us to maintain our operating margins.
Competition in our industry is primarily based upon product line breadth, product availability, technology, service capabilities and price. To the extent that existing or future competitors seek to gain or retain market share by reducing price or by increasing support service offerings, we may be required to lower our prices or to make additional expenditures for support services, thereby reducing our profitability.
Adverse changes in global economic conditions may negatively affect our industry, business and results of operations.
Financial markets in the United States, Europe and Asia experienced substantial disruption from the second half of 2008 through early 2010, including, among other things, extreme volatility in security prices, severely diminished liquidity and credit availability, rating downgrades of certain investments and declining valuations of others. During this time period, governments took unprecedented actions intended to address these market conditions and the effectiveness of these actions is not yet fully known. Although macroeconomic conditions in the United States generally improved in 2012, the overall health of the economy remains fragile. High unemployment rates and continuing challenges in the housing sector, among other factors, continue to weigh on the economy.
The MRO product distribution industry is affected by changes in economic conditions outside our control, which can result in increased vacancies and lower effective rents in the residential rental housing market and a general decrease in product demand from our customers. In addition, a significant number of our facilities maintenance customers are educational institutions and health care facilities, which depend on public funding. Tax revenue for federal, state and local governments has decreased substantially during the economic recession and in response to the reduced revenue, governments have cut public funding and may continue to cut funding to our existing and potential customers.
Such economic developments may affect our business in a number of ways. Reduced demand may drive us and our competitors to offer products at promotional prices, which would have a negative impact on our profitability. In addition, credit availability may adversely affect the ability of our customers and suppliers to obtain financing for significant purchases and operations and could result in a decrease in, or cancellation of, orders for our products. If demand for our products slows down or decreases, we will not be able to improve our revenues and we may run the risk of failing to satisfy the financial and other restrictive covenants to which we are subject under our existing indebtedness. Reduced revenues as a result of decreased demand may also reduce our working capital and otherwise hinder our ability to improve our performance in connection with our long-term strategy.
One of the key markets in which we operate is impacted by trends in home improvement, home remodeling and home building. Adverse changes in economic factors specific to these industries may negatively impact the rate of growth of our net sales.
The residential facilities market is impacted by trends in home improvement, home remodeling and new home construction. Trends in these areas are in turn dependent upon a number of factors, including demographic trends, interest rates, credit markets, tax policy, employment levels, consumer confidence and the general economy. Unfavorable changes in demographics or a weakening of
the national economy or of any regional or local economy in which we operate could adversely affect consumer spending, result in decreased demand for repair, improvement, remodeling or construction products and adversely affect our business.
An impairment in the carrying value of our goodwill or other intangible assets could adversely affect our financial condition and results of operations.
Goodwill represents the difference between the purchase price of acquired companies and the related fair values of net assets acquired. We test goodwill for impairment annually and whenever events or changes in circumstances indicate that impairment may have occurred. We compare the carrying value of the reporting unit, including goodwill, to the fair value of the unit. Carrying value is based on the assets and liabilities associated with the operations of that reporting unit. If the carrying value is less than the fair value, no impairment exists. If the carrying value is higher than the fair value, then there is an indication of impairment. A significant amount of judgment is involved in determining if an indication of impairment exists. Factors may include, among others: a significant decline in our expected future cash flows; a significant adverse change in legal factors or in the business climate; unanticipated competition; the testing for recoverability of a significant asset group within a reporting unit; and slower growth rates. Any adverse change in these factors would have a significant impact on the recoverability of these assets and negatively affect our financial condition and consolidated results of operations. We compute the amount of impairment by comparing the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. We are required to record a non-cash impairment charge if the testing performed indicates that goodwill has been impaired.
As with goodwill, we test our indefinite-lived intangible assets for impairment annually and whenever events or changes in circumstances indicate that their carrying value may not be recoverable. We estimate the fair value of the trademarks based on an income valuation model using the relief from royalty method, which requires assumptions related to projected revenues from our annual long-range plan, assumed royalty rates that could be payable if we did not own the trademarks, and a discount rate.
We cannot accurately predict the amount and timing of any impairment of assets. Should the value of goodwill or other intangible assets become impaired, there could be an adverse effect on our financial condition and consolidated results of operations.
Fluctuations in the cost of raw materials, fuel prices or currency exchange rates could significantly reduce our revenues and profitability.
As a distributor of manufactured products, our profitability is related to the prices we pay to the manufacturers from which we purchase our products and to the cost of transporting the products to us and our customers. The price that our suppliers charge us for our products is dependent in part upon the availability and cost of the raw materials used to produce those products. Such raw materials are often subject to price fluctuations, frequently due to factors beyond our control, including changes in supply and demand, general U.S. and international economic conditions, labor costs, competition and government regulations. Increases in the cost of raw materials, such as copper, oil, stainless steel, aluminum, zinc, plastic and polyvinyl chloride ("PVC") and other commodities and raw materials have occurred in the past and adversely impacted our operating results. Transportation prices are significantly dependent on fuel prices, which generally change due to factors beyond our control, such as changes in worldwide demand, disruptions in supply, changes in the political climate in the Middle East and other regions and changes in government regulations, including existing and pending legislation and regulations relating to climate change. For example, efforts to combat climate change through reduction of greenhouse gases may result in higher fuel costs through taxation or other means. Fluctuations in raw materials and fuel prices may increase our costs and significantly reduce our revenues and profitability. The nature and extent of such an impact is difficult to predict, quantify and measure. To the extent the costs of products increase or decrease, the prices we charge for our products may correspondingly increase or decrease, adversely affecting our revenues and profitability.
In addition, many of our suppliers incur costs of production in non-U.S. currencies. Accordingly, depreciation of the U.S. dollar against foreign currencies could increase the price we pay for these products. For example, a substantial portion of our products are sourced from suppliers in China and the value of the Chinese Yuan has increased relative to the U.S. dollar since July 2005, when it was allowed to fluctuate against a basket of foreign currencies. Most experts believe that the value of the Yuan will continue to increase relative to the U.S. dollar over the next few years. Such a move would most likely result in an increase in the cost of products that are sourced from suppliers in China.
Loss of supplier agreements, lack of product availability or loss of delivery sources could decrease our revenues and profitability.
Our ability to offer a wide variety of products to our customers is dependent upon our ability to obtain adequate product supply from manufacturers or other suppliers. While in many instances we have agreements, including supply chain agreements, with our suppliers, these agreements are generally terminable by either party on limited notice. Even though we can replace each of our suppliers and no individual supplier represented more than 7% of our total purchases during the fiscal year ended December 28, 2012,
the loss of several supplier agreements, or a substantial decrease in the availability of products from our suppliers, could have a short-term material impact on our business.
In addition, supply interruptions could arise from shortages of raw materials, labor disputes, natural or man-made disasters, or weather conditions affecting products or shipments, transportation disruptions or other factors beyond our control. Loss of a key foreign supplier could disrupt our supply chain for approximately 60 to 90 days, or longer, and loss of key suppliers from an individual country could result in disruptions of approximately 120 to 150 days, or longer. Short and long-term disruptions in our supply chain would result in higher inventory levels as we replace similar products domestically, a higher cost of product and ultimately a decrease in our revenues and profitability. Although we are not substantially dependent on any individual supplier, a disruption in the timely availability of our product by our key suppliers could result in a decrease in our revenues and profitability.
A change in supplier rebates could adversely affect our income and gross margins.
The terms on which we purchase products from many of our suppliers entitle us to receive a rebate based on the volume of our purchases. These rebates effectively reduce our costs for products. If market conditions change, suppliers may adversely change the terms of some or all of these programs. Although these changes would not affect the recorded costs of products already purchased, they may lower our gross margins on products we sell or income we realize in future periods. Further, if we fail to meet specified volume thresholds for certain suppliers, we may not receive the most favorable rebates available, which could increase our expected costs and decrease our gross margins.
In some cases, we are dependent on long supply chains, which may subject us to interruptions in the supply of many of the products that we distribute.
A significant portion of the products that we distribute is imported from foreign countries, including China. We are thus dependent on long supply chains for the successful delivery of many of our products. The length and complexity of these supply chains make them vulnerable to numerous risks, many of which are beyond our control, which could cause significant interruptions or delays in delivery of our products. Factors such as labor disputes, currency fluctuations, changes in tariff or import policies, severe weather or terrorist attacks or armed hostilities may disrupt these supply chains. In addition to these factors, loading container cargo in Chinese ports can be disrupted or delayed by congestion in port terminal facilities, inadequate equipment to load, dock and offload container vessels or energy-related tie-ups. In any such case, our product shipments will be delayed. We expect more of our name brand and exclusive brand products will be imported in the future, which will further increase these risks. A significant interruption in our supply chains caused by any of the above factors could result in increased costs or delivery delays and result in a decrease in our revenues and profitability.
If the government of China were to reduce or withdraw the tax benefits they provide our Chinese suppliers, the cost of some of our products could increase and therefore our profitability may be significantly reduced.
China’s turnover tax system consists of value-added tax ("VAT"), consumption tax and business tax. Export sales are exempted under VAT rules and an exporter who incurs input VAT on the manufacture of goods can claim a tax rebate from Chinese tax authorities. Currently, our Chinese suppliers benefit from the tax rebates that China provides them to export their products. If these tax rebates are reduced or eliminated, some of our Chinese-sourced products could become more expensive for us, thereby reducing our profitability.
We could face potential product quality and product liability claims relating to the products we distribute, as well as other legal claims, which could result in a decline in revenues and profitability and negatively impact customer confidence.
We rely on manufacturers and other suppliers to provide us with the products we sell and distribute. As we do not have direct control over the quality of the products manufactured or supplied by such third party suppliers, we are exposed to risks relating to the quality of the products we distribute. It is possible that inventory from a manufacturer or supplier could be sold to our customers and later be alleged to have quality problems or to have caused personal injury or property damage, subjecting us to potential claims from customers or third parties. The risk of claims may be greater with respect to our exclusive brand products, as these products are customarily manufactured by third party suppliers outside the United States, particularly in China. We have been subject to claims in the past, which have been resolved without material financial impact. Product liability claims can be expensive to defend and can divert the attention of management and other personnel for significant time periods, regardless of the ultimate outcome, and could result in settlement payments and adjustments not covered by or in excess of insurance. In addition, we may not be able to obtain insurance on terms acceptable to us or at all. An unsuccessful product liability defense could be very costly and could result in a decline in revenues and profitability. In addition, uncertainties with respect to the Chinese legal system may adversely affect us in resolving claims arising from our exclusive brand products manufactured in China. Because many laws and regulations are relatively
new and the Chinese legal system is still evolving, the interpretations of many laws, regulations and rules are not always uniform. Finally, even if we are successful in defending any claim relating to the products we distribute, claims of this nature could negatively impact customer confidence in our products and our company.
We also operate a large fleet of trucks and other vehicles and therefore face the risk of accidents. While we currently maintain insurance coverage to address a portion of these types of liabilities, we cannot make assurances that we will be able to obtain such insurance on acceptable terms in the future, if at all, or that any such insurance will provide adequate coverage against potential claims.
We are involved from time to time in a number of legal proceedings, including government inquiries and investigations, as well as product liability, employment, tort and other litigation. We cannot predict with certainty the outcomes of these legal proceedings and other contingencies. Defending against these lawsuits and proceedings may involve significant expense and diversion of management's attention and resources from other matters.
Disruption in our information technology could significantly lower our revenues and profitability.
Our operations are dependent upon our information technology that encompasses all of our major business functions. We rely upon our information technology to manage and replenish inventory, to fill and ship customer orders on a timely basis and to coordinate our sales and marketing activities across all of our brands. We believe that our information technology plays a key role in our ability to achieve operating and financial efficiencies. Despite the implementation of network security measures, our information technology could be penetrated by outside parties (such as computer hackers or cyber terrorists) intent on extracting information, corrupting information or disrupting business processes. Such unauthorized access could disrupt our business and could result in a loss of assets or reputational damage. Any substantial disruption of our information technology for any prolonged time period could result in delays in receiving inventory and supplies or filling customer orders and, accordingly, could significantly lower our revenues and profitability.
Information technology enhancements require substantial ongoing capital expenditures and could involve execution and operational risk to our business.
Information technology plays an increasingly important role in the distribution industry and is central in maintaining a competitive advantage. We have long recognized the importance of technology and have consistently invested in information technology to differentiate ourselves from our competitors and make us even more relevant to customers. The pace of this investment is expected to continue, and most likely increase, as we continue to improve our business through the deployment of new technology. Future technology enhancements - which may be required to achieve our long-term growth plans - are continually planned in many areas of our business. These enhancements may require substantial capital expenditures, and the implementation of any new technology carries execution and operational risk.
Our allowance for doubtful accounts may prove inadequate or we may be negatively affected by credit risk exposures.
Our business depends on the creditworthiness of our customers. We periodically review our allowance for doubtful accounts for adequacy considering economic conditions and trends, collateral values and credit quality indicators, including past charge-off experience and levels of past due accounts. We cannot be certain that our allowance for doubtful accounts will be adequate over time to cover losses in our accounts receivable because of adverse changes in the economy or events adversely affecting specific customers, industries or markets. The current economic environment is dynamic and the creditworthiness of our customers and the value of collateral underlying our accounts receivable can change significantly over very short periods of time. Our allowance may not keep pace with changes in the creditworthiness of our customers or collateral values. If the credit quality of our customer base materially decreases, if the risk of a market, industry, or group of customers changes significantly, or if our allowance for doubtful accounts is not adequate, our business, financial condition and results of operations could suffer.
The loss of any of our significant customers could significantly reduce our revenues and profitability.
Our 10 largest customers generated approximately $90.0 million, or approximately 6.8%, of our sales in the fiscal year ended December 28, 2012, and our largest customer accounted for approximately 1.3% of our sales in the fiscal year ended December 28, 2012. The loss of one or more of our significant customers or deterioration in our relations with any of them could significantly reduce our revenues and profitability.
We cannot assure you that we will be able to successfully complete the integration of our recent acquisitions of JanPak and CleanSource, or any future acquisitions or manage other consequences of our acquisitions, which could impede our ability to remain competitive and, ultimately, our revenues and profitability.
Acquisitions involve significant risks and uncertainties, including difficulties integrating acquired personnel and other corporate cultures into our business, difficulties associated with information technology conversions, the potential loss of key employees, customers or suppliers, the assumption of liabilities and exposure to unforeseen liabilities of acquired companies, the difficulties in achieving target synergies and the diversion of management attention and resources from existing operations. We may not be able to fully integrate the operations of JanPak and CleanSource, or any future acquired businesses with our own in an efficient and cost-effective manner or without significant disruption to our existing or acquired operations. Our failure to integrate future acquired businesses effectively or to manage other consequences of our acquisitions, including increased indebtedness, could impede our ability to remain competitive and, ultimately, impact our revenues and profitability.
We may not be able to facilitate our growth strategy by identifying or completing transactions with attractive acquisition candidates, which could impede our revenues and profitability.
Our acquisitions have contributed significantly to our growth. An important element of our growth strategy is to continue to seek additional businesses to acquire in order to add new customers within our existing markets and to acquire brands in new markets. We cannot assure you that we will be able to identify attractive acquisition candidates or complete the acquisition of any identified candidates at favorable prices and upon advantageous terms and conditions. Furthermore, we believe that our industry is currently in a process of consolidation, and competition for attractive acquisition candidates is therefore likely to escalate, thereby limiting the number of acquisition candidates and/or increasing the overall costs of making acquisitions. In addition, we may not be able to obtain financing necessary to complete acquisitions on attractive terms or at all. Difficulties we may face in identifying or completing acquisitions could impede our revenue growth and profitability.
Our ability to both maintain our existing customer base and to attract new customers is dependent in many cases upon our ability to deliver products and fulfill orders in a timely and cost-effective manner.
To ensure timely delivery of our products to our customers, we frequently rely on third parties, including couriers such as UPS and other national shippers as well as various local and regional trucking contractors and logistics consulting and management companies. Outsourcing this activity generates a number of risks, including decreased control over the delivery process and service timeliness and quality. Any sustained inability of these third parties to deliver our products to our customers could result in the loss of customers or require us to seek alternative delivery sources, if they are available, which may result in significantly increased costs and delivery delays. Furthermore, the need to identify and qualify substitute service providers or increase our internal capacity could result in unforeseen operational problems and additional costs. Moreover, if demand for our products increases, we may be unable to secure sufficient additional capacity from our current service providers, or others, on commercially reasonable terms, if at all.
Disruption in our distribution centers could significantly lower our revenues and profitability.
Our distribution centers are essential to the efficient operation of our national distribution network. Any serious disruption to these distribution centers due to fire, earthquake, severe weather, act of terrorism or any other cause could damage a significant portion of our inventory. In addition, we could incur significantly higher costs and longer lead times associated with distributing our products to our customers during the time that it takes for us to reopen or replace these centers. As a result, any such disruption could significantly lower our revenues and profitability.
We may be unable to retain senior executives and attract and retain other qualified employees, which might hinder our growth and could impede our ability to run our business and potentially reduce our revenues and profitability.
Our success depends in part on our ability to attract, hire, train and retain qualified managerial, sales, operational and marketing personnel. We face significant competition for these types of personnel in our industry. We may be unsuccessful in attracting and retaining the personnel we require to conduct and expand our operations successfully and, in such an event, our revenues and profitability could decline. In addition, key personnel may leave us and compete against us. Our success also depends, to a significant extent, on the continued service of our senior management team. The loss of any member of our senior management team or other qualified employees could impair our ability to execute our business plan and growth strategy, cause us to lose customers and reduce our net sales, or lead to employee morale problems and/or the loss of key employees.
We may not be able to protect our trademarks and service marks, which could diminish the strength of our trademarks or limit our ability to use our trademarks and, accordingly, undermine our competitive position.
We believe that our trademarks (including both trademarks and service marks) are important to our success and our competitive position. For instance, we market and sell products primarily through fourteen distinct and targeted brands: Wilmar®, Barnett®, AmSan®, JanPakSM , CleanSource®, Sexauer®, Hardware Express®, Copperfield®, Maintenance USA®, U.S. Lock®, SunStar®, LeranSM, Trayco®, and AF Lighting®. We believe many of our customers have developed strong consumer loyalty to these targeted brands. Accordingly, we devote resources to the establishment and protection of our trademarks and our exclusive brand products. However, the actions we have taken may be inadequate to prevent imitation and/or infringement of our trademarks by others or to prevent others from claiming violations of their trademarks and proprietary rights by us. Our rights in our trademarks are subject to rights of others whose actual or constructive use of such trademark (or a confusingly similar mark) commenced before the date our rights vested. Future actions by third parties may diminish the strength of our trademarks or limit our ability to use our trademarks and, accordingly, undermine our competitive position.
Certain private equity investment funds affiliated with GS Capital Partners VI Fund, L.P. and its related entities (“GS Capital Partners”) and P2 Capital Partners, LLC and its related entities (“P2 Capital Partners”) own a significant majority of our equity, and their interests may not be aligned with our note holders or creditors.
GS Capital Partners and P2 Capital Partners own substantially all of our equity. These private equity investment funds have the power, subject to certain exceptions, to direct our affairs and policies and to elect the majority of the members of our Board of Directors. Through such representation on our Board of Directors, they are able to substantially influence the appointment of management and entry into extraordinary transactions, including mergers and sales of assets.
The interests of GS Capital Partners and P2 Capital Partners could conflict with the interests of the note holders or creditors. For example, if we encounter financial difficulties or are unable to pay our debts as they mature, the interests of GS Capital Partners and P2 Capital Partners as equity holders might conflict with the interests of the note holders or creditors. GS Capital Partners and P2 Capital Partners may also have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their equity investments, although such transactions might involve risks to the note holders or creditors. In addition, GS Capital Partners and P2 Capital Partners or their respective affiliates may in the future own businesses that directly or indirectly compete with ours or our suppliers or customers of ours.
Risks Relating to Our Indebtedness
Our substantial indebtedness could adversely affect our financial health and prevent us from fulfilling our obligations.
As of December 28, 2012, our total indebtedness was $823.6 million, of which $21.5 million represents the unamortized fair value premium recorded in connection with the Merger, $8.9 million was outstanding in the form of letters of credit and $0.7 million relates to capital lease obligations. As of December 28, 2012, we had $365.0 million HoldCo Notes outstanding, $300.0 million OpCo Notes outstanding, and $127.5 million outstanding on the ABL Facility. Also, as of December 28, 2012, we had $17.5 million of total cash and cash equivalents and $113.5 million in availability under the ABL Facility. Our substantial indebtedness could have important consequences to our financial health. For example it could:
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make it more difficult for us to satisfy our obligations with respect to the HoldCo Notes, OpCo Notes, the ABL Facility, and our other indebtedness,
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increase our vulnerability to general adverse economic and industry conditions or a downturn in our business,
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require us to dedicate a substantial portion of our cash flow from operations to debt service thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes,
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limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate,
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place us at a competitive disadvantage compared to our competitors that are not as highly leveraged,
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limit, along with the financial and other restrictive covenants in our indebtedness, among other things, our ability to borrow additional funds, and
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result in an event of default if we fail to satisfy our obligations under the HoldCo Notes, OpCo Notes, the ABL Facility, or our other indebtedness or fail to comply with the financial and other restrictive covenants contained in the indentures, the ABL Facility, or our other debt; such event of default could result in all of our debt becoming immediately due and payable and could permit certain of our lenders to foreclose on our assets securing such indebtedness.
We cannot be certain that our earnings will be sufficient to allow us to timely pay principal and interest on our debt and meet our other obligations. If we do not have sufficient earnings, we may be required to refinance all or part of our existing debt, sell assets, borrow more money or sell more securities, none of which we can guarantee we will be able to do. Our ability to incur additional debt will be limited by the terms and conditions of our credit facility. Any of the above listed factors could have a material adverse effect on our business, financial condition and results of operations.
The indentures governing the HoldCo Notes and OpCo Notes and the agreement governing the ABL Facility include restrictive and financial covenants that may limit our operating and financial flexibility.
The indentures governing the HoldCo Notes and OpCo Notes, and the agreement governing the ABL Facility, each contain covenants that, among other things, restrict our ability to take specific actions, even if we believe them to be in our best interest. These include restrictions on our ability to:
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incur additional indebtedness,
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pay dividends or distributions on, or redeem or repurchase, capital stock,
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prepay, redeem or repurchase specified indebtedness,
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merge, consolidate or sell assets or enter into other business combination transactions,
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make acquisitions, capital expenditure investments or other investments,
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enter into transactions with affiliates,
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incur certain liens,
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enter into sale-leaseback transactions,
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use proceeds from sale of assets,
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limit the payment of dividends by our subsidiaries, and
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change our business.
In addition, 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.
Despite current indebtedness levels, we may still be able to incur substantial additional indebtedness.
We may be able to incur substantial additional indebtedness in the future to finance acquisitions, investments, or for other purposes, subject to the restrictions contained in the documents governing our indebtedness. As of December 28, 2012, we were able to incur up to a maximum of $113.5 million in total additional indebtedness under the ABL Facility, based on year-end inventory and trade accounts receivable balances. Although the ABL Facility and the indentures governing the HoldCo Notes and OpCo Notes contain some limitations on our ability to incur indebtedness, we may still incur substantial indebtedness. If new indebtedness is added to our current indebtedness levels, the substantial leverage risks described above that we now face would intensify.
The volatility and disruption of the capital and credit markets may impair our access to sufficient capital.
We may not be able to obtain additional financing on favorable terms, or at all, as credit markets may be uncertain and potentially volatile. In addition, we may not be able to refinance our outstanding debt when due, which could have a material adverse effect on our business. Decreased access to the credit markets and other financing sources could also restrict our ability to make acquisitions and grow our business.
Furthermore, if our operating results, cash flow or capital resources prove inadequate, or if interest rates increase significantly, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt and other obligations. If we are unable to service our debt, we could be forced to reduce or delay planned capital expenditures, sell assets, restructure or refinance our debt or seek additional equity capital, and we may be unable to take any of the actions on satisfactory terms or in a timely manner. Further, any of these actions may not be sufficient to allow us to service our debt obligations or may have an adverse impact on our business. The terms of the ABL Facility and the indentures governing the HoldCo Notes and OpCo Notes will limit our ability to take certain of these actions. Our failure to generate sufficient operating cash flow to pay our debts, to refinance our indebtedness or to successfully undertake any of these other actions could have a material adverse effect on us.
ITEM 1B.
ITEM 1B. Unresolved Staff Comments
None.
ITEM 2.
ITEM 2. Properties
We operate from 163 locations throughout the United States, Canada and Puerto Rico consisting of 70 distribution centers, 21 free-standing professional contractor showrooms, 59 vendor-managed inventory locations, ten administrative and support facilities and three cross-dock facilities.
We lease 98 properties. The majority of these leases are for varying term lengths up to five years. We own a call center located in Jacksonville, Florida and distribution centers in Long Island, New York, Louisville, Kentucky, and Bluefield, West Virginia, all of which have attached administrative and support facilities. We also own distribution centers in Bristol, Tennessee, and Piedmont, South Carolina. None of the owned properties are subject to any mortgages; however, our call center in Jacksonville, Florida is subject to a development agreement with the City of Jacksonville. Our 59 vendor-managed inventory locations are customer-specific locations whereby we assist those customers with their MRO inventory management process.
We believe that our properties are in good operating condition and adequately serve our current business operations.
The ranges in size of the locations we operate are as follows (not including vendor-managed inventory locations and cross-dock facilities):
The following table sets forth the states, territories and provinces in which we operate (not including vendor-managed inventory locations and cross-dock facilities):
ITEM 3.
ITEM 3. Legal Proceedings
On May 10, 2011, we were named as a defendant in an action filed before the Nineteenth Judicial Circuit Court of Lake County, Illinois, which was subsequently removed to the United States District Court for the Northern District of Illinois. The complaint alleges that we sent thousands of unsolicited fax advertisements to businesses nationwide in violation of the Telephone Consumer Protection Act of 1991, as amended by the Junk Fax Prevention Act of 2005 (“TCPA”). At the time of filing the complaint, the plaintiff also filed a motion asking the Court to certify a class of plaintiffs comprised of businesses who allegedly received unsolicited fax advertisements from us. Other reported TCPA claims have resulted in a broad range of outcomes, with each case being dependent on its own unique set of facts and circumstances. Accordingly, we cannot reasonably estimate the amount of loss, if any, arising from this matter. We are vigorously contesting class action certification and liability, and will continue to evaluate our defenses based upon our internal review, advice from external legal counsel and investigation of prior events, new information, and future circumstances.
We are involved in various other legal proceedings that have arisen in the ordinary course of our business and have not been fully adjudicated. These actions, when ultimately concluded and determined, will not, in the opinion of management, have a material effect upon our consolidated financial statements.
Because the outcome of litigation is inherently uncertain, we may not prevail in these proceedings and we cannot estimate our ultimate exposure in such proceedings if we do not prevail. Accordingly, any rulings against us in the above proceedings could have a material adverse effect on our consolidated financial statements.
ITEM 4.
ITEM 4. Mine Safety Disclosures
None.
PART II
ITEM 5.
ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
From December 16, 2004 through September 7, 2012, our common stock was publicly traded on the New York Stock Exchange (“NYSE”) under the symbol “IBI”. Subsequent to the Merger Transaction, our outstanding common stock became privately-held, and therefore there is no established public trading market.
Holders
As of March 8, 2013, there were approximately 90 holders of record of our outstanding common stock.
Dividends
We have never declared dividends on our common stock. Our ability to declare and pay dividends on our common stock is subject to the requirements of Delaware law. In addition, we are a parent company with no business operations of our own. Accordingly, our sources of cash are dividends and distributions with respect to our ownership interest in Interline New Jersey that are derived from the earnings and cash flow generated by our businesses. Our ability to pay dividends to stockholders and the ability of Interline New Jersey to pay dividends to us is restricted under the ABL Facility, the HoldCo Notes, and the OpCo Notes. See Item 7. "Management's Discussion and Analysis - Liquidity and Capital Resources" for a more detailed description of our debt instruments.
Unregistered Sales of Equity Securities
None.
Purchases of Equity Securities by the Issuer
None.
ITEM 6.
ITEM 6. Selected Financial Data
The table below presents our selected historical consolidated financial data (in thousands) for 2012, 2011, 2010, 2009 and 2008. The information presented below should be read in conjunction with Item 7.
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with “Selected Financial Data” and our consolidated financial statements included elsewhere in this report. Some of the statements in the following discussion are forward-looking statements. See “Forward-Looking Statements” above. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including the risks described elsewhere in this report under "Risk Factors".
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”); plumbing; hardware, tools and fixtures; 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 fourteen 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®, JanPakSM , 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®, SunStar®, 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 sales force of approximately 800 field sales representatives, approximately 400 inside sales and customer service representatives, a direct marketing program consisting of catalogs and promotional flyers, brand-specific websites, a national accounts sales program, and other supply chain programs, such as vendor managed inventory.
We deliver our products through our network of 70 distribution centers and 21 professional contractor showrooms located throughout the United States, Canada, and Puerto Rico, 59 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.
Merger Transaction
On September 7, 2012, pursuant to an Agreement and Plan of Merger dated as of May 29, 2012, Isabelle Holding Company Inc., a Delaware corporation, Isabelle Acquisition Sub Inc., a Delaware corporation and a wholly-owned subsidiary of Parent, merged with and into the Company, with the Company surviving the Merger as a wholly-owned subsidiary of Parent. Immediately following the effective time of the Merger, Parent was merged with and into the Company with the Company surviving. Under the Merger Agreement, stockholders of the Company received $25.50 in cash for each share of Company common stock. The Merger was unanimously approved by Interline's Board of Directors and a majority of Interline's stockholders holding the outstanding shares of the common stock. See Note 3. Transactions to our audited consolidated financial statements included in this annual report for further information about the Merger Agreement. Prior to the Merger Date, the Company operated as a public company with its common stock traded on the New York Stock Exchange. As a result of the Merger, Interline's common stock became privately-held.
Our primary business activities remain unchanged after the Merger. As a result of the Merger, we applied the acquisition method of accounting and established a new accounting basis on September 8, 2012. Although the Company continued as the same legal entity after the Merger, since the financial statements are not comparable as a result of acquisition accounting, the results of operations and related cash flows are presented for two periods: the period prior to the Merger and the period subsequent to the Merger.
In connection with the Merger, we incurred significant indebtedness and became more leveraged. In addition, the purchase price paid in connection with the Merger has been allocated to recognize the acquired assets and liabilities at fair value. The purchase accounting adjustments have been recorded to: (i) establish intangible assets for our trademarks and customer relationships, and (ii) revalue our OpCo Notes to fair value. Subsequent to the Merger, interest expense and non-cash amortization charges have significantly increased. As a result, our Successor financial statements subsequent to the Merger are not comparable to our Predecessor financial statements.
Acquisitions
On December 11, 2012, Interline New Jersey acquired all of the outstanding stock of JanPak, Inc. ("JanPak") for $82.5 million in cash, subject to working capital and other closing adjustments. JanPak, which is headquartered in Davidson, North Carolina, is a large regional distributor of janitorial and sanitation supplies and packaging products, primarily serving property management and building service contractors as well as manufacturing, health care and educational facilities through 16 distribution centers across the Southeast and South Central United States. This acquisition represents an expansion of the Company's offering of JanSan products in the Southeastern, Mid-Atlantic, and South Central United States.
On January 28, 2011, Interline New Jersey acquired substantially all of the assets and a portion of the liabilities of Northern Colorado Paper, Inc. (“NCP”) for $9.5 million in cash and an earn-out of up to $0.3 million in cash over two years. NCP, which is headquartered in Greeley, Colorado, is a regional distributor of JanSan supplies, primarily serving institutional facilities in the health care, education and food service industries. This acquisition represents an expansion of the Company's offering of JanSan products in the western United States.
On October 29, 2010, Interline New Jersey acquired substantially all of the assets and a portion of the liabilities of CleanSource, Inc. (“CleanSource”) for $54.6 million in cash and an earn-out of up to $5.5 million in cash over two years. CleanSource, which is headquartered in San Jose, California, is a large regional distributor of JanSan supplies. CleanSource offers over 4,000 products and primarily serves institutional facilities in the health care and education markets, as well as building services contractors. This acquisition represents a geographical expansion of the Company's offering of JanSan products to the West Coast of the United States.
Refinancing Transactions
In connection with the Merger, the Company entered into the following financing transactions:
•
a new senior secured asset-based revolving credit facility totaling $275.0 million (the "ABL Facility");
•
the issuance of $365.0 million aggregate principal amount of senior notes (the "HoldCo Notes"); and
•
the modification of the $300.0 million senior subordinated notes due 2018 (the “OpCo Notes”).
Simultaneously with the closing of the Merger, the following occurred: the funding of the new ABL Facility, the release of the net proceeds of the $365.0 million HoldCo Notes from escrow, the termination of the Company's previous $225.0 million asset-based revolving credit facility, and the modification of the OpCo Notes. On November 16, 2010, Interline New Jersey completed a series of refinancing transactions, including an offering of the OpCo Notes. See “Management's Discussion and Analysis of Financial Condition and Results of Operations-Refinancing Transactions,” “Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources”, and Note 10. Debt included in Part II. Item 8 of this annual report for further information regarding our outstanding indebtedness.
As a result of the Merger, acquisitions and refinancing transactions described above, our historical financial results or results of operations may not be indicative of our financial results or results of operations in the future.
Purchases of Equity Securities by the Issuer
On August 15, 2011, the Company announced that its Board of Directors had authorized the repurchase of up to an aggregate amount of $25.0 million of the Company's common stock. The Authorization did not have an expiration date and could be modified, suspended, or discontinued by the Board of Directors at any time, in accordance with applicable securities laws. As of December 30,
2011, the Company had repurchased 1,783,822 shares of common stock pursuant to the Authorization at an aggregate cost of $25.0 million, or an average cost of $14.01 per share, through open market transactions, thereby completing the amount of shares that may be purchased under the Authorization.
In connection with the Merger transaction, each share of common stock of Interline was canceled on September 7, 2012, and converted automatically into a right to receive $25.50 in cash, without interest.
Results of Operations
The following table presents information derived from the consolidated statements of operations expressed as a percentage of net sales in accordance with US GAAP. US GAAP requires that we separately present our results for the period September 8, 2012 through December 28, 2012 ("Successor Period") and for the period from December 31, 2011 through September 7, 2012 ("Predecessor Period"). Management believes reviewing our operating results for the fiscal years ended December 28, 2012 and December 30, 2011 by combining the results of the Predecessor and Successor periods is more useful in identifying trends in, or reaching conclusions regarding, our overall operating performance and performs reviews at that level. Accordingly, in addition to presenting our results of operations as reported in our consolidated financial statements in accordance with US GAAP, the table below presents the non-GAAP combined results for the fiscal years ended December 28, 2012 and December 30, 2011, which we also use to compute the percentage change to the prior year, as we believe this presentation provides a more meaningful basis for comparison of our results. The combined operating results may not reflect the actual results we would have achieved had the Merger closed prior to September 7, 2012, and may not be predictive of our future results of operations.
____________________
(1)
Percent increase (decrease) represents the actual change as a percentage of the prior year’s result.
NM - Not Meaningful
The following discussion refers to the term average daily sales and average organic daily sales. Average daily sales are defined as sales for a period of time divided by the number of shipping days in that period of time. Average organic daily sales are defined as sales for a period of time divided by the number of shipping days in that period of time excluding any sales from acquisitions made subsequent to the beginning of the prior year period. For a reconciliation of average organic daily sales growth to US GAAP-based financial measures, see “Reconciliation of Average Organic Daily Sales to Net Sales” table below.
Overview. During the combined fiscal year ended December 28, 2012, our sales increased 5.8% in total and 6.2% on an average daily sales basis, primarily reflecting the impact of continued economic improvements across our facilities maintenance end-market, combined with our continued investments in our sales forces, our information technology, and our acquisitions of JanPak and NCP. On an organic basis, our sales increased 4.5% and on an average organic daily sales basis, our sales increased by 4.9%. Sales to our institutional facilities customers, which made up 45% of our total sales, increased 8.5% in total, 5.4% on an average organic sales basis, and increased 5.9% on an average organic daily sales basis. Sales to our multi-family housing facilities customers, which made up 32% of our total sales, increased 7.9% in total and increased 8.3% on an average daily sales basis. Sales to our residential facilities customers, which made up 23% of our total sales, decreased 1.1% in total and decreased 0.8% on an average daily sales basis. 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 into 2013 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 1.6% in the combined fiscal year ended 2012 compared to 6.7% in the comparable prior year period. Excluding expenses associated with the Merger, operating income was 6.1% of sales in the combined fiscal year ended 2012. The decrease in operating income as a percentage of sales is primarily a result of the Merger related expenses, lower gross profit margins related to changes in customer and product mix, and to a lesser extent, some product cost pressure as compared to the prior year, and higher depreciation and amortization expense, which was predominately driven by the Merger, offset in part by lower selling, general and administrative ("SG&A") expenses as a percentage of sales.
Net loss as a percentage of net sales was 1.2% in the combined fiscal year ended 2012 compared to net income as a percent of sales of 3.0% in the comparable prior year period largely as a result of the impact of the costs associated with the Merger.
Combined Fiscal Year Ended December 28, 2012 Compared to Fiscal Year Ended December 30, 2011
Net Sales. Net sales increased by $72.9 million, or 5.8%, to $1,322.3 million in the combined fiscal year ended December 28, 2012 from $1,249.5 million in the fiscal year ended December 30, 2011. The increase in sales is primarily attributable to sales of $47.1 million from net increases in sales to our institutional facilities customers, including $16.9 million from acquisitions, plus $30.4 million from net increases in sales to our multi-family housing facilities customers, partially offset by a decrease in sales to our residential facilities customers of $3.6 million. On an organic basis, our sales increased 4.5%, and on an average organic daily sales basis, our sales increased 4.9%. On an uncombined basis, net sales decreased by $844.9 million and $331.7 million for the period September 8, 2012 through December 28, 2012 and the period December 31, 2011 through September 7, 2012, respectively, as compared to the prior fiscal year ended December 30, 2011. These decreases are directly attributable to the comparison of 76 selling days in the current year Successor Period and 177 selling days in the current year Predecessor Period, with 254 selling days in the prior year Predecessor Period.
Gross Profit. Gross profit increased by $19.5 million, or 4.2%, to $482.0 million in the combined fiscal year ended December 28, 2012 from $462.5 million in the fiscal year ended December 30, 2011. Our gross profit margin decreased 60 basis points to 36.4% for the combined fiscal year ended December 28, 2012 compared to 37.0% for the fiscal year ended December 30, 2011. This decrease in gross profit margin was related to our acquisitions, which accounted for 20 basis points of the decrease in gross profit margins, while the remaining decline was primarily attributable to changes in customer and product mix, and to a lesser extent some product cost pressure as compared to the prior year. On an uncombined basis, gross profit decreased by $314.2 million and $128.7 million for the period September 8, 2012 through December 28, 2012 and the period December 31, 2011 through September 7, 2012, respectively, as compared to the prior fiscal year ended December 30, 2011. These decreases are directly attributable to the comparison of 76 selling days in the current year Successor Period and 177 selling days in the current year Predecessor Period, with 254 selling days in the prior year Predecessor Period.
Selling, General and Administrative Expenses. SG&A expenses increased by $16.2 million, or 4.6%, to $370.9 million in the combined fiscal year ended December 28, 2012 from $354.8 million in the fiscal year ended December 30, 2011. As a percentage of net sales, SG&A decreased 30 basis points to 28.1% for the combined fiscal year ended December 28, 2012 compared to 28.4% for the fiscal year ended December 30, 2011. The decrease in SG&A expenses as a percentage of sales is primarily due to lower bad debt expense, lower occupancy costs, and lower delivery costs as a percentage of sales as a result of the sales growth discussed above. On an uncombined basis, SG&A decreased by $239.2 million and $99.3 million for the period September 8, 2012 through December 28, 2012 and the period December 31, 2011 through September 7, 2012, respectively, as compared to the prior fiscal year ended December 30, 2011. These decreases are directly attributable to the comparison of 80 expense days in the current year Successor Period and 180 expense days in the current year Predecessor Period, with 260 expense days in the prior year Predecessor Period.
Depreciation and Amortization. Depreciation and amortization expense increased by $6.8 million, or 28.7%, to $30.5 million in the combined fiscal year ended December 28, 2012 from $23.7 million in the fiscal year ended December 30, 2011. As a percentage of net sales, depreciation and amortization was 2.3% and 1.9% for the combined fiscal year ended December 28, 2012 and December 30, 2011, respectively. The increase in depreciation expense was due to higher capital spending associated with our information technology infrastructure and distribution center consolidation and integration efforts that occurred during the last three years. The increase in amortization expense is primarily driven by the incremental amortization of the fair value adjustments for the definite-lived intangible asset values recorded as a result of the Merger. On an uncombined basis, depreciation and amortization decreased by $10.9 million and $6.0 million for the period September 8, 2012 through December 28, 2012 and the period December 31, 2011 through September 7, 2012, respectively, as compared to the prior fiscal year ended December 30, 2011. These decreases are directly attributable to the comparison of 80 expense days in the current year Successor Period and 180 expense days in the current year Predecessor Period, respectively, with 260 expense days in the prior year Predecessor Period, offset in part by the increase in amortization on the definite-lived intangibles identified in connection with the Merger.
Merger related expenses. Merger related expenses incurred in the combined fiscal year ended December 28, 2012 of $58.7 million are comprised of professional fees of $22.4 million, share-based compensation of $18.3 million, fees paid to our sponsors of $10.0 million, transaction related compensation of $6.8 million, and other costs of $1.2 million, all incurred as a direct result of the Merger.
Operating (loss) income. As a result of the foregoing, operating income decreased by $62.2 million, or 74.1%, to $21.8 million in the combined fiscal year ended December 28, 2012 from $84.0 million in the fiscal year ended December 30, 2011.
Loss on extinguishment of debt. In connection with the termination of the previous asset-based revolving facility, $2.2 million of unamortized deferred debt financing costs were written off during the third quarter, in the Predecessor Period.
Interest Expense. Interest expense increased $12.0 million, or 49.5%, to $36.4 million in the combined fiscal year ended December 28, 2012 from $24.4 million in the fiscal year ended December 30, 2011. The increase in interest expense is directly attributable to the borrowings made under the ABL Facility and the issuance of the HoldCo Notes to finance the Merger transactions, and the incremental interest associated with the modification of the OpCo Notes as more fully discussed in "Liquidity and Capital Resources" below. On an uncombined basis, interest expense decreased by $4.6 million and $7.7 million for the period September 8, 2012 through December 28, 2012 and the period December 31, 2011 through September 7, 2012, respectively, as compared to the prior fiscal year ended December 30, 2011. These decreases are directly attributable to the comparison of 80 expense days in the current year Successor Period and 180 expense days in the current year Predecessor Period, respectively, with 260 expense days in the prior year Predecessor Period, offset in part by the increase in interest expense as a result of the financing transactions discussed above.
Income tax (benefit) provision. Income taxes decreased by $23.0 million, or 96.3%, to a provision of $0.9 million in the combined fiscal year ended December 28, 2012 as compared to $23.8 million in the fiscal year ended December 30, 2011. The effective tax rate for the period September 8, 2012 through December 28, 2012 and the period December 31, 2011 through September 7, 2012, respectively, as compared to the prior fiscal year ended December 30, 2011 was 27.0%, 47.0% and 38.8%, respectively. The change in the effective tax rate is caused by the non-deductibility of certain Merger related expenses.
____________________
(1)
Percent increase (decrease) represents the actual change as a percentage of the prior year’s result.
Fiscal Year Ended December 30, 2011 Compared to Fiscal Year Ended December 31, 2010
Net Sales. Net sales increased by $162.5 million during 2011 to $1,249.5 million from $1,087.0 million in 2010, an increase of 14.9%, primarily attributable to the CleanSource and NCP acquisitions. Organic sales were $1,105.8 million in 2011 and $1,087.0 million in 2010, a 1.7% increase primarily due to modest economic improvements across our end-markets and incremental sales resulting from the addition of sales force personnel, offset somewhat by three fewer shipping days during the fiscal year ended December 30, 2011 compared to the fiscal year ended December 31, 2010. Average organic daily sales increased 2.9% resulting from a 3.4% increase in sales to our facilities maintenance customers and a 3.2% increase in sales to our professional contractor customers partially offset by a 0.2% decrease in sales to our specialty distributor customers. We believe our average organic daily sales increase is associated with modest economic improvements throughout our end-markets and incremental sales resulting from the addition of sales force personnel.
Gross Profit. Gross profit increased by $48.2 million, or 11.6%, to $462.5 million in 2011 from $414.2 million in 2010. This increase in gross profit was attributable to our acquisitions of CleanSource and NCP, as well as our organic sales growth. Our gross profit margins decreased 110 basis points to 37.0% in 2011 from 38.1% in 2010. This decrease in gross margin is primarily due to lower gross margins related to our CleanSource and NCP acquisitions.
Selling, General and Administrative Expenses. SG&A expenses increased by $35.9 million, or 11.3%, to $354.8 million in 2011 from $318.8 million in 2010. As a percentage of net sales, SG&A decreased 90 basis points to 28.4% for 2011 compared to 29.3% for 2010. The decrease in SG&A expenses as a percentage of sales is primarily due to the impact from our CleanSource and NCP acquisitions, lower one-time costs in the current year as compared to the prior year, lower bad debt expense, lower occupancy related expenses, and lower variable compensation expense, offset in part by higher delivery expenses and higher health care costs.
Depreciation and Amortization. Depreciation and amortization expense increased by $3.5 million, or 17.3%, to $23.7 million in 2011 from $20.2 million in 2010. As a percentage of net sales, depreciation and amortization was 1.9% in both the 2011 and 2010. The increase in depreciation and amortization expense was due to higher depreciation resulting from our higher capital spending over the last three years associated with our information technology infrastructure and distribution center consolidation and integration efforts as well as from our CleanSource and NCP acquisitions.
Operating Income. As a result of the foregoing, operating income increased $8.8 million, or 11.7%, to $84.0 million in 2011 from $75.2 million in 2010. As a percentage of net sales, operating income decreased to 6.7% in 2011 compared to 6.9% in 2010.
Loss on Extinguishment of Debt. There was no extinguishment of debt during 2011. During 2010, we repurchased $137.3 million of the 8 1/8% Notes and repaid the indebtedness under our prior credit facility. The remaining $13.4 million of the 8 1/8% Notes were redeemed on January 3, 2011. The 8 1/8% Notes were redeemed at an average price of 104.256% of par. In connection with the redemption of the 8 1/8% Notes and the repayment of the prior credit facility, we recorded a loss on early extinguishment of debt of $11.5 million. The loss was comprised of $6.9 million in tender premiums and transaction costs associated with the redemption of the 8 1/8% Notes and a non-cash charge of $4.6 million in deferred financing costs and original issue discount written-off associated with the redemption of the 8 1/8% Notes and the repayment of the prior credit facility.
Interest Expense. Interest expense increased by $5.6 million to $24.4 million in 2011 from $18.7 million in 2010. This increase was primarily due to a higher weighted average interest rate as our ratio of fixed versus floating rate debt increased from the series of refinancing transactions completed on November 16, 2010, which extended our debt maturities.
Income Tax Provision. The effective tax rate was 38.8% in 2011 compared to 40.3% in 2010. The decrease in the effective tax rate was primarily due to the prior year impact from our refinancing transaction, the reduction of the write-off of deferred tax assets associated with share-based compensation arising from stock options that were forfeited due to employee terminations, and a reduction in non-deductible and other expenses, partially offset by an increase in state income taxes.
Reconciliation of Average Organic Daily Sales to Net Sales
Average organic daily sales are defined as sales for a period of time divided by the number of shipping days in that period of time excluding any sales from acquisitions made subsequent to the beginning of the prior year period. The computation of average organic daily sales for each fiscal year shown below is as follows (dollar amounts in thousands):
____________________
(1)
The computation of average daily sales is performed using combined Predecessor and Successor net sales, as we believe that there was no impact to net sales as a result of the Merger and we also believe that it is more useful in identifying trends in, or reaching conclusions regarding, our overall operating performance.
(2)
Average daily sales are defined as sales for a period of time divided by the number of shipping days in that period of time.
(3)
Average organic daily sales are defined as sales for a period of time divided by the number of shipping days in that period of time excluding any sales from acquisitions made subsequent to the beginning of the prior year period.
Average organic daily sales is presented herein because we believe it to be relevant and useful information to our investors since it is used by our management to evaluate the operating performance of our business, as adjusted to exclude the impact of acquisitions, and compare our organic operating performance with that of our competitors. However, average organic daily sales is not a measure of financial performance under US GAAP and it should be considered in addition to, but not as a substitute for, other measures of financial performance reported in accordance with US GAAP, such as net sales. Management utilizes average organic daily sales as an operating performance measure in conjunction with US GAAP measures such as net sales.
Seasonality
We experience some seasonal fluctuations as sales of our products typically increase in the second and third fiscal quarters of the year due to increased apartment turnover and related maintenance and repairs in the multi-family residential housing sector during these periods. Typically, November, December and January sales are lower across most of our brands because customers may defer purchases at year-end as their budget limits are met and because of the winter holiday season between Thanksgiving Day and New Year's Day. Our Copperfield brand customarily experiences approximately two-thirds of its sales between July and December. As such, our first quarter sales and earnings typically tend to be lower than the remaining three quarters of the year. In addition, our working capital requirements in the second half of the year tend to be lower.
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.
The debt instruments of Interline New Jersey, primarily the ABL Facility and the indenture governing the terms of the OpCo Notes, contain significant restrictions on the payment of dividends and distributions to the Company by Interline New Jersey.
Interline New Jersey and the Company were in compliance with all covenants contained in the ABL Facility, OpCo Notes, and HoldCo Notes as of December 28, 2012.
As of December 28, 2012, we had $300.0 million of the OpCo Notes outstanding, plus a fair value premium of $21.5 million, $365.0 million of the HoldCo Notes outstanding, $127.5 million of the ABL Facility outstanding, and $113.5 million of availability under our ABL Facility, net of $8.9 million in letters of credit.
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. Letters of credit, which are issued under our ABL Facility, are used to support payment obligations incurred for our general corporate purposes.
As of December 28, 2012, we had $113.5 million of availability under our ABL Facility, net of $8.9 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 in the foreseeable future.
Financial Condition
Working capital decreased by $14.7 million to $311.3 million as of December 28, 2012 from $325.9 million as of December 30, 2011. The decrease in working capital was mainly the resulting impact of the Merger transactions, as cash was used to fund the transactions, combined with an increase to accrued interest, due in part to the interest accrued on the HoldCo Notes. These items were offset in part by cash flows from operations.
Cash Flow
Operating Activities. Net cash provided by operating activities was $4.4 million for the period September 8, 2012 through December 28, 2012, $25.0 million for the period from December 31, 2011 through September 7, 2012, $72.9 million for the fiscal year ended December 30, 2011, and $60.8 million for the fiscal year ended December 31, 2010.
Successor. Net cash provided by operating activities of $4.4 million for the period September 8, 2012 through December 28, 2012 primarily consisted of net loss of $28.4 million, adjustments for non-cash items of $25.0 million and cash provided by working capital items of $7.8 million. Adjustments for non-cash items primarily consisted of $12.8 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, $10.0 million in share-based compensation associated with the modification of the rolled over options as a result of the Merger transactions as well as share-based compensation associated with options issued during the period, $2.0 million in deferred income taxes, $1.2 million of amortization of debt financing costs, and $0.5 million in provisions for doubtful accounts. These amounts were partially offset by $1.0 million in amortization of the fair value adjustment recorded to the OpCo Notes in connection with the Merger, and $0.3 million of amortization of financing costs. The cash provided by working capital items primarily consisted of $24.4 million from decreased trade receivables, net of changes in provision for doubtful accounts, resulting from timing of sales and collections, $10.7 million from increased trade payables balances as a result of the timing of purchases and related payments, and an $8.3 million increase in accrued interest due in part to interest on the ABL Facility and HoldCo Notes that were incurred in connection with the Merger, combined with the increase in the interest rate on the OpCo notes, as well as normal timing of accrual and payment activity on the OpCo Notes. The cash provided by working capital items was partially offset by $16.4 million from increased inventory levels primarily related to increased demand combined with opportunistic year-end purchases, $9.6 million from a decrease in accrued expenses and other current liabilities as a result of payment of costs associated with the Merger, timing of sales tax payments, and timing of other miscellaneous accrual and payment activity, $6.4 million from changes in income taxes, and $3.1 million in increased prepaid expenses and other current assets primarily as a result of timing of collections of rebates from our vendors.
Predecessor. Net cash provided by operating activities of $25.0 million for the period from December 31, 2011 through September 7, 2012 primarily consisted of net income of $12.8 million, adjustments for non-cash items of $39.3 million and cash used by working capital items of $27.2 million. Adjustments for non-cash items primarily consisted of $17.7 million in depreciation and amortization of property, equipment and intangible assets, $15.2 million in share-based compensation, which includes $11.2 million that was a result of the acceleration of share-based compensation in connection with the Merger transactions, $7.7 million in deferred income taxes, $2.2 million in loss on the extinguishment of debt recorded as a result of the extinguishment of the prior asset-based revolving credit facility, $1.3 million in provision for doubtful accounts, and $1.0 million in amortization of debt financing costs. These amounts were partially offset by $4.6 million in excess tax benefits from share-based compensation and $1.2 million of other items. The cash used by working capital items primarily consisted of $30.0 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, $12.4 million from decreased trade payables balances as a result of the timing of purchases and related payments, and $4.0 million from changes in income taxes. The use of cash was partially offset by $8.8 million from increased accrued expenses and other current liabilities as a result of costs associated with the Merger, timing of sales tax payments, offset in part by lower payroll and incentive compensation accruals as compared to prior year-end due to timing of payments, $5.6 million from decreased inventory levels due to the normal sales activity and timing of purchases, and $3.9 million in accrued interest due to normal accrual and payment activity.
Net cash provided by operating activities of $72.9 million during the fiscal year ended December 30, 2011 primarily consisted of net income of $37.7 million, adjustments for non-cash items of $39.7 million and cash used by working capital items of $4.6 million. Adjustments for non-cash items primarily consisted of $23.7 million in depreciation and amortization of property, equipment and intangible assets, $7.7 million in deferred income taxes, $5.6 million in share-based compensation, net of excess tax benefits, $2.5 million in provisions for doubtful accounts, and $1.4 million in amortization of debt financing costs. These amounts were partially offset by $0.8 million of amortization of lease incentive obligations, and $0.5 million of other items. The cash used by working capital items primarily consisted of $13.4 million in increased inventory primarily as a result of increased demand and opportunistic year-end purchases, and $4.3 million from increased trade receivables resulting from increased sales in the current year as compared to the prior year. The use of cash was partially offset by $9.5 million from increased trade payables balances as a result of the timing of purchases and related payments, $2.5 million in decreased prepaid expenses and other current assets primarily from lower rebates receivable, and $0.6 million from changes in income taxes.
Net cash provided by operating activities of $60.8 million during the fiscal year ended December 31, 2010 primarily consisted of net income of $27.9 million, adjustments for non-cash items of $44.7 million and cash used by working capital items of $16.0 million. Adjustments for non-cash items primarily consisted of $20.6 million in depreciation and amortization of property, equipment and intangible assets, including $0.4 million of depreciation recorded within cost of sales, $11.5 million loss on the early extinguishment of our 8 1/8% Notes, $5.7 million in provisions for doubtful accounts, $3.5 million in share-based compensation, net of excess tax benefits, $2.5 million in deferred income taxes and $1.1 million in amortization of debt financing costs. The cash used by working capital items primarily consisted of $22.7 million in increased inventory primarily as a result of increased demand, opportunistic year-end purchases and the stocking of our distribution centers in Chicago, Illinois; Jacksonville, Florida; and Philadelphia, Pennsylvania, $8.9 million in increased prepaid expenses and other current assets primarily from higher rebates receivable and $1.5 million from the increase in income taxes. The uses of cash were partially offset by $7.5 million from increased trade payables balances as a result of the timing of purchases and related payments, $5.2 million generated from trade receivables resulting from increased collections, and $2.5 million increased accrued expenses arising from the issuance of the OpCo Notes.
Investing Activities. Net cash used in investing activities was $914.0 million for the period September 8, 2012 through December 28, 2012, $15.2 million for the period from December 31, 2011 through September 7, 2012, $29.0 million in the fiscal year ended December 30, 2011 and $71.1 million for the fiscal year ended December 31, 2010.
Successor. Net cash used in investing activities for the period September 8, 2012 through December 28, 2012 was attributable to $825.7 million in cash paid to acquire the Company in connection with the Merger, $82.5 million for the acquisition of JanPak, and $5.7 million of capital expenditures made in the ordinary course of business.
Predecessor. Net cash used in investing activities for the period from December 31, 2011 through September 7, 2012 was attributable to $12.0 million of capital expenditures made in the ordinary course of business and $3.3 million related to the purchase of a business.
Net cash used in investing activities in the fiscal year ended December 30, 2011 was primarily attributable to $19.4 million of capital expenditures made in the ordinary course of business and $9.7 million in costs related to purchases of businesses.
Net cash used in investing activities during the fiscal year ended December 31, 2010 was attributable to $54.8 million in costs related to purchases of businesses, $17.7 million in capital expenditures made in the ordinary course of business and $1.4 million in net sales and maturities of short-term investments comprised of pre-refunded municipal bonds secured by U.S. Treasury securities.
Financing Activities. Net cash provided by financing activities totaled $819.6 million for the period September 8, 2012 through December 28, 2012, $0.7 million for the period from December 31, 2011 through September 7, 2012, and net cash used in financing activities totaled $33.7 million for the fiscal year ended December 30, 2011 and $2.0 million for the fiscal year ended December 31, 2010.
Successor. Net cash provided by financing activities for the period September 8, 2012 through December 28, 2012 was attributable to $365.0 million in proceeds from the issuance of the HoldCo Notes in connection with the Merger, $350.9 million of equity proceeds in connection with the Merger, $217.5 million in proceeds from the ABL Facility, $1.5 million of proceeds from the issuance of common stock, and a $1.3 million net increase in purchase card payable, offset in part by $90.0 million in repayments on the ABL Facility, and $26.4 million in debt financing costs on the ABL Facility, OpCo Notes, and HoldCo Notes, which were incurred or modified in connection with the Merger.
Predecessor. Net cash provided by financing activities for the period from December 31, 2011 through September 7, 2012 was attributable to $6.8 million of proceeds from stock options exercised and excess tax benefits from share-based compensation, partially offset by $3.8 million net decrease in purchase card payable, $1.5 million in treasury stock acquired to satisfy minimum statutory tax withholding requirements resulting from the vesting or exercising of equity awards, and $0.5 million of payments on capital lease obligations.
Net cash used in financing activities during the fiscal year ended December 30, 2011 of $33.7 million was primarily attributable to $26.2 million in treasury stock purchases through the $25.0 million stock repurchase authorization from our Board of Directors and treasury stock acquired to satisfy minimum statutory tax withholding requirements resulting from the vesting or exercising of equity awards, the redemption of the remaining $13.4 million of our 8 1/8% Notes, and $0.6 million of payments on capital lease obligations, partially offset by a $5.5 million net increase in purchase card payable and $1.0 million of proceeds from stock options exercised and excess tax benefits from share-based compensation.
Net cash used in financing activities during the fiscal year ended December 31, 2010 was primarily attributable to our repayment of $156.2 million of term debt and capital lease obligations, our repurchase of $143.7 million of our 8 1/8% Notes, including payment of tender premiums and expenses, payment of $10.4 million of debt financing costs on our OpCo Notes, and net decrease in purchase card payable of $3.5 million offset by proceeds from the issuance of our OpCo Notes of $300.0 million and $11.7 million of proceeds from stock options exercised and excess tax benefits from share-based compensation, net of treasury stock acquired to satisfy minimum statutory tax withholding requirements resulting from the vesting or exercising of equity awards.
Capital Expenditures
Capital expenditures were $5.7 million for the period September 8, 2012 through December 28, 2012, and $12.0 million for the period from December 31, 2011 through September 7, 2012. Combined capital expenditures for the fiscal year ended December 28, 2012 were $17.7 million, compared to $19.4 million for the fiscal year ended December 30, 2011, and $17.7 million for the fiscal year ended December 31, 2010.
Capital expenditures as a percentage of net sales were 1.4% for the period September 8, 2012 through December 28, 2012, and 1.3% for the period from December 31, 2011 through September 7, 2012. Combined capital expenditures as a percentage of net sales for the fiscal year ended December 28, 2012 was 1.3%, compared to 1.6% for the fiscal year ended December 30, 2011, and 1.6% for the fiscal year ended December 31, 2010.
Capital expenditures during 2012, 2011, and 2010 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.
During the combined year ended December 28, 2012, we acquired leasehold improvements through non-cash lease incentives of $0.1 million. During 2011, we acquired $0.5 million of property in the form of leasehold improvements through lease incentives primarily associated with our Kansas City, Kansas distribution center and $0.5 million in office equipment through capital leases. During 2010, we acquired $2.5 million of property in the form of leasehold improvements through lease incentives primarily associated with our Chicago, Illinois; Jacksonville, Florida; and Philadelphia, Pennsylvania distribution centers.
Credit Facility
Concurrently with the closing of the Merger, Interline New Jersey and certain of its material wholly-owned domestic subsidiaries, as co-borrowers, entered into the ABL 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 principal amount outstanding will be due and payable in full at maturity, on September 7, 2017. The ABL Facility replaces the $225.0 million asset-based revolving credit facility that was in place prior to the Merger. Debt financing costs capitalized in connection with the new ABL Facility were $5.6 million. Additionally, the Company recorded a loss on the extinguishment of the previous asset-based revolving facility in the amount of $2.2 million, comprised of the write-off of unamortized deferred debt financing costs.
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:
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85% of the book value of eligible accounts receivable; plus
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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;
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minus certain reserves as may be established under 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 first-priority security interest in substantially all of the existing and future personal property of the Company's U.S. subsidiaries. From September 7, 2012 until the quarter following the closing of the ABL Facility, borrowings will bear interest at a rate equal to LIBOR plus 1.75% in the case of Eurodollar revolving loans, and an applicable base rate plus 0.75% in the case of Alternate Base Rate ("ABR") loans.
After the end of the quarter following the closing of the ABL Facility, the interest rates will be determined as of the end of each fiscal quarter in accordance with applicable rates set forth in the grid below:
The applicable rates for Category 2 and Category 3 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 1.50:1.00. As of December 28, 2012, the interest rate in effect with respect to the ABL Facility was 1.75% for the Eurodollar revolving loans and 3.75% for the ABR revolving loans.
In addition to paying interest on outstanding principal under the ABL facility, Interline New Jersey is required to pay a commitment fee in respect of unutilized commitments, which is equal to 0.375% per annum for the ABL Facility if utilization is less than 50% of the aggregate commitments and 0.25% per annum if the utilization of the ABL Facility exceeds 50% of the aggregate commitments. The principal balance outstanding may be voluntarily prepaid in advance, without penalty or premium, at any time in whole or in part, subject to certain breakage costs.
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:
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create, incur, assume or suffer to exist, any liens,
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create, incur, assume or permit to exist, directly or indirectly, any additional indebtedness,
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consolidate, merge, amalgamate, liquidate, wind up or dissolve themselves,
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convey, sell, lease, license, assign, transfer or otherwise dispose of their assets,
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make certain restricted payments,
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make certain investments,
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amend or otherwise alter the terms of documents related to certain subordinated indebtedness,
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enter into transactions with affiliates, and
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prepay certain indebtedness.
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 change of control. If such an event of default occurs the agent under the ABL Facility is entitled to take various actions, including the 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.
OpCo Notes
The OpCo Notes are unconditionally guaranteed, jointly and severally, by the Company and Interline New Jersey's existing and future domestic subsidiaries that guarantee the ABL Facility (collectively the ''Guarantors''). The OpCo Notes are not guaranteed by any of Interline New Jersey's foreign subsidiaries.
In connection with the Merger, the OpCo Notes were amended to modify the definition of “Change of Control” and add a definition of “Permitted Holders” in the related indenture, which permitted the Merger to occur without triggering a “Change of Control” under the indenture governing the OpCo Notes. As consideration for these amendments, and in addition to a consent payment of $1.5 million, Interline New Jersey agreed to certain additional amendments that applied from and including the Merger date. These additional amendments included, among other items, increasing the interest rate on the OpCo Notes from 7.00% to 7.50% per annum, increasing the redemption price of the OpCo Notes for certain periods, making the OpCo Notes and the related guarantees rank equal in right of payment to all future incurrences of senior indebtedness (including the ABL Facility) and replacing the restriction on the incurrence of secured indebtedness contained in the anti-layering covenant with a covenant restricting Interline New Jersey and its restricted subsidiaries from incurring liens, other than permitted liens, without equally and ratably securing the OpCo Notes. Additionally, the OpCo Notes were remeasured to the fair value on the date of the Merger transactions, which resulted in a premium of $22.5 million that will be amortized through interest expense over the term of the notes using the effective interest method. Debt financing costs capitalized in connection with the modification of the OpCo Notes were $4.4 million, and the unamortized balance of the originally capitalized debt financing costs of $5.7 million were allocated to goodwill in connection with purchase accounting.
The OpCo Notes mature on November 15, 2018, and interest is payable on May 15 and November 15 of each year. Interline New Jersey has the option to redeem the OpCo Notes prior to November 15, 2013 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, 2013, Interline New Jersey may redeem some or all of the OpCo 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, 2013, Interline New Jersey may, from time to time, redeem up to 35% of the aggregate principal amount of the OpCo Notes with the net cash proceeds received by Interline New Jersey from certain equity offerings at a price equal to 107.00% of the principal amount of the OpCo 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 OpCo Notes remain outstanding immediately thereafter.
The Indenture governing the OpCo Notes contains covenants limiting, among other things, the ability of Interline New Jersey and its restricted subsidiaries to incur additional indebtedness; pay dividends on their capital stock or redeem, repurchase or retire their capital stock; make certain investments; enter into transactions with affiliates; incur liens; create restrictions on the payment of dividends or other amounts from Interline New Jersey’s restricted subsidiaries to Interline New Jersey; sell assets or subsidiary stock and consolidate, merge or transfer assets. These covenants are subject to a number of important exceptions and qualifications.
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.
Share Repurchases
In August 2011, the Company's Board of Directors authorized the repurchase of up to an aggregate of $25.0 million of the Company's outstanding common stock. Share repurchases made under this authorization were expected to be accomplished from time
to time based on market conditions, the Company's cash and debt position, and other factors as determined by management. The Authorization did not have an expiration date and could be modified, suspended, or discontinued by the Board of Directors at any time, in accordance with applicable securities laws. Shares could be repurchased through open market or privately negotiated transactions. During the year ended December 30, 2011, the Company repurchased 1,783,822 shares of common stock pursuant to this authorization at an aggregate cost of $25.0 million, or an average cost of $14.01 per share, through open market transactions, which completed the share repurchases under the Authorization. The Company used cash flows from operating activities to pay the purchase price for the repurchased shares. The repurchased shares became treasury shares.
In connection with the Merger transaction, each share of common stock of Interline was canceled on September 7, 2012, and converted automatically into a right to receive $25.50 in cash, without interest.
Contractual Obligations and Off-Balance Sheet Arrangements
The following table sets forth our contractual obligations as of December 28, 2012 (in thousands):
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(1)
Our ABL Facility calls for an unused commitment fee of 0.375%, which is excluded from the table. As of December 28, 2012, we had $8.9 million in letters of credit. See "Liquidity and Capital Resources" above for more information.
(2)
Average interest of 1.75% on the ABL Facility is based on the 30-day LIBOR rate, plus the applicable revolver Eurodollar spread. Actual interest could vary with changes in LIBOR.
(3)
Other includes deferred compensation and retirement plans and the fair market value of the earn-out related to an immaterial acquisition.
(4)
Trade accounts payable of $113.6 million are excluded from the table but are generally payable within 30 to 60 days. See Item 8. "Financial Statements and Supplementary Data" and the accompanying audited consolidated financial statements.
(5)
As more fully disclosed in Note 18. Income Taxes to our audited consolidated financial statements included in this report, as of December 28, 2012, we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes totaling $1.5 million as of that date. As a result, this amount is not included in the table above.
As of December 28, 2012, except for operating leases and letters of credit, we had no material off-balance sheet arrangements.
Critical Accounting Policies
In preparing the consolidated financial statements in conformity with 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. The significant accounting policies that we believe are the most critical in order to fully understand and evaluate our financial position and results of operations include the following policies.
Revenue Recognition
While our recognition of revenue is predominantly derived from routine transactions and does not involve significant judgment, revenue recognition represents an important accounting policy for us. We recognize a sale when the product has been shipped and risk of loss has passed to the customer, collection of the resulting receivable is probable, persuasive evidence of an arrangement exists and the price is fixed or determinable. Sales are recorded net of estimated discounts, rebates and returns. A portion of our sales is delivered directly from the supplier to our customers. These direct-shipment sales are recorded on a gross basis with the corresponding cost of goods sold. We provide limited product return and protection rights to certain customers. We accrue product return reserves. The provision is made for estimated product returns based on sales volumes and our experience. Actual returns have not varied materially from amounts provided historically.
Vendor Rebates
Many of our arrangements with our vendors provide for us to receive a rebate of a specified amount, payable to us when we achieve any of a number of measures generally related to the volume of purchases from our vendors. We account for these rebates as a reduction of the prices of the related vendors' products, which reduces the inventory cost until the period in which we sell the product, at which time these rebates reduce cost of sales in our income statement. Throughout the year, we estimate the amount of rebates receivable based upon the expected level of purchases. We continually revise these estimates to reflect actual rebates earned based on actual purchase levels. Historically, our actual rebates have been within our expectations used for our estimates. If we fail to achieve a measure which is required to obtain a vendor rebate, we will record a charge in the period that we determine the criteria or measure for the vendor rebate will not be met to the extent the vendor rebate was estimated and included as a reduction to cost of sales. If market conditions were to change, vendors may change the terms of some or all of these programs. Although these changes would not affect the amounts which we have recorded related to products already purchased, it may impact our gross margin on products we sell or revenues earned in future periods.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability to collect outstanding amounts from customers. The allowance includes specific amounts for those accounts that are likely to be uncollectible, such as accounts of customers in bankruptcy and general allowances for those accounts that management currently believes to be collectible but may later become uncollectible. Estimates are used to determine the allowance for bad debts and are based on historical collection experience, current economic trends, creditworthiness of customers and changes in customer payment terms. Adjustments to credit limits are made based upon payment history and our customers' current creditworthiness. If the financial condition of our customers were to deteriorate, additions to the allowance may be needed that will increase selling, general and administrative expenses and decrease accounts receivable.
Valuation of Excess and Obsolete Inventory
Inventories are valued at the lower of cost or market. We determine inventory cost using the weighted-average cost method. We adjust inventory for excess and obsolete inventory and for the difference by which the cost of the inventory exceeds the estimated market value. In order to determine the adjustments, management reviews inventory quantities on hand, slow movement reports and sales history reports. Management estimates the required adjustment based on estimated demand for products and market conditions. To the extent historical results are not indicative of future results and if events occur that affect our relationships with suppliers or the salability of our products, additional write-offs may be needed that will increase our cost of sales and decrease inventory.
Goodwill, Intangibles and Other Long-Lived Assets
Management assesses the recoverability of our goodwill and indefinite-lived identifiable intangibles on an annual basis. Management also assesses the recoverability of goodwill, identifiable intangibles and other long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The following factors, if present, may trigger an impairment review: (1) significant underperformance relative to expected historical or projected future operating results; (2) significant negative industry or economic trends; (3) a significant increase in competition; and (4) a significant increase in interest rates on debt. If the recoverability of these assets is unlikely because of the existence of one or more of the above-mentioned factors, an impairment analysis is performed based on a weighting of both the present value of future projected cash flows (the “income approach”) and the use of comparative market multiples (the “market approach”). Management must make assumptions regarding estimated future cash flows and other factors to determine the fair value of these respective assets. If these estimates or related assumptions change in the future, we may be required to record an impairment charge. Impairment charges would be included in our statements of operations, and would result in reduced carrying amounts of the related assets in our balance sheets.
Share-Based Compensation
Under the fair value recognition provisions of US GAAP, share-based compensation cost is measured at the grant date based on the fair value of the award. For awards containing only service conditions, we recognize share-based compensation cost on a straight-line basis over the expected vesting period or to the retirement eligibility date, if less than the vesting period. For awards with performance conditions, we recognize share-based compensation cost on a straight-line basis for each performance criteria tranche over the implied service period when we believe it is probable that the performance targets, as defined in the agreements, will be achieved. We currently use the Black-Scholes option pricing model to determine the fair value of stock options. The fair value of restricted stock awards, restricted share units and deferred stock units was based on the fair market values of the underlying stock on the dates of grant. The determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the expected term of the awards, projected employee stock option exercise behaviors, risk-free interest rates, estimated forfeitures, per share value at date of grant, and expected dividends.
We estimate the expected term of options granted by calculating the average term from our historical stock option exercise experience. Prior to the Merger, we estimated the volatility of our common stock based on the historical performance of our common stock. Subsequent to the Merger, we estimate the volatility of our common stock based on the historical volatilities of comparable companies over a historical period that matches the expected life of the options on the date of grant. We base the risk-free interest rate on zero-coupon yields implied from U.S. Treasury issues with remaining terms similar to the expected term on the options. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in the option pricing model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. See Note 14. Share-Based Compensation to our audited consolidated financial statements included in this report.
If we use different assumptions for estimating stock-based compensation expense in future periods, or if actual forfeitures differ materially from our estimated forfeitures, the change in our stock-based compensation expense could materially affect our operating income and net income.
Income Taxes
Significant judgment is required in determining our provision for income taxes, current tax assets and liabilities, deferred tax assets and liabilities and our future taxable income for purposes of assessing our ability to realize future benefit from our deferred tax assets. A valuation allowance is established to reduce our deferred tax assets to the amount that is considered more likely than not to be realized through the generation of future taxable income and other tax planning opportunities. To the extent that a determination is made to establish or adjust a valuation allowance, the expense or benefit is recorded in the period in which the determination is made.
Our accounting for income taxes requires us to exercise judgment for known issues under discussion with tax authorities and transactions yet to be settled. The final outcome of these tax uncertainties is dependent upon various matters including tax examinations, legal proceedings, changes in regulatory tax laws, or interpretation of those tax laws, or expiration of statutes of limitation. However, based on the number of jurisdictions, the uncertainties associated with litigation and the status of examinations, including the protocols of finalizing audits by the relevant tax authorities, which could include formal legal proceedings, there is a high degree of uncertainty regarding the future cash outflows associated with these tax uncertainties. See Note 18. Income Taxes to our audited consolidated financial statements included in this report.
Future rulings by tax authorities and future changes in tax laws and their interpretation, changes in projected levels of taxable income and future tax planning strategies could impact our actual effective tax rate and our recorded tax balances. If actual results differ from estimates we have used, or if we adjust these estimates in future periods, our operating results and financial position could be materially affected.
Legal Contingencies
From time to time, in the course of our business, we become involved in legal proceedings. In accordance with US GAAP, if it is probable that, as a result of a pending legal claim, an asset had been impaired or a liability had been incurred at the date of the financial statements and the amount of the loss is estimable, an accrual for the costs to resolve the claim is recorded in accrued expenses in our balance sheets. Professional fees related to legal claims are included in selling, general and administrative expenses in our statements of operations. Management, with the assistance of outside counsel, determines whether it is probable that a liability from a legal claim has been incurred and estimates the amount of loss. The analysis is based upon potential results, assuming a combination of litigation and settlement strategies. As discussed in Note 16. Commitments and Contingencies to our audited
consolidated financial statements included in this report, management does not believe that currently pending proceedings will have a material adverse effect on our consolidated financial statements. However, it is possible that future results of operations for any particular period could be materially affected by changes in our assumptions related to these proceedings.
Recently Issued Accounting Guidance
In July 2012, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2012-02, Intangibles - Goodwill and Other (Topic 350) ("ASU 2012-02"). The objective of the amendments in this ASU is to reduce the cost and complexity of performing an impairment test for indefinite-lived intangible assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance among long-lived asset categories. The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible assets and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Subtopic 350-30. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. Because this guidance simply enhances the consistency and reduces the costs of impairment testing (and would not change the conclusion of the impairment testing) it will not have a material impact on the Company's consolidated financial statements.
In August 2012, the FASB issued ASU No. 2012-03, Technical Amendments and Corrections to SEC Sections ("ASU 2012-03"). This ASU amends (1) various SEC paragraphs pursuant to the issuance of Staff Accounting Bulletin No.114, (2) the SEC's Final Rule, Technical Amendments to Commission Rules and Forms Related to the FASB's Accounting Standards Codification, Release Nos. 33-9250, 34-65052, and IC-29748 August 8, 2011, and (3) Corrections Related to FASB ASU 2010-22, Accounting for Various Topics. The objectives of these amendments are to update expired accounting standard references and reference the International Financial Reporting Standards (IFRS) as an appropriate framework of standards and compliance for certain disclosure requirements. Because the amendments relates to staff guidance for SEC materials and consist of codification referencing and IFRS inclusion it will not have a material impact on the Company's consolidated financial statements.
In October 2012, the FASB issued ASU No. 2012-04, Technical Corrections and Improvements ("ASU 2012-04"). This ASU contains amendments that affect a wide variety of topics in the codification, as well as provide incremental improvements to US GAAP that are not purely technical corrections. The amendments in ASU 2012-04 were effective upon issuance, except for amendments that were subject to transition guidance, which will be effective for fiscal periods beginning after December 15, 2012 for public entities and December 15, 2013 for nonpublic entities. Because this ASU provides technical corrections and enhanced guidance, it will not have a material impact on the Company's consolidated financial statements.
In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220) - Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The objective of this ASU is to improve the reporting of reclassifications out of accumulated other comprehensive income ("AOCI") by requiring an entity to report the effect of significant reclassifications out of AOCI on the respective line items in net income if the amount being reclassified is required under US GAAP to be reclassified in its entirety to net income. For other amounts that are not required under US GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under US GAAP that provide additional detail about those amounts. The amendments do not change the current requirements for reporting net income or other comprehensive income in the financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of AOCI by component. The amendments in ASU 2013-02 are effective prospectively for reporting periods beginning after December 15, 2012, with early adoption permitted. Because the amendments merely enhance the disclosures of reclassifications out of AOCI, it will not have a material impact on the Company's consolidated financial statements.
In February 2013, the FASB issued 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 is permitted. This ASU is not expected to have a material impact on the Company's consolidated financial statements.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Commodity Price Risk
We are aware of the potentially unfavorable effects inflationary pressures may create through higher product and material costs, higher asset replacement costs and related depreciation, and higher interest rates. In addition, our operating performance is affected by price fluctuations in copper, oil, stainless steel, aluminum, zinc, plastic and PVC, and other commodities and raw materials. We seek to minimize the effects of inflation and changing prices through economies of purchasing and inventory management resulting in cost reductions and productivity improvements as well as price increases to maintain reasonable profit margins. However, such commodity price fluctuations have from time to time created cyclicality in our financial performance, and could continue to do so in the future. In addition, our use of priced catalogs may not allow us to offset such cost increases quickly, resulting in a decrease in gross margins and profit.
Interest Rate Risk
Our variable rate term debt is sensitive to changes in the general level of interest rates. As of December 28, 2012, the interest rate in effect with respect to the outstanding balance of $127.5 million variable rate debt was 1.75% for the Eurodollar revolving loans and 3.75% for the ABR revolving loans. While our variable rate term debt obligations exposes us to the risk of rising interest rates, we do not believe that the potential exposure is material to our overall financial performance or results of operations. Based on the outstanding variable rate debt as of December 28, 2012, a 1.0% annual increase or decrease in current market interest rates would have the effect of causing a $1.3 million pre-tax change to our statement of operations.
The fair market value of our OpCo Notes, HoldCo Notes, and ABL Facility is subject to interest rate risk. As of December 28, 2012, the estimated fair market value of our debt was as show below (in thousands):
Foreign Currency Exchange Risk
The majority of our purchases from foreign-based suppliers are from China and other countries in Asia and are transacted in U.S. dollars. Accordingly, our risk to foreign currency exchange rates was not material as of December 28, 2012.
Most of our foreign suppliers incur costs of production in non-U.S. currencies. Accordingly, depreciation of the U.S. dollar against foreign currencies could increase the price we pay for these products. A substantial portion of our products is sourced from suppliers in China and the value of the Chinese Yuan has increased relative to the U.S. dollar since July 2005, when it was allowed to fluctuate against a basket of foreign currencies. Most experts believe that the value of the Yuan will continue to increase relative to the U.S. dollar over the next few years absent a policy change in how China regulates its currency. The continued increase in the value of the Chinese Yuan relative to the U.S. dollar would most likely result in an increase in the cost of products that are sourced from suppliers in China.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data
Report of Independent Registered Certified Public Accounting Firm
To the Board of Directors and Stockholders of Interline Brands, Inc.:
In our opinion, the accompanying consolidated balance sheet of Interline Brands, Inc. and its subsidiaries (Successor) as of December 28, 2012, and the related consolidated statements of operations, comprehensive loss, stockholders' equity and cash flows for the period from September 8, 2012 through December 28, 2012 present fairly, in all material respects, the financial position of Interline Brands, Inc. and its subsidiaries (Successor) at December 28, 2012, and the results of their operations and their cash flows for the period from September 8, 2012 through December 28, 2012 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Jacksonville, FL
March 12, 2013
Report of Independent Registered Certified Public Accounting Firm
To the Board of Directors and Stockholders of Interline Brands, Inc.:
In our opinion, the accompanying consolidated statements of operations, comprehensive income, stockholders' equity and cash flows for the period from December 31, 2011 through September 7, 2012 of Interline Brands, Inc. and its subsidiaries (Predecessor) present fairly, in all material respects, the results of their operations and their cash flows for the period from December 31, 2011 through September 7, 2012 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Jacksonville, FL
March 12, 2013
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Interline Brands, Inc.
Jacksonville, FL
We have audited the accompanying consolidated balance sheet of Interline Brands, Inc. and subsidiaries ("Predecessor" or the "Company") as of December 30, 2011, and the related consolidated statements of operations, comprehensive (loss) income, stockholders' equity, and cash flows for the years ended December 30, 2011 and December 31, 2010. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such 2011 and 2010 consolidated financial statements present fairly, in all material respects, the financial position of Interline Brands, Inc. and subsidiaries as of December 30, 2011, and the results of their operations and their cash flows for the years ended December 30, 2011 and December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
As discussed in the second paragraph under the subtopic Recently Adopted Accounting Guidance of Note 2 to the consolidated financial statements, the Company adopted Financial Accounting Standards Board Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU 2011-05”). The accompanying 2011 and 2010 financial statements have been retrospectively adjusted for the presentation of separate consolidated statements of comprehensive (loss) income immediately following the consolidated statements of operations.
/s/ DELOITTE & TOUCHE LLP
Certified Public Accountants
Jacksonville, FL
February 28, 2012
(August 6, 2012 as to the adoption of ASU 2011-05 in Note 2)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(in thousands)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share data)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY, CONTINUED
(in thousands, except share data)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(in thousands)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of Business
Interline Brands, Inc., a Delaware corporation, and its subsidiaries (“Interline” or the “Company”) is a leading national distributor and direct marketer of broad-line maintenance, repair and operations (“MRO”) products into the facilities maintenance end-market. The Company sells plumbing, electrical, hardware, security, appliances, heating, ventilation and air conditioning (“HVAC”), janitorial and sanitation (“JanSan”) supplies and other MRO products. Interline’s diverse customer base of over 100,000 customers consists of 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. Interline's customers range in size from individual contractors and independent hardware stores to apartment management companies and national purchasing groups.
The Company markets and sells its products primarily through fourteen distinct and targeted brands. The Company utilizes a variety of sales channels, including a direct sales force, telesales representatives, a direct marketing program consisting of catalogs and promotional flyers, brand-specific websites and a national accounts sales program. The Company delivers its products through its network of distribution centers and professional contractor showrooms located throughout the United States, Canada and Puerto Rico, vendor managed inventory locations at large professional contractor and institutional customer locations and its dedicated fleet of trucks and third-party carriers. Through its broad distribution network, the Company is able to provide 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.
Interline Brands, Inc. is the holding company of the Interline group of businesses, including its principal operating subsidiary, Interline Brands, Inc., a New Jersey corporation (“Interline New Jersey”).
Basis of Presentation
On September 7, 2012 (the "Merger Date"), pursuant to an Agreement and Plan of Merger (the "Merger Agreement") dated as of May 29, 2012, Isabelle Holding Company Inc., a Delaware corporation (“Parent”), Isabelle Acquisition Sub Inc., a Delaware corporation and a wholly-owned subsidiary of Parent (“Merger Sub”, and together with Parent, the "Acquiring Parties"), merged with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly-owned subsidiary of Parent. Immediately following the effective time of the Merger, Parent was merged with and into the Company, with the Company surviving (the "Second Merger"). Under the Merger Agreement, stockholders of the Company received $25.50 in cash for each share of Company common stock. The Merger was unanimously approved by Interline's Board of Directors and a majority of Interline's stockholders holding the outstanding shares of the common stock. See Note 3. Transactions for further information about the Merger Agreement. Prior to the Merger Date, the Company operated as a public company with its common stock traded on the New York Stock Exchange. As a result of the Merger, Interline's common stock became privately-held.
The Merger has been accounted for in accordance with accounting principles generally accepted in the United States of America ("US GAAP") for business combinations and accordingly, the Company's assets and liabilities were recorded using their fair values as of September 7, 2012.
Although the Company continued as the same legal entity after the Merger, since the financial statements are not comparable as a result of acquisition accounting, the accompanying consolidated financial statements are presented for two periods: the period prior to the Merger ("Predecessor") and the period subsequent to the Merger ("Successor").
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Interline Brands, Inc. and all of its wholly-owned subsidiaries. These statements have been prepared in accordance with US GAAP. All intercompany balances and transactions have been eliminated in consolidation.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Fiscal Year
The Company operates on a 52-53 week fiscal year, which ends on the last Friday in December. As a result of the Merger that occurred on September 7, 2012, the 2012 fiscal year is comprised of two periods, the 16-week Successor period from September 8, 2012 through December 28, 2012, and the 36 week Predecessor period from December 31, 2011 through September 7, 2012. The fiscal year ended December 30, 2011 was a 52 week year. The fiscal year ended December 31, 2010 was a 53 week year. References herein to 2012, 2011 and 2010 are for the 2012 Successor and Predecessor periods, and the fiscal years ended December 30, 2011 and December 31, 2010, respectively.
Estimates
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates and assumptions.
Fair Value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Disclosure about how fair value is determined for assets and liabilities is based on a hierarchy established from the significant levels of inputs as follows:
Level 1
quoted prices in active markets for identical assets or liabilities;
Level 2
quoted prices in active markets for similar assets and liabilities and inputs that are observable for the asset or liability; or
Level 3
unobservable inputs, such as discounted cash flow models or valuations.
The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
The fair value of cash and cash equivalents, accounts receivable, and accounts payable approximate the carrying amount because of the short maturities of these items.
The fair value of the Company’s ABL facility, OpCo Notes, and HoldCo Notes (as defined in Note 10. Debt) is determined by quoted market prices and other inputs that are observable for these liabilities, which are Level 2 inputs. The carrying amount and fair value of the ABL facility, OpCo Notes, and HoldCo Notes as of December 28, 2012 and December 30, 2011 were as follows (in thousands):
Foreign Currency Translation
Assets and liabilities of the Company's foreign subsidiaries, where the functional currency is the local currency, are translated into United States dollars at the year-end exchange rate. Revenues and expenses are translated using average exchange rates prevailing during the year.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and highly liquid investments that can be readily converted into cash or that have an original maturity of three months or less.
Concentrations of Credit Risk
Financial instruments, which potentially subject the Company to concentration of credit risk, consist principally of accounts receivable. The Company's accounts receivable are principally from facilities maintenance, professional contractor and specialty distributor customers in the United States and Canada. Concentration of credit risk with respect to accounts receivable is limited due to the large number of customers comprising the Company's customer base. The Company performs credit evaluations of its customers; however, the Company's policy is not to require collateral. As of December 28, 2012 and December 30, 2011, the Company had no significant concentrations of credit risk.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make payments. The allowance for doubtful accounts is estimated using factors such as past collection history and general risk profile. Receivables are charged against the allowance for doubtful accounts when it is probable that the receivable will not be recovered.
Inventories
Inventories, consisting substantially of finished goods, are valued at the lower of cost or market. Inventory cost is determined using the weighted-average cost method. The Company adjusts inventory for excess and obsolete inventory and for the difference by which the cost of the inventory exceeds the estimated market value. In order to determine the adjustments, management reviews inventory quantities on hand, slow movement reports and sales history reports. Management estimates the required adjustment based on estimated demand for products and market conditions. To the extent historical results are not indicative of future results and if events occur that affect the Company's relationships with suppliers or the salability of their products, additional write-offs may be needed that will increase cost of sales and decrease inventory.
Vendor Rebates
Many of the Company's arrangements with its vendors provide for the Company to receive a rebate of a specified amount of consideration, payable to the Company when the Company achieves any of a number of measures, generally related to the volume level of purchases from its vendors. The Company accounts for such rebates as a reduction of the prices of the vendor's products and therefore as a reduction of inventory until it sells the product, at which time such rebates reduce cost of sales in the Company's statement of operations. Throughout the year, the Company estimates the amount of rebates earned based on estimated purchases to date relative to the purchase levels that mark the Company's progress toward earning the rebates. The Company continually revises these estimates to reflect actual rebates earned based on actual purchase levels.
Property and Equipment
Property and equipment purchased in the normal course of business is stated at cost, net of accumulated depreciation. Expenditures for additions, renewals and betterments are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. Property and equipment acquired in connection with acquisitions are recorded at amounts which approximate fair market value as of the date of the acquisition. Upon the retirement or disposal of assets, the cost and accumulated depreciation or amortization is eliminated from the accounts and the resulting gain or loss is credited or charged to operations.
Leasehold improvements and assets under capital leases are amortized, using the straight-line method, over the lesser of the estimated useful lives or the term of the lease. Lease incentive obligations accrued as a result of leasehold improvements are amortized as a decrease in rent expense over the life of the related leasehold improvements.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Depreciation and amortization, including assets under capital leases, is computed using the straight-line method based upon estimated useful lives of the assets as follows (in years):
Costs of Computer Software Developed or Obtained for Internal Use
The Company capitalizes costs related to internally developed software and amortizes those costs over five years. Only costs incurred during the development stage, including design, coding, installation and testing are capitalized. These capitalized costs consist of both internal labor costs as well as third party contract costs directly associated with the software development. Upgrades or modifications that result in additional functionality are capitalized. Capitalized costs were $0.4 million for the period September 8, 2012 through December 28, 2012, $3.1 million for the period December 31, 2011 through September 7, 2012, $3.8 million for the fiscal year ended 2011 and $3.1 million for the fiscal year ended 2010. As of December 28, 2012 and December 30, 2011, there was $7.9 million and $7.3 million, respectively, of unamortized capitalized software costs. During 2012, 2011 and 2010, amortization expense associated with capitalized software costs was as follows (in thousands):
Goodwill
Goodwill represents the excess of the cost of acquired companies over the fair value of their net assets. The Company performs a goodwill impairment analysis, using the two-step method, on an annual basis and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The Company has elected to perform its annual goodwill impairment test as of the last day of each fiscal year. The recoverability of goodwill is measured at the reporting unit level, which the Company has determined to be consistent with its operating segment, by comparing the reporting unit's carrying amount, including goodwill, to the fair market value of the reporting unit. The Company determines the fair market value of its reporting unit based on a weighting of both the present value of future projected cash flows (the “income approach”) and the use of comparative market multiples (the “market approach”). The market approach compares the Company's reporting unit to other comparable companies based on valuation multiples to arrive at fair value. The income approach is based on assumptions that are consistent with the Company's estimates of future cash flows. Due to the proximity of the Merger Date to the fiscal 2012 year-end, the prior transaction method was also used in the valuation of goodwill and other intangibles for the December 28, 2012 impairment evaluation. The Merger represented a third-party transaction at fair market value as assessed at the date of the transaction. The determination of whether goodwill has become impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the value of the Company's reporting unit, including assumptions related to future growth rates, discount factors and tax rates, among other considerations. Changes in the Company's strategy or assumptions, environmental or other regulations, and/or operating, economic or market conditions could significantly impact these judgments. The Company monitors these conditions and other factors to determine if interim impairment tests are necessary in future periods. Changes in conditions that occur after the annual impairment analysis and that impact these assumptions may result in a future goodwill impairment charge, which could be material. The Company has not identified any impairment losses with respect to goodwill for any period presented.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Other Intangible Assets
Other intangible assets include amounts assigned to trademarks, customer lists and relationships, non-compete agreements and deferred debt issuance costs. Other intangibles are amortized over their useful lives, 7 to 19 years for customer lists and relationships, and over the term of the agreements for non-compete arrangements. Customer lists and relationships are amortized on either a straight-line or accelerated basis, depending on the characteristics of the asset at the beginning of its life. Deferred debt issuance costs are amortized as a component of interest expense over the term of the related debt using the effective interest method or a method that approximates the effective interest method. The Company has determined that its trademarks have indefinite lives and has elected to perform its annual impairment test on indefinite-lived assets as of the last day of each year. The Company has not identified any impairment losses with respect to trademarks for any period presented.
Impairment of Long-Lived Assets
The Company evaluates its long-lived assets for impairment on an annual basis or when an event occurs or circumstances change that would indicate that the fair value of the long-lived asset has fallen below its carrying amount. Such evaluations include an assessment of customer retention, cash flow projections and other factors the Company believes are relevant. The discounted future expected net cash flows of each identifiable asset are used to measure impairment losses. The determination of whether long-lived assets have become impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the value of the long-lived asset. Changes in the Company's strategy or assumptions, environmental or other regulations, and/or market conditions could significantly impact these judgments. The Company monitors market conditions and other factors to determine if interim impairment tests are necessary. The Company has not identified any impairment losses with respect to long-lived assets for any period presented.
Risk Insurance
The Company has a $0.4 million self-insured retention per occurrence in connection with its workers' compensation and auto insurance policies (collectively “Risk Insurance”). The Company accrues its estimated cost in connection with its portion of its Risk Insurance losses using an actuarial methodology based on claims filed, historical development factors and an estimate of claims incurred but not yet reported. The Company does not discount its workers compensation reserve. Claims paid are charged against the reserve.
Taxes Collected and Remitted
The Company records non-income taxes collected from customers and remitted to governmental agencies on a net basis.
Revenue Recognition
The following four basic criteria must be met before the Company recognizes revenue:
•
persuasive evidence of an arrangement exists;
•
delivery has occurred or services have been rendered;
•
the price to the buyer is fixed or determinable; and
•
collectability is reasonably assured.
The Company recognizes a sale when the risk of loss has passed to the customer. For goods shipped by third party carriers, the Company recognizes revenue upon shipment since the terms are generally FOB shipping point. For goods delivered on the Company's dedicated fleet of trucks, the Company recognizes revenue upon delivery to the customer. Sales are recorded net of estimated discounts, rebates and returns. A portion of the Company's sales are delivered direct from the suppliers. These direct-shipment sales are recorded on a gross basis, with the corresponding cost of goods sold. The Company bills some shipping and handling costs to its customers and has included this amount in revenue. The Company provides product return and protection rights to certain customers. A provision is made for estimated product returns based on sales volumes and our experience. Actual returns have not varied materially from amounts provided historically.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Cost of Sales
Cost of sales includes merchandise costs less vendor rebates, freight-in and a portion of operating costs related to the activities of some of our regional replenishment centers.
Shipping and Handling Costs
Shipping and handling costs to customers have been included in selling, general and administrative expenses on the consolidated statements of operations. Shipping and handling costs were as follows (in thousands):
Advertising Costs
Costs of producing and distributing sales catalogs and promotional flyers are capitalized and charged to expense over the life of the related catalog and promotional flyers. Advertising expenses, net of co-op advertising, and co-op advertising was as follows (in thousands):
Share-Based Compensation
For awards containing only service conditions, the Company recognizes share-based compensation cost on a straight-line basis over the expected vesting period or to the retirement eligibility date, if less than the vesting period. For awards with performance conditions, the Company recognizes share-based compensation cost on a straight-line basis for each performance criteria tranche over the implied service period when the Company believes it is probable that the performance targets, as defined in the agreements, will be achieved. In addition, the Company estimates the amount of expected forfeitures when calculating share-based compensation costs. See Note 14. Share-Based Compensation for more information.
Income Taxes
Taxes on income are provided using an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement carrying values and the tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. Such deferred income tax asset and liability computations are based on enacted tax laws and rates applicable to periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Accounting for income taxes requires the Company to exercise judgment in evaluating uncertain tax positions taken by the Company. The Company accounts for uncertainty in income taxes in accordance with US GAAP. The final outcome of these tax uncertainties is dependent upon various matters including tax examinations, legal proceedings, changes in regulatory tax laws, or interpretation of those tax laws, or expiration of statutes of limitation. The Company recognizes potential penalties and interest related to unrecognized tax benefits within its statements of operations as selling, general and administrative expenses and interest expense, respectively. To the extent penalties and interest are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of selling, general and administrative expenses and interest expense, respectively. See Note 18. Income Taxes for more information.
Segment Information
The Company has one operating segment and, therefore, one reportable segment, the distribution of MRO products into the facilities maintenance end-market. The Company’s revenues and assets outside the United States are not significant. The Company’s net sales by product category were as follows (in thousands):
____________________
(1)
The Company continually refines its robust product classification groupings and, as a result, stock keeping units are periodically realigned within product categories.
Recently Issued Accounting Guidance
In July 2012, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2012-02, Intangibles - Goodwill and Other (Topic 350) ("ASU 2012-02"). The objective of the amendments in this ASU is to reduce the cost and complexity of performing an impairment test for indefinite-lived intangible assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance among long-lived asset categories. The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible assets and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Subtopic 350-30. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. Because this guidance simply enhances the consistency and reduces the costs of impairment testing (and would not change the conclusion of the impairment testing) it will not have a material impact on the Company's consolidated financial statements.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
In August 2012, the FASB issued ASU No. 2012-03, Technical Amendments and Corrections to SEC Sections ("ASU 2012-03"). This ASU amends (1) various SEC paragraphs pursuant to the issuance of Staff Accounting Bulletin No.114, (2) the SEC's Final Rule, Technical Amendments to Commission Rules and Forms Related to the FASB's Accounting Standards Codification, Release Nos. 33-9250, 34-65052, and IC-29748 August 8, 2011, and (3) Corrections Related to FASB ASU 2010-22, Accounting for Various Topics. The objectives of these amendments are to update expired accounting standard references and reference the International Financial Reporting Standards (IFRS) as an appropriate framework of standards and compliance for certain disclosure requirements. Because the amendments relates to staff guidance for SEC materials and consist of codification referencing and IFRS inclusion it will not have a material impact on the Company's consolidated financial statements.
In October 2012, the FASB issued ASU No. 2012-04, Technical Corrections and Improvements ("ASU 2012-04"). This ASU contains amendments that affect a wide variety of topics in the codification, as well as provide incremental improvements to US GAAP that are not purely technical corrections. The amendments in ASU 2012-04 were effective upon issuance, except for amendments that were subject to transition guidance, which will be effective for fiscal periods beginning after December 15, 2012 for public entities and December 15, 2013 for nonpublic entities. Because this ASU provides technical corrections and enhanced guidance, it will not have a material impact on the Company's consolidated financial statements.
In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220) - Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income ("ASU 2013-02"). The objective of this ASU is to improve the reporting of reclassifications out of accumulated other comprehensive income ("AOCI") by requiring an entity to report the effect of significant reclassifications out of AOCI on the respective line items in net income if the amount being reclassified is required under US GAAP to be reclassified in its entirety to net income. For other amounts that are not required under US GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under US GAAP that provide additional detail about those amounts. The amendments do not change the current requirements for reporting net income or other comprehensive income in the financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of AOCI by component. The amendments in ASU 2013-02 are effective prospectively for reporting periods beginning after December 15, 2012, with early adoption permitted. Because the amendments merely enhance the disclosures of reclassifications out of AOCI, it will not have a material impact on the Company's consolidated financial statements.
In February 2013, the FASB issued 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 is permitted. This ASU is not expected to have a material impact on the Company's consolidated financial statements.
Recently Adopted Accounting Guidance
In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS (“ASU 2011-04”). The amendments in ASU 2011-04 provide clarification of certain fair value concepts such as principal market determination; valuation premise and highest and best use; measuring fair value of instruments with offsetting market or counterparty credit risks; blockage factor and other premiums and discounts; and liabilities and instruments classified in shareholders' equity. In addition, the pronouncement provides guidance for new disclosures such as transfers between Level 1 and Level 2 of the fair value hierarchy; Level 3 fair value measurements; an entity's use of an asset when it is different from its highest and best use; and fair value hierarchy disclosures for financial instruments not measured at fair value but disclosed.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Effective December 31, 2011, the Company adopted the fair value measurement and disclosure requirements. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements.
In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU 2011-05”), as amended by ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 (“ASU 2011-12”). This pronouncement brings consistency to the way reporting entities disclose comprehensive income in their consolidated financial statements and related notes. ASU 2011-05, as amended by ASU 2011-12, no longer permits disclosure of comprehensive income in either the statement of shareholders' equity or in a note to the consolidated financial statements. Instead, reporting entities have two options for presenting comprehensive income. The first option presents comprehensive income in a single statement, which includes two components: net income and other comprehensive income. The second option allows the presentation of comprehensive income in two separate but consecutive statements: one for net income and the other for other comprehensive income. Effective December 31, 2011, the Company adopted new disclosure requirements for comprehensive income, including the required retrospective application. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements.
In September 2011, the FASB issued ASU No. 2011-08, Intangibles - Goodwill and Other (Topic 350) (“ASU 2011-08”). The amendments in ASU 2011-08 are intended to simplify how entities test goodwill for impairment. The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. Effective December 31, 2011, the Company adopted the provisions of this guidance. Because this guidance only enhances the steps performed to determine whether a potential impairment exists (but should not impact the resulting conclusion), the adoption did not have an impact on the Company's consolidated financial statements.
3. TRANSACTIONS
The Merger and Merger Agreement
Pursuant to the Merger Agreement, Merger Sub merged with and into the Company, with the Company surviving as a wholly-owned subsidiary of Parent. Parent is an affiliate of GS Capital Partners VI L.P. and, at the closing of the transaction, certain interests of Parent became owned by investment funds managed by P2 Capital Partners, LLC and certain members of Company management.
As of the effective time of the Second Merger, the issued and outstanding common stock of the Company was owned as follows: (i) approximately 84% by GS Capital Partners VI Fund, L.P., GS Capital Partners VI Offshore Fund, L.P., GS Capital Partners VI GmbH & Co. KG, GS Capital Partners VI Parallel, L.P., MBD 2011 Holdings, L.P., Bridge Street 2012 Holdings, L.P. (collectively, the “GSCP Parties”), (ii) approximately 14% by P2 Capital Master Fund I, L.P. and P2 Capital Master Fund VII, L.P. (collectively, the “P2 Parties”), and (iii) approximately 2% by certain members of the Company's management.
At the effective time of the Merger, each share of common stock of Interline (other than shares owned by Interline, Parent, Merger Sub, any stockholders who were entitled to and who properly exercised appraisal rights under Delaware law (collectively, the "Excluded Stockholders"), and a portion of shares owned by P2 Capital Partners), was canceled and converted automatically into a
right to receive $25.50 in cash (the "Merger Consideration"), without interest. In connection with the closing of the Merger, P2 Capital Partners rolled 927,386 shares into the Company. In addition, at the effective time of the Merger, each outstanding option to purchase
shares of common stock of Interline were accelerated and fully vested, if not previously vested, and canceled (unless otherwise agreed to by the holder thereof and Parent) and converted into the right to receive cash consideration in an amount equal to the product of the total number of shares previously subject to the option and the excess, if any, of the Merger Consideration over the exercise price per share of the option. All outstanding Restricted Share Units were also accelerated, fully vested and then canceled and converted into the right to receive cash consideration in an amount equal to the Merger Consideration in respect of each share underlying the canceled Restricted Share Unit. In connection with the closing of the Merger, certain members of the Company's senior management reinvested a portion of their after-tax proceeds from the Merger attributable to each component of their existing equity, on terms agreed upon between management and Parent. A portion of this reinvestment was satisfied through an exchange of options based on the intrinsic value of the options on the date of closing of the Merger for shares and/or options in Parent. The options that were exchanged were done so on a 10:1 ratio, with a fair value of $255.00 per share.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
The authorization to issue the preferred stock of the Company was canceled at the time of the Merger.
The Related Financing Transactions
In connection with the Merger, the Company entered into the following financing transactions:
•
a new senior secured asset-based revolving credit facility totaling $275.0 million; and
•
the issuance of $365.0 million aggregate principal amount of senior notes.
Simultaneously with the closing of the Merger, the following occurred: the funding of the new senior secured asset-based revolving credit facility, the release of the net proceeds of the $365.0 million aggregate principal amount of senior notes from escrow, and the termination of the Company's previous $225.0 million asset-based revolving credit facility. See Note 10. Debt for further information regarding the financing transactions.
The Consent Solicitation
In connection with the Merger, on June 21, 2012, Interline New Jersey commenced the Consent Solicitation regarding certain amendments to the indenture governing the OpCo Notes (the "Bond Amendments"). The Bond Amendments permitted the Merger to occur without triggering a "Change of Control" under the indenture governing the OpCo Notes. As consideration for that amendment, and in addition to an aggregate consent payment of $1.5 million paid by Parent, Interline New Jersey agreed to certain additional amendments that apply from and including the closing date of the Merger. These additional amendments included, among other items, increasing the interest rate on the OpCo Notes from 7.00% to 7.50% per annum, increasing the redemption price of the OpCo Notes for certain periods, making the OpCo Notes rank equal in right of payment to all future incurrences of senior indebtedness (including the ABL Facility) and replacing the restriction on the incurrence of secured indebtedness contained in the anti-layering covenant with a covenant restricting Interline New Jersey and its restricted subsidiaries from incurring liens, other than permitted liens, without equally and ratably securing the OpCo Notes.
On June 27, 2012, Interline New Jersey received the requisite consents to the Bond Amendments and, as a result, a supplemental indenture reflecting the Bond Amendments was executed and became effective. Interline New Jersey received consents to the Bond Amendments from holders of $296.3 million aggregate principal amount of the OpCo Notes (representing 98.8% of the principal amount outstanding) as of the expiration date of the Consent Solicitation.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Sources and Uses
The sources and uses of funds in connection with the Merger transactions are summarized below (in thousands):
Purchase Accounting
The Merger resulted in a significant change in ownership and was accounted for using the acquisition method under Accounting Standards Codification Topic 805, Business Combinations. Under the acquisition method, the preliminary purchase price was allocated to the underlying tangible and intangible assets acquired and liabilities assumed based on their respective fair values, with the remainder allocated to goodwill. Goodwill recorded in connection with the Merger transaction represents intangible assets that do not qualify for separate recognition, such as assembled workforce. None of the goodwill recorded in connection with the Merger will be deductible for income tax purposes. The purchase price paid and related costs and transaction fees incurred have been accounted for in the Company's consolidated financial statements.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
The preliminary purchase price allocation is summarized in the following table (in thousands):
The preliminary allocation of purchase price to intangible assets as of September 7, 2012 was determined based primarily upon assumptions related to future cash flows, discount and royalty rates, and customer attrition rates. As the estimates and assumptions used to determine the preliminary fair values involve a complex series of judgments about future events and uncertainties and due to the timing of the transaction, these values are not yet finalized, but will be no later than one year from the date of the Merger transaction. A measurement period adjustment of $1.9 million was recorded to adjust the fair value of trademarks, which was adjusted through goodwill during the period ended December 28, 2012.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Merger Costs
The following table summarizes the Merger costs for the period December 31, 2011 through December 28, 2012, including professional fees and other related costs (in thousands):
Professional fees, share-based compensation, sponsors' fees, transaction related compensation, and other fees are included in Merger related expenses line item in the statement of operations. Financing fees associated with the ABL Facility, OpCo Notes, and HoldCo Notes were capitalized in other intangible assets, and will be amortized using the straight-line method for the ABL Facility and the effective interest method for the OpCo Notes and HoldCo Notes over the respective terms of the agreements. Approximately $10.9 million of the financing costs were paid to Goldman, Sachs & Co., a related party to the Company.
Pro Forma Financial Information
The following pro forma results of operations gives effect to the Merger transactions as if they had occurred on the first day of the first quarter of fiscal 2012 (December 31, 2011). The pro forma results of operations reflect adjustments (i) to record amortization resulting from purchase accounting, (ii) to record incremental interest expense associated with the ABL Facility and HoldCo Notes as well as the modified OpCo Notes, (iii) to eliminate costs incurred in connection with the Merger including acquisition-related share-based compensation, transaction costs, and loss on extinguishment of debt, and (iv) to record incremental straight-line rent expense. This pro forma financial information should not be relied upon as necessarily being indicative of the historical results that would have been obtained if the Merger transactions had actually occurred on that date, nor the results of operations in the future.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
4. ACQUISITIONS
Acquisition of JanPak
On December 11, 2012, Interline New Jersey acquired all of the outstanding stock of JanPak, Inc. ("JanPak") for $82.5 million in cash, subject to working capital and other closing adjustments. Direct acquisition costs of $0.5 million were incurred in connection with the JanPak acquisition. JanPak, which is headquartered in Davidson, North Carolina, is a large regional distributor of
janitorial and sanitation supplies and packaging products, primarily serving property management and building service contractors as well as manufacturing, health care and educational facilities through 16 distribution centers across the Southeast and South Central United States. This acquisition represents an expansion of the Company's offering of JanSan products in the Southeastern, Mid-Atlantic, and South Central United States.
In accordance with the purchase method of accounting, the acquired net assets were recorded at fair value at the date of acquisition. The purchase price was based primarily on the estimated future operating results of JanPak. As the estimates and assumptions used to determine the preliminary fair values involve a complex series of judgments about future events and uncertainties and due to the timing of the acquisition, these values are not yet finalized, but will be no later than one year from the date of the transaction. None of the goodwill recorded in connection with the JanPak acquisition will be deductible for income tax purposes. The results of operations of JanPak are included in the consolidated results of operations of the Company from the date of acquisition.
The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed in the JanPak acquisiton at the date of acquisition (in thousands):
Of the $32.6 million of acquired intangible assets, $13.7 million was assigned to registered trademarks that are not subject to amortization as the Company believes these intangible assets have indefinite lives. The remaining $18.9 million of acquired intangible assets consists of customer relationships and have a weighted-average useful life of approximately 19 years. The goodwill for the JanPak acquisition represents the value associated with the assembled workforce, anticipated growth from new customer relationships as well as the geographic expansion attained in connection with the acquisition.
Net sales and net income for the year ended December 28, 2012 of $10.3 million and $0.1 million are included in the Consolidated Statement of Operations relating to JanPak for the period December 12, 2012 through December 28, 2012.
Acquisition of Northern Colorado Paper
On January 28, 2011, Interline New Jersey acquired substantially all of the assets and a portion of the liabilities of Northern Colorado Paper, Inc. (“NCP”) for $9.5 million in cash and an earn-out of up to $0.3 million in cash over two years. NCP, which is headquartered in Greeley, Colorado, is a regional distributor of JanSan supplies, primarily servicing institutional facilities in the health
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
care, education and food service industries. This acquisition represents an expansion of the Company's offering of JanSan products in the western United States. The targets were not achieved in connection with the earn-out provisions of the agreement.
Acquisition of CleanSource
On October 29, 2010, Interline New Jersey acquired substantially all of the assets and a portion of the liabilities of CleanSource, Inc. (“CleanSource”) for $54.6 million in cash and an earn-out of up to $5.5 million in cash over two years. CleanSource, which is headquartered in San Jose, California, is a large regional distributor of JanSan supplies. CleanSource offers over 4,000 products and primarily serves institutional facilities in the health care and education markets, as well as building services
contractors. This acquisition represents a geographical expansion of the Company's JanSan offering to the West Coast of the United States. The fair value of the earn-out associated with the acquisition of CleanSource was $3.8 million as of December 30, 2011.
Net sales and net income for the year ended December 31, 2010 of $18.6 million and $0.1 million are included in the Consolidated Statement of Operations relating to CleanSource for the period October 29, 2010 through December 31, 2010.
Pro Forma Financial Information
The following table sets forth the unaudited pro forma net sales and net (loss) income of the Company, which give effect to the JanPak acquisition as if it had occurred on January 1, 2011 and the CleanSource acquisition as if it had occurred on December 27, 2008. The unaudited pro forma net sales and net (loss) income are not presented to give effect to the NCP acquisition as if it had occurred on December 26, 2009, as it is not significant. The unaudited pro forma net sales and net (loss) income do not purport to present what the Company's results would actually have been if the aforementioned transactions had in fact occurred on such dates or at the beginning of the periods indicated, nor do they project the Company's financial position or results at any future date for any future period.
5. ACCOUNTS RECEIVABLE
The Company’s trade receivables are exposed to credit risk. The majority of the markets served by the Company are comprised of numerous individual accounts, none of which is individually significant. The Company monitors the creditworthiness of its customers on an ongoing basis and provides a reserve for estimated bad debt losses. If the financial condition of the Company’s customers were to deteriorate, increases in its allowance for doubtful accounts may be needed.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
The activity in the allowance for doubtful accounts consisted of the following (in thousands):
____________________
(1)
Accounts receivable written-off as uncollectible, net of recoveries.
6. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consisted of the following as of December 28, 2012 and December 30, 2011 (in thousands):
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
7. PROPERTY AND EQUIPMENT
Major classifications of property and equipment as of December 28, 2012 and December 30, 2011 were as follows (in thousands):
Depreciation and amortization expense, including amounts for assets under capital leases, was as follows (in thousands):
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
8. GOODWILL AND OTHER INTANGIBLE ASSETS
Changes to goodwill during 2012, 2011, and 2010 were as follows (in thousands):
In connection with the Merger transactions as discussed in Note 3. Transactions, the Company recorded $492.1 million of preliminary goodwill as a part of purchase accounting. The acquired goodwill in 2012 primarily relates to the Company's acquisition of JanPak in December of 2012. The acquired goodwill in 2011 primarily relates to the Company's acquisition of NCP in January 2011. The acquired goodwill in 2010 primarily relates to the Company's acquisition of CleanSource in October 2010.
Purchase price adjustments in 2011 relate to the revision of the liability for exit activities associated with the Eagle and AmSan LLC (“AmSan”) acquisitions, net of related adjustments to deferred taxes. Purchase price adjustments in 2010 relate to the revision of the liability for exit activities associated with the Eagle acquisition, net of related adjustments to deferred taxes.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
The gross carrying amount and accumulated amortization of the Company's intangible assets other than goodwill as of December 28, 2012 and December 30, 2011 were as follows (in thousands):
As discussed in Note 3. Transactions, in connection with the Merger transaction, the Company recognized intangible assets related to trademarks and customer relationships. Trademarks have been determined to have indefinite lives; customer relationships have an economic useful life of between 7 and 19 years and will be amortized over those periods using an accelerated amortization method.
The amortization of debt financing costs, recorded as a component of interest expense, and write-off of debt financing costs, included in the loss on extinguishment of debt, was as follows (in thousands):
____________________
(1) Related to the extinguishment of the prior asset-based revolving credit facility. See Note 10. Debt for further information.
(2) Related to the redemption of the 8 1/8% senior subordinated notes. See Note 10. Debt for further information.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Amortization expense on other intangible assets was as follows (in thousands):
Expected amortization expense on other intangible assets (excluding deferred financing costs which will vary depending upon debt payments) for each of the five succeeding fiscal years is expected to be as follows (in thousands):
9. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consisted of the following as of December 28, 2012 and December 30, 2011 (in thousands):
____________________
(1)
Purchase card payable is comprised of trade vendor invoices that were paid pursuant to a purchase card agreement with a third-party intermediary. The Company has a purchase card agreement with a third-party intermediary whereby the third-party intermediary pays the trade vendor invoices in accordance with the terms agreed to by the vendor and the Company. The third-party intermediary bills the Company for amounts disbursed on a monthly basis. As a result, there could be an outstanding payable due to the third-party intermediary at any period end. The net activity in purchase card payable is shown as cash flows from financing activities.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
10. DEBT
Long-term debt consisted of the following as of December 28, 2012 and December 30, 2011 (in thousands):
____________________
(1)
As of December 28, 2012, the OpCo notes included an unamortized fair value premium of $21.5 million, recorded as a result of the Merger. See Note 3. Transactions for further information.
ABL Facility
Concurrently with the closing of the Merger, Interline New Jersey and certain of its material wholly-owned domestic subsidiaries, as co-borrowers, entered into a new ABL facility (the "ABL 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 principal amount outstanding will be due and payable in full at maturity, on September 7, 2017. The ABL Facility replaces the $225.0 million asset-based revolving credit facility that was in place prior to the transactions. Debt financing costs capitalized in connection with the new ABL Facility were $5.6 million. Additionally, the Company recorded a loss on the extinguishment of the previous asset-based revolving facility in the amount of $2.2 million, comprised of the write-off of unamortized deferred debt financing costs.
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.
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 first-priority security interest in substantially all of the existing and future personal property of the Company's U.S. subsidiaries. From September 7, 2012 until the quarter following the closing of the ABL Facility, borrowings will bear interest at a rate equal to LIBOR plus 1.75% in the case of Eurodollar revolving loans, and an applicable base rate plus 0.75% in the case of Alternate Base Rate ("ABR") revolving loans.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
After the end of the quarter following the closing of the ABL Facility, the interest rates will be determined as of the end of each fiscal quarter in accordance with applicable rates set forth in the grid below:
The applicable rates for Category 2 and Category 3 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 1.50:1.00. As of December 28, 2012, the interest rate in effect with respect to the ABL Facility was 1.75% for the Eurodollar revolving loans and 3.75% for the ABR revolving loans.
In addition to paying interest on outstanding principal under the ABL facility, Interline New Jersey is required to pay a commitment fee in respect of unutilized commitments, which is equal to 0.375% per annum for the ABL Facility if utilization is less than 50% of the aggregate commitments and 0.25% per annum if the utilization of the ABL Facility exceeds 50% of the aggregate commitments. The principal balance outstanding may be voluntarily prepaid in advance, without penalty or premium, at any time in whole or in part, subject to certain breakage costs.
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 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 change of control. If such an event of default occurs the agent under the ABL Facility is entitled to take various actions, including the 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.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
OpCo Notes
In November 2010, Interline New Jersey completed a series of refinancing transactions: (1) an offering of $300.0 million of 7.00% senior subordinated notes due 2018 (the "OpCo Notes") and (2) entering into the predecessor $225.0 million asset-based revolving credit facility. The proceeds from the OpCo Notes were used to redeem $137.3 million of the 8 1/8% senior subordinated notes due 2012 (the "8 1/8% Notes") and to repay the indebtedness under the prior credit facility. In connection with the redemption of the 8 1/8% Notes and the repayment of the prior credit facility, Interline New Jersey recorded a loss on early extinguishment of debt of $11.5 million. The loss was comprised of $6.9 million in tender premiums and transaction costs associated with the redemption of the 8 1/8% Notes and a non-cash charge of $4.6 million in deferred financing costs and original issue discount written-off associated with the redemption of the 8 1/8% Notes and the repayment of the prior credit facility.
The OpCo Notes are unconditionally guaranteed, jointly and severally, by the Company and Interline New Jersey's existing and future domestic subsidiaries that guarantee the ABL Facility (collectively the ''Guarantors''). The OpCo Notes are not guaranteed by any of Interline New Jersey's foreign subsidiaries.
In connection with the Merger transactions, as fully described in Note 3. Transactions, the OpCo Notes were amended to modify the definition of “Change of Control” and add a definition of “Permitted Holders” in the related indenture, which permitted the Merger to occur without triggering a “Change of Control” under the indenture governing the OpCo Notes. As consideration for these amendments, and in addition to a consent payment of $1.5 million, Interline New Jersey agreed to certain additional amendments that applied from and including the Merger date. These additional amendments included, among other items, increasing the interest rate on the OpCo Notes from 7.00% to 7.50% per annum, increasing the redemption price of the OpCo Notes for certain periods, making the OpCo Notes and the related guarantees rank equal in right of payment to all future incurrences of senior indebtedness (including the ABL Facility) and replacing the restriction on the incurrence of secured indebtedness contained in the anti-layering covenant with a covenant restricting Interline New Jersey and its restricted subsidiaries from incurring liens, other than permitted liens, without equally and ratably securing the OpCo Notes. Additionally, the OpCo Notes were remeasured to the fair value on the date of the Merger, which resulted in a premium of $22.5 million that will be amortized through interest expense over the term of the notes using the effective interest method. Debt financing costs capitalized in connection with the modification of the OpCo Notes were $4.4 million, and the unamortized balance of the originally capitalized debt financing costs of $5.7 million were allocated to goodwill in connection with purchase accounting.
The OpCo Notes mature on November 15, 2018, and interest is payable on May 15 and November 15 of each year. Interline New Jersey has the option to redeem the OpCo Notes prior to November 15, 2013 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, 2013, Interline New Jersey may redeem some or all of the OpCo 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, 2013, Interline New Jersey may, from time to time, redeem up to 35% of the aggregate principal amount of the OpCo Notes with the net cash proceeds received by Interline New Jersey from certain equity offerings at a price equal to 107.00% of the principal amount of the OpCo 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 OpCo Notes remain outstanding immediately thereafter.
The Indenture governing the OpCo Notes contains covenants limiting, among other things, the ability of Interline New Jersey and its restricted subsidiaries to incur additional indebtedness; pay dividends on their capital stock or redeem, repurchase or retire their capital stock; make certain investments; enter into transactions with affiliates; incur liens; create restrictions on the payment of dividends or other amounts from Interline New Jersey’s restricted subsidiaries to Interline New Jersey; sell assets or subsidiary stock and consolidate, merge or transfer assets. These covenants are subject to a number of important exceptions and qualifications.
HoldCo Notes
In connection with the Merger, as discussed in Note 3. Transactions, Interline Delaware issued $365.0 million in aggregate principal amount of 10.00%/10.75% senior notes (the "HoldCo Notes") due November 15, 2018. Debt financing costs capitalized in connection with the HoldCo Notes were $16.7 million.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
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.
Interline New Jersey and the Company were in compliance with all covenants contained in the ABL Facility, OpCo Notes, and HoldCo Notes as of December 28, 2012.
As of December 28, 2012 and December 30, 2011, Interline New Jersey had $113.5 million and $177.3 million available under its respective revolving credit facilities. There were $127.5 million and no borrowings under the revolving credit facilities as of December 28, 2012 and December 30, 2011, respectively. Total letters of credit issued under the revolving credit facilities as of December 28, 2012 and December 30, 2011 were $8.9 million and $8.3 million, respectively. The maturity of the OpCo Notes of $321.5 million, including an unamortized premium of $21.5 million, and the maturity of the HoldCo Notes of $365.0 million are both due in their entirety on November 15, 2018.
11. PREFERRED STOCK
Prior to the Merger Date, as defined in Note 3. Transactions, the Company had the authority to issue 20,000,000 shares of preferred stock, par value $0.01 per share. As of December 30, 2011, there were no preferred shares issued or outstanding.
In connection with the Merger transaction, the authorization to issue the preferred stock of the Company was canceled.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
12. COMMON STOCK
Employee Stock Purchase Plan
On September 7, 2012, the Company's Board of Directors (the "Board") adopted the Interline Brands, Inc. Employee Stock Purchase Plan (the "ESPP Plan"), pursuant to which certain employees of the Company, including the Company’s named executive officers, were given the opportunity to acquire shares of common stock of the Company at the closing of the Merger at the same price as paid by the GSCP and P2 Parties in the Merger. Up to 50,000 shares of common stock were available under the ESPP Plan. The Plan terminated on December 31, 2012. During the period from September 8, 2012 through December 28, 2012, employees purchased 31,819 shares under this plan at a price of $255.00 per share.
Share Repurchases
In August 2011, the Company's Board of Directors authorized the repurchase of up to an aggregate of $25.0 million of the Company's outstanding common stock (the “Authorization”). Share repurchases made under this Authorization were accomplished from time to time based on market conditions, the Company's cash and debt position, and other factors as determined by management. The Authorization did not have an expiration date and could be modified, suspended, or discontinued by the Board at any time, in accordance with applicable securities laws. Shares could be repurchased through open market or privately negotiated transactions. As of December 30, 2011, the Company had repurchased 1,783,822 shares of common stock pursuant to this authorization at an aggregate cost of $25.0 million, or an average cost of $14.01 per share, through open market transactions. The Company used cash flows from operating activities to pay the purchase price for the repurchased shares. The repurchased shares became treasury shares. As of December 31, 2011, the Company had completed the share repurchases under the Authorization.
In connection with the Merger (as defined in Note 3. Transactions), each share of common stock of Interline was canceled on September 7, 2012, and converted automatically into a right to receive $25.50 in cash, without interest.
13. COMPREHENSIVE INCOME
Comprehensive income refers to net income plus revenues, expenses, gains and losses that are recorded directly as an adjustment to stockholders' equity, net of tax, including changes in employee benefit plan obligations and foreign currency translation.
Accumulated other comprehensive income is comprised entirely of foreign currency translation adjustments as of December 28, 2012 and December 30, 2011.
14. SHARE-BASED COMPENSATION
As disclosed in Note 3. Transactions, in connection with the Merger, all of the outstanding share-based compensation awards were accelerated and fully vested, if not previously vested, and converted into the right to receive cash consideration. Additionally, a new share-based compensation plan was adopted in connection with the Merger, as more fully described below. Total compensation cost and income tax benefits recognized in the consolidated statements of operations for the Company's stock-based awards were as follows (in thousands):
____________________
(1) In connection with the Merger, total share-based compensation of $18.3 million was recognized and included in Merger related expenses in the consolidated statements of operations, $11.2 million of which was recorded in the Predecessor Period, and $7.0 million was recorded in the Successor Period.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Current Equity Compensation Plan
On September 7, 2012 the Board adopted the Interline Brands, Inc. 2012 Option Plan (the “2012 Plan”) pursuant to which 168,845 shares of common stock of the Company may be the subject of grants of options. The 2012 Plan is administered by the Compensation Committee of the Board. Under the 2012 Plan, time-vested option awards and performance-vested option awards may be granted to employees and directors of the Company.
The 2012 Plan will terminate on September 7, 2022. However, the Board may suspend, amend, alter, discontinue or terminate the 2012 Plan prior to the termination date, except as provided in the 2012 Plan. Awards granted prior to the termination of the 2012 Plan may extend beyond the date of such termination. During the period from September 7, 2012 through December 28, 2012, 73,954 time-based option awards and 73,954 performance-based stock options were granted. As of December 28, 2012, 20,937 shares of common stock were available for future grant.
Time-Vested Option Award Agreements
Subject to an optionee’s continued employment (except as described below), options granted under these agreements become vested as to twenty percent (20.0%) of the time-vested options on each of the first, second, third, fourth and fifth anniversaries of the grant date, with accelerated vesting upon a change in control of the Company. Upon the optionee’s termination for cause, any unexercised portion of the option, whether or not vested, will terminate. The optionee is subject to covenants restricting competition with the Company and solicitation of employees and customers of the Company during the optionee’s term of employment and for a period of time thereafter.
Performance-Vested Option Award Agreements
Performance-vested options become vested and exercisable with respect to twenty percent (20.0%) of the shares subject to the option based upon the Company’s achievement of specified EBITDA targets for the Company’s 2012, 2013, 2014, 2015 and 2016 fiscal years (each, an “Annual Performance Period”); subject (except as described below) to the optionee remaining employed through the date on which audited financial statements for the applicable Annual Performance Period are presented to the Board. Upon a change in control of the Company (i) prior to the first anniversary of the date of grant, the option will become fully vested and (ii) prior to the end of any of the other Annual Performance Periods, a number of options will vest equal to the number of unvested options multiplied by a fraction, the numerator of which is the number of performance periods in which the targets have been achieved and the denominator of which is the number of periods that have elapsed since the date of grant. Upon the optionee’s termination for cause, any unexercised portion of the option, whether or not vested, will terminate. The optionee is subject to covenants restricting competition with the Company and solicitation of employees and customers of the Company during the optionee’s term of employment and for a period of time thereafter.
Rollover Option Award Agreements
In connection with the Merger, certain members of management were provided the opportunity to roll over options held under the 2004 Plan, as defined below, into the 2012 Plan. In total, 508,449 options under the 2004 Plan were rolled into the new Company at a 10:1 ratio resulting in 50,845 options with a weighted-average exercise price of $117.07. As a result of the rollover of these options, the Company recorded $7.0 million in share-based compensation expense in the Successor Period.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
The fair values of stock options granted under the 2012 Plan were estimated using the Black-Scholes option-pricing model. Expected volatility was based on the historical volatilities of comparable companies over a historical period that matches the expected life of the options on the date of grant. The Company also considers historical data to estimate the timing and amount of stock option exercises and forfeitures. The expected life represents the period of time that stock options are expected to remain outstanding and is based on the contractual term of the stock options and expected exercise behavior. The risk-free interest rate is based on U.S. Treasury zero-coupon issues with a remaining term equal to the expected option life assumed at the date of grant. The Black-Scholes weighted-average assumptions for the 2012 Plan were as follows:
The weighted-average fair value per option of stock options granted during the period September 8, 2012 through December 28, 2012 was $122.07.
A summary of stock options activity under the 2012 Plan from September 8, 2012 through December 28, 2012 is presented below:
____________________
(1)
The aggregate intrinsic value represents the amount by which the fair value of the underlying stock at period end exceeds the stock option exercise price.
(2)
Represents shares rolled over from the 2004 Plan at a 10:1 ratio.
Prior Equity Compensation Plans
On September 7, 2012, in connection with the closing of the Merger, each outstanding share of the Company's common stock was canceled and automatically converted into the right to receive $25.50 per share in cash. Also effective as of the closing of the Merger, outstanding awards under the 2000 and 2004 stock incentive plans vested in full and were converted into either immediate
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
cash payments or fully vested new options to purchase common stock of the Parent. No additional shares are available to be granted under these plans.
During 2000, Interline New Jersey established a Stock Award Plan (the “2000 Plan”), under which Interline New Jersey could award a total of 6,395 shares of common stock in the form of incentive stock options (which could be awarded to key employees only), nonqualified stock options, stock appreciation rights (“SARs”) and restricted stock awards, all of which could be awarded to directors, officers, key employees and consultants. The Company's compensation committee determined in its sole discretion whether a SAR is settled in cash, shares or a combination of cash and shares. In connection with the Company's initial public offering in December 2004, options to purchase shares of the common stock of Interline New Jersey were converted into options to purchase shares of the Company's common stock. Effective December 25, 2009 no awards shall be granted under the 2000 Plan.
During 2004, the Company adopted the 2004 Equity Incentive Plan, (the “2004 Plan”), under which the Company may award 1,175,000 shares in the form of incentive stock options, nonqualified stock options, stock appreciation rights, or SARs, restricted stock, restricted share units (“RSUs”), deferred stock units (“DSUs”) and stock bonus awards, all of which may be awarded to any employee, director, officer or consultant of the Company. In May 2006, the stockholders of the Company approved an amendment to the 2004 Plan whereby the number of shares of the Company's common stock reserved for issuance under the 2004 Plan was increased by 2,000,000 shares and to further restrict the repricing of awards granted under the 2004 Plan without first obtaining approval by the Company's stockholders. In May 2008, the stockholders of the Company approved amendments to the 2004 Plan, including to increase the number of shares of common stock reserved for issuance and available for grants thereunder to 3,800,000 as of January 1, 2008 and to change the method by which shares subject to full value awards granted thereunder are counted against the 2004 Plan's share limit. Effective January 1, 2008, shares subject to grants of full value awards, or awards other than options or SARs, count against the applicable share limits under the 2004 Plan as 1.8 shares for every 1 share granted, while shares subject to stock options or SARs count against the applicable share limits as 1 share for every 1 share granted.
These plans allowed the Company to fulfill its incentive stock option, nonqualified stock option, SAR, restricted stock, RSU, DSU and stock bonus award obligations using unissued or treasury shares.
Stock Options
Under the terms of the 2000 Plan, the exercise price per share for an incentive stock option may not be less than 100% of the fair market value of a share of common stock on the grant date. The exercise price per share for an incentive stock option granted to a person owning stock possessing more than 10% of the total combined voting power of all classes of stock may not be less than 110% of the fair market value of a share of common stock on the grant date. These incentive stock options vested in 25% increments over four years and may not be exercisable after the expiration of ten years from the date of grant.
Under the terms of the 2004 Plan, the exercise price of the options will not be less than the fair market value of the common stock at the date of grant, generally vest in 25% increments over four years and may not be exercisable after the expiration of seven or ten years from the date of grant.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
The fair values of stock options were estimated using the Black-Scholes option-pricing model. Expected volatility was based on historical performance of the Company's stock. The Company also considers historical data to estimate the timing and amount of stock option exercises and forfeitures. The expected life represents the period of time that stock options are expected to remain outstanding and is based on the contractual term of the stock options and expected exercise behavior. The risk-free interest rate is based on U.S. Treasury zero-coupon issues with a remaining term equal to the expected option life assumed at the date of grant. The Black-Scholes weighted-average assumptions were as follows:
The weighted-average fair value per option of stock options granted during the period December 31, 2011 through September 7, 2012, and the fiscal years ended 2011 and 2010 was $7.84, $14.93, and $7.21, respectively.
A summary of stock options activity as of September 7, 2012 and changes during the period then ended is presented below:
____________________
(1)
The aggregate intrinsic value represents the amount by which the fair value of the underlying stock at period end exceeds the stock option exercise price.
During the period from December 31, 2011 through September 7, 2012 and the fiscal years ended December 30, 2011 and December 31, 2010, there were 156,297, 43,962, and 673,817 stock options exercised with an intrinsic value of $1.4 million, $0.3 million, and $2.6 million, respectively. Total intrinsic value represents the difference between the exercise price and the market price on the date of exercise. Proceeds from stock options exercised during the period from December 31, 2011 through September 7, 2012 and the fiscal years ended December 30, 2011 and December 31, 2010 were $2.2 million, $0.7 million, and $10.8 million, respectively.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
In connection with the Merger, 2,560,744 options were exercised with an aggregate intrinsic value of $16.9 million, and 171,881 options were canceled. Subsequent to the Merger, 508,449 options were outstanding with a weighted-average exercise price of $11.71, a weighted-average contractual term of 3.12 years and an aggregate intrinsic value of $7.0 million. In connection with the Merger, these 508,449 options were rolled into the new Company at a 10:1 ratio resulting in 50,845 options with a weighted-average exercise price of $117.07. As a result of the rollover of these options, the Company recorded $7.0 million in share-based compensation expense in the Successor Period.
Restricted Stock, Restricted Share Units and Deferred Stock Units
Shares of restricted stock granted under the 2004 Plan to executives, employees and non-employee directors do not have an exercise price. The share-based compensation expense associated with the restricted stock is based on the quoted market price of the Company's shares of common stock on the date of grant. One-half of the restricted stock awards granted to employees vest evenly over three years and one half vest evenly over five years.
RSUs granted under the 2004 Plan to management do not have an exercise price. The share-based compensation expense associated with the RSUs is based on the quoted market price of the Company's shares of common stock on the date of grant. Depending on the grant, (1) one-half of the RSUs vest on the second grant date anniversary provided that certain pre-established annual percentage increases in specific Company-wide metrics, such as EBITDA, are attained and one-half vest evenly over three years; or (2) one-half of the RSUs vest evenly over two years and one-half vest evenly over three years; or (3) one-third of the RSUs vest evenly over each of the first three years following the date of grant; or (4) one-half of the RSUs vest evenly over three years and one-half vest evenly over five years; or (5) on the earlier of: (A) the fourth grant date anniversary, provided that the average daily closing price of a share of the Company's common stock during any 20-consecutive-trading-day period (“Average Closing Price”) commencing on or after the grant date equals or exceeds a specified amount prior to the fourth grant date anniversary; or (B) the date that is the later of: (x) the date on which the Average Closing Price equals or exceeds a higher specified amount and (y) the fifth grant date anniversary of the Transaction Date, provided that it occurs not later than the seventh grant date anniversary. Under all vesting schedules, the RSUs will only vest provided the grantee's service to the Company has not terminated prior to the vesting date.
DSUs granted under the 2004 Plan to non-employee directors do not have an exercise price. The share-based compensation expense associated with the DSUs is based on the quoted market price of the Company's shares of common stock on the date of grant. DSUs vest on the grant date or evenly over the non-employee directors' current service terms, depending on the grant. All DSUs are to be settled in shares of the Company's common stock upon termination of the non-employee directors' service or one year after termination of the non-employee directors' service, depending on the grant.
A summary of restricted stock, RSUs and DSUs as of September 7, 2012 and changes during the period then ended is presented below:
The total fair value of restricted stock vested during the period December 31, 2011 through September 7, 2012, and the fiscal years ended 2011 and 2010 was less than $0.1 million, $3.8 million, and less than $0.1 million, respectively. The total fair value of RSUs vested during the period December 31, 2011 through September 7, 2012 and the fiscal years ended 2011 and 2010 was $4.7
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
million, $1.8 million, and $0.3 million, respectively. The total fair value of deferred stock units vested during the period from December 31, 2011 through September 7, 2012 was $0.2 million. No deferred stock units vested during the 2011 and 2010 fiscal years.
In connection with the Merger, all outstanding restricted share units and deferred stock units vested with a fair value of $14.7 million and $3.5 million, respectively. Subsequent to the Merger, there were no restricted stock, restricted shares units or deferred stock units outstanding.
15. EMPLOYEE BENEFIT PLAN
The Company has a qualified profit sharing plan under Section 401(k) of the Internal Revenue Code. Pursuant to the 401(k) plan, the Company matches employee contributions at a rate of 25% of the first 5% contributed by the employees, up to a maximum of $3,125 per employee. Company contributions to the 401(k) plan were as follows (in thousands):
16. COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company leases its facilities, vehicles, and other equipment under operating and capital leases expiring at various dates through 2024. Minimum future rental payments under these operating and capital leases as of December 28, 2012 are as follows (in thousands):
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Certain of the leases provide that the Company pays taxes, insurance and other operating expenses applicable to the leased premises. Rent expense under all operating leases was as follows (in thousands):
Employment Agreements
The Company has employment agreements with various expiration dates through 2014 with certain officers and employees, unless terminated earlier by the Company, at combined salaries of $5.4 million, plus bonuses and subject to adjustments.
Contingent Liabilities
As of December 28, 2012 and December 30, 2011, the Company was contingently liable for outstanding letters of credit aggregating to $8.9 million and $8.3 million, respectively.
Legal Proceedings
On May 10, 2011, the Company was named as a defendant in an action filed before the Nineteenth Judicial Circuit Court of Lake County, Illinois, which was subsequently removed to the United States District Court for the Northern District of Illinois. The complaint alleges that the Company sent thousands of unsolicited fax advertisements to businesses nationwide in violation of the Telephone Consumer Protection Act of 1991, as amended by the Junk Fax Prevention Act of 2005 (“TCPA”). At the time of filing the complaint, the plaintiff also filed a motion asking the Court to certify a class of plaintiffs comprised of businesses who allegedly received unsolicited fax advertisements from the Company. Other reported TCPA claims have resulted in a broad range of outcomes, with each case being dependent on its own unique set of facts and circumstances. Accordingly, the Company cannot reasonably estimate the amount of loss, if any, arising from this matter. The Company is vigorously contesting class action certification and liability, and will continue to evaluate its defenses based upon its internal review, advice from external legal counsel and investigation of prior events, new information, and future circumstances.
The Company is involved in various other legal proceedings in the ordinary course of its business that are not anticipated to have a material effect on the Company’s consolidated financial statements.
Because the outcome of litigation is inherently uncertain, the Company may not prevail in these proceedings and the ultimate exposure cannot be estimated if the Company were not to prevail. Accordingly, any rulings against the Company could have a material adverse effect on the consolidated financial statements.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
17. INTEREST AND OTHER INCOME
Interest and other income consisted of the following during 2012, 2011 and 2010 (in thousands):
18. INCOME TAXES
The Company files numerous consolidated and separate income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal income tax examinations for years before 2009 and is no longer subject to state and local, or foreign income tax examinations by tax authorities for years before 2008.
The (benefit) provision for income taxes for 2012, 2011 and 2010, is as follows (in thousands):
As of December 28, 2012, the approximate amount of earnings of foreign subsidiaries that the Company considers permanently reinvested and for which deferred taxes have not been provided was $14.7 million. Because of the availability of U.S. foreign tax credits, it is not practicable to determine the U.S. federal income tax impact if such earnings were not permanently reinvested.
The Company has foreign tax credits in the amount of $0.6 million which may be used to offset future foreign source income taxable in the U.S. If not used, the foreign tax credits will expire at the end of 2013.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
The components of (loss) income before income taxes for 2012, 2011 and 2010 were as follows (in thousands):
The reconciliation of the provision for income taxes at the federal statutory tax rate to the provision for income taxes for 2012, 2011 and 2010 is as follows:
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
Deferred income taxes result primarily from temporary differences in the recognition of certain expenses for financial and income tax reporting purposes. The components of the Company's deferred tax assets and liabilities as of December 28, 2012 and December 30, 2011 consist of the following (in thousands):
Unrecognized Tax Benefits
In accordance with US GAAP, the Company will recognize the impact of a tax position if a position is "more likely than not" to prevail.
A reconciliation of the beginning and ending unrecognized tax benefits for the period from September 8, 2012 through December 28, 2012 (Successor) is as follows (in thousands):
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
There were no material uncertain tax positions as of September 7, 2012, December 30, 2011, or December 31, 2010.
The unrecognized tax benefit, if recognized, would not have a material effect on the effective tax rate at December 28, 2012.
The Company recognizes potential penalties and interest related to unrecognized tax benefits within its statements of operations as selling, general and administrative expenses and interest expense, respectively. To the extent penalties and interest are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of selling, general and administrative expenses and interest expense, respectively. For the year ended December 28, 2012, the Company recorded an interest expense of $0.1 million.
The unrecognized tax benefit with respect to certain of the Company's tax positions may increase or decrease over the next twelve months; however, management does not expect the change, if any, to have a material effect on the Company's financial position or results of operations within the next twelve months.
During 2012, the IRS began an examination of the company's federal income tax return for the fiscal years 2009-2010. While the Company is not presently aware of any proposed adjustments, the examination remains ongoing and therefore the Company cannot determine at this time the impact this examination will have on the Company's financial condition or results of operations.
19. GUARANTOR SUBSIDIARIES
The OpCo Notes of Interline New Jersey (the “Subsidiary Issuer”), issued in November 2010, are fully and unconditionally guaranteed, jointly and severally, on an unsecured senior basis by Interline Brands, Inc. (the “Parent Company”) and all of Interline New Jersey’s 100% owned domestic subsidiaries: JanPak, Inc., Wilmar Holdings, Inc., Wilmar Financial, Inc., and Glenwood Acquisition LLC (collectively the “Guarantor Subsidiaries”). The guarantees by the Parent Company and the Guarantor Subsidiaries are senior to any of their existing and future subordinated obligations, equal in right of payment with any of their existing senior subordinated indebtedness, subordinated to any of their senior indebtedness outstanding prior to the Merger and equal in right of payment to any senior indebtedness outstanding as of the Merger Date and any future senior indebtedness.
The Parent Company conducts virtually all of its business operations through the Subsidiary Issuer. Accordingly, the Parent Company’s only material sources of cash are dividends and distributions with respect to its ownership interests in the Subsidiary Issuer that are derived from the earnings and cash flow generated by the Subsidiary Issuer. For the period December 31, 2011 through September 7, 2012, dividends totaling $1.5 million have been paid to the Parent Company from the Subsidiary Issuer for the purpose of funding share repurchases to satisfy minimum tax withholding requirements on share-based compensation. On September 8, 2012, a dividend of $162.3 million was paid to the Parent Company from the Subsidiary Issuer for the purpose of funding the Merger transactions. Through December 30, 2011, dividends totaling $26.2 million have been paid to the Parent Company from the Subsidiary Issuer for the purpose of funding the share repurchase that occurred during that year.
Effective July 2, 2012, all of the preferred stock between the Parent and the Subsidiary Issuer was canceled and retired.
The following tables set forth, on a condensed consolidating basis, the balance sheets, statements of operations and comprehensive (loss) income, and statements of cash flows for the Parent Company, Subsidiary Issuer and Guarantor Subsidiaries for all financial statement periods presented in the Company’s consolidated financial statements. The non-guarantor subsidiaries are minor and are included in the condensed financial data of the Subsidiary Issuer. The Subsidiary Issuer does not allocate integration expenses, corporate overhead or other expenses for shared services to the Parent Company or the Guarantor Subsidiaries; therefore, the following tables do not reflect any such allocation.
The condensed consolidating financial statements presented below for the period ended December 28, 2012 and from September 8, 2012 through December 28, 2012 (the Successor period) reflect the historical accounting basis for the Subsidiary Issuer and for the Guarantor Subsidiaries, with the exception of JanPak, which is recorded at fair value. Certain purchase accounting adjustments resulting from the Merger are reflected in the consolidating adjustments column.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
____________________
(1)
The Subsidiary Issuer does not allocate integration expenses, corporate overhead or other expenses for shared services to the Guarantor Subsidiaries; therefore, the results for the Guarantor Subsidiaries do not reflect any such allocation.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
____________________
(1)
The Subsidiary Issuer does not allocate integration expenses, corporate overhead or other expenses for shared services to the Guarantor Subsidiaries; therefore, the results for the Guarantor Subsidiaries do not reflect any such allocation.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
FOR THE FISCAL YEAR ENDED DECEMBER 30, 2011
PREDECESSOR
(in thousands)
____________________
(1)
The Subsidiary Issuer does not allocate integration expenses, corporate overhead or other expenses for shared services to the Guarantor Subsidiaries; therefore, the results for the Guarantor Subsidiaries do not reflect any such allocation.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2010
PREDECESSOR
(in thousands)
____________________
(1)
The Subsidiary Issuer does not allocate integration expenses, corporate overhead or other expenses for shared services to the Guarantor Subsidiaries; therefore, the results for the Guarantor Subsidiaries do not reflect any such allocation.
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
INTERLINE BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the periods September 8, 2012 to December 28, 2012 (Successor), December 31, 2011 to September 7, 2012 (Predecessor), and the years ended December 30, 2011 and December 31, 2010 (Predecessor)
20. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the Company's quarterly results of operations for 2012 and 2011 (in thousands):
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
As announced on Current Report on Form 8-K filed on September 13, 2012, in connection with the Merger, Deloitte & Touche LLP, formerly the independent registered public accountant for the Company, was dismissed as the Company’s independent registered public accounting firm as of September 7, 2012. As announced on Current Report on Form 8-K filed on September 19, 2012, the Company engaged PricewaterhouseCoopers LLP as the Company’s new independent registered certified public accounting firm.
ITEM 9A.
ITEM 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer), evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 28, 2012. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 28, 2012, our disclosure controls and procedures were effective to ensure that: (1) material information disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure and (2) information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.
Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, under the Internal Control-Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 28, 2012.
Changes in Internal Control over Financial Reporting
No change in our internal control over financial reporting occurred during the quarter ended December 28, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Limitations on the Effectiveness of Controls
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of a control system are met. Further, any control system reflects limitations on resources, and the benefits of a control system must be considered relative to its costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. The design of a control system is also based upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected. Our disclosure controls are designed to provide reasonable assurance of achieving their objectives. Based on our evaluation of the effectiveness of our internal control over financial reporting, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that, as of December 28, 2012, our disclosure controls and procedures were effective at the reasonable assurance level.
ITEM 9B.
ITEM 9B. Other Information
None.
PART III
ITEM 10.
ITEM 10. Directors, Executive Officers and Corporate Governance
Our Board of Directors
Our current Board of Directors consists of ten members. Members of the Board of Directors are elected in accordance with the provisions of the Third Amended and Restated Certificate of Incorporation, the Sixth Amended and Restated Bylaws and the Stockholders Agreement dated September 7, 2012 (the “Stockholders Agreement”). The Stockholders Agreement was entered into by and among GS Capital Partners and its affiliates, P2 Capital Partners and its affiliates, and certain stockholders of the Company. Pursuant to the Stockholders Agreement, GS Capital Partners (which owns a majority of the Company's shares) has the right to designate five members of our Board of Directors and P2 Capital Partners has the right to designate two members of our Board of Directors, unless otherwise agreed by GS Capital Partners and P2 Capital Partners. In addition, the Stockholders Agreement provides that the Chief Executive Officer and the President of the Company shall be members of our Board of Directors, with the Chief Executive Officer also serving as Chairman of the Board. Because of these requirements and because our equity is privately-held, we do not currently have a policy or procedures with respect to shareholder recommendations for nominees to our Board of Directors.
As a result of the Stockholders Agreement, Messrs. Mehra, Gross and Crampton, and Ms. Berry, as well as Philip Grovit (who no longer serves on our Board of Directors), were designated as members of our Board of Directors by GS Capital Partners, and Messrs. Moller and Paulson were designated by P2 Capital Partners. In addition, the Board of Directors appointed two independent directors to our Board of Directors: Dennis J. Letham, who also serves as Chair of our Audit Committee; and Jozeph Opdeweegh, who also serves as a member of our Compensation Committee. Pursuant to the Stockholders' Agreement, Mr. Opdeweegh was designated as a member of our Board of Directors by GS Capital Partners. In addition, GS Capital Partners and P2 Capital Partners agreed to increase the size of our Board of Directors to ten members in connection with Mr. Letham's appointment in March 2013 and that Mr. Letham would be designated as a member of our Board of Directors by GS Capital Partners pursuant to the terms of the Stockholders' Agreement. Each of our directors, other than Messrs. Letham and Opdeweegh, are employed by us or our principal stockholders.
The names of our current directors, along with their present positions and qualifications, their principal occupations and directorships held with public corporations during the past five years and their ages as of March 12, 2013 are set forth below:
Director Backgrounds and Qualifications
Unless otherwise indicated, the business experience of our directors described below represents their experience over at least the last five years.
Michael J. Grebe has served as Chairman of the Board of Directors of Interline since January 2007; as a director of Interline since June 2004; as Chairman of the Board of Directors of Interline New Jersey from January 2007 until September 2012; as a director of Interline New Jersey from May 2000 until September 2012; and as Chief Executive Officer of Interline and Interline New Jersey since June 2004. Mr. Grebe has also previously served as President of Interline and Interline New Jersey and as Chief Operating Officer of Interline New Jersey. Prior to joining Interline, Mr. Grebe served as a Group Vice President of Airgas, Inc. (“Airgas”) a distributor of industrial gases, from 1997 to 1998. Mr. Grebe joined Airgas following its acquisition of IPCO Safety, Inc., a national distributor of industrial safety supplies, where he served as President from 1991 to 1996. Mr. Grebe's qualifications to serve on our Board of Directors include his more than 20 years of experience serving in senior-level leadership positions in distribution companies, and his more than 10 years of experience serving as CEO, President and/or COO of Interline and Interline New Jersey.
Kenneth D. Sweder has served as a director of Interline since September 2012, as President of Interline and Interline New Jersey since February 2011, as Chief Operating Officer of Interline and Interline New Jersey since October 2008, and as Chief Merchandising Officer of Interline and Interline New Jersey since April 2007. Prior to joining Interline, Mr. Sweder was the First Vice President of Property Operations Strategy at Equity Residential Properties from June 2004 to April 2007, a management consultant at Bain & Company from June 2000 to May 2004, and in various positions within the National Corporate Banking division of PNC Bank from July 1991 to May 2000, most recently as Vice President. Mr. Sweder's qualifications to serve on our Board of Directors include his extensive knowledge of our business, industry and operations; high level of financial and capital markets literacy; deep acquisition and integration expertise; and significant experience with our sales, marketing and technology platforms.
Ann Berry has served as a director of Interline since September 2012. Ms. Berry is a Vice President in the Principal Investment Area of the Merchant Banking Division of Goldman, Sachs & Co., which she joined in 2008. She also serves as a director of U.S. Security Associates. Ms. Berry's qualifications to serve on our Board of Directors are described below.
Christopher Crampton has served as a director of Interline and Interline New Jersey since September 2012. Mr. Crampton is a Managing Director in the Principal Investment Area of the Merchant Banking Division of Goldman, Sachs & Co., which he joined in 2003. He also serves as a director of Americold Realty Trust, Andrews International, MRC Global, Inc. and U.S. Security Associates. Mr. Crampton's qualifications to serve on our Board of Directors are described below.
Bradley Gross has served as a director of Interline and Interline New Jersey since September 2012. Mr. Gross is a Managing Director of Goldman, Sachs & Co. Mr. Gross joined Goldman, Sachs & Co. in the Real Estate Principal Investment Area in 1995 and joined the Principal Investment Area in 2000. Mr. Gross currently serves as a director of Flynn Restaurant Group LLC, Aeroflex Holding Corp., Americold Realty Trust and Griffon Corporation. Within the past five years, he has served as a director of First Aviation Services, Inc., Capmark Financial Group, MoneyGram International, Inc. and Cequel Communications, LLC. Mr. Gross' qualifications to serve on our Board of Directors are described below.
Dennis J. Letham has served as a director of Interline since March 2013. From 1995 until his retirement in 2011, Mr. Letham served as Executive Vice President, Finance and Chief Financial Officer of Anixter International, Inc. During 1993 to 1995, Mr. Letham served as Executive Vice President and Chief Financial Officer of Anixter, Inc., the principal operating subsidiary of Anixter International, Inc. Prior to joining Anixter, Mr. Letham served in various leadership positions during his 10-year career with National Intergroup, Inc. Mr. Letham began his career with Arthur Andersen & Co. where he held progressive responsibilities in the Audit Department. Mr. Letham also serves on the Board of Directors of Tenneco, Inc. Mr. Letham's qualifications to serve on our Board of Directors include his prior experience as a Chief Financial Officer of a large public distribution company, and his extensive experience in complex financial, accounting and operational issues.
Sanjeev Mehra has served as a director of Interline since September 2012. Mr. Mehra has been a partner of Goldman, Sachs & Co. since 1998 and a Managing Director of Goldman, Sachs & Co.'s Principal Investment Area of its Merchant Banking Division since 1996. He also serves as a director of ARAMARK Corporation, KAR Auction Services, Inc., SunGard Data Systems, Inc., Sigma Electric, Max India Limited and TVS Logistics Services Limited, and in the past five years has served as a director of Hawker Beechcraft, Inc., First Aviation Services, Inc., Adam Aircraft Industries, Inc. and Burger King Holdings, Inc. Mr. Mehra's qualifications to serve on our Board of Directors are described below.
Claus J. Moller has served as a director of Interline since September 2012. Mr. Moller is the Founder and Managing Partner of P2 Capital Partners, a private equity firm. Mr. Moller's qualifications to serve on our Board of Directors are described below.
Jozef Opdeweegh has served as a director of Interline since February 2013. Mr. Opdeweegh is currently the Chief Executive Officer of Neovia Logistics Services, LLC (f/k/a Caterpillar Logistics Services, Inc.). Mr. Opdeweegh previously served as the Chief Executive Officer of Americold Realty Trust from March 2009 to February 2012, as interim Chief Executive Officer of Americold Realty Trust from September 2008 through March 2009 and as a Trustee of Americold Realty Trust since March 2008. From 2000 through the end of 2007, Mr. Opdeweegh served as the Chief Executive Officer and President of Syncreon, Inc. (f/k/a TDS Logistics & Walsh Western), a supply chain services company focused on the automotive and technology industry. Mr. Opdeweegh's qualifications to serve on our Board of Directors include his extensive knowledge of complex supply chain solutions, warehouse operations and distribution.
Joshua D. Paulson has served as a director of Interline and Interline New Jersey since September 2012. Mr. Paulson is a Partner with P2 Capital Partners, a private equity firm. Mr. Paulson's qualifications to serve on our Board of Directors are described below.
We believe that each of our directors nominated by our private equity sponsors have the experience and qualifications that will allow them to make substantial contributions to the Board of Directors. Messrs. Crampton, Gross, Mehra, Moller and Paulson, and Ms. Berry, have expertise in distribution, operations, logistics and marketing as a result of their experience working on investments in other distribution companies. These directors hold positions with national and global private equity firms and possess experience in owning and managing enterprises like the Company and are familiar with corporate finance, strategic business planning activities and issues involving stakeholders more generally. In addition, these directors have experience in corporate governance through their experience serving as directors of other public and private companies.
Our Executive Officers
The following table sets forth the name, age and positions, as of March 12, 2013, of individuals who are currently executive officers of the Company. To our knowledge, there are no family relationships between any director or executive officer and any other director or executive officer of the Company.
John A. Ebner has served as Chief Financial Officer of Interline and Interline New Jersey since January 2010, and previously served as Treasurer of Interline and Interline New Jersey from January 2010 to May 2010. Prior to joining Interline, Mr. Ebner worked for 13 years with Alltel Corporation where he served in various senior leadership roles including Treasurer, Senior Vice President of Investor Relations, Vice President of Finance - Wireless Operations, Vice President - Industry Relations, and Vice President - Pricing and Product Management. Mr. Ebner served as an investment banker with JP Morgan from 1995 to 1996.
Lucretia D. Doblado has served as Chief Information Officer of Interline and Interline New Jersey since October 2006. Prior to joining Interline, Ms. Doblado served as the Senior Vice President and Chief Information Officer of The Bombay Company, Inc. from October 2003 to September 2006 and a Partner at Accenture, a premier consulting and business integration firm, from 1986 to 2002, where she assisted clients for 17 years building information technology solutions for Fortune 500 and international companies.
Michael Agliata has served as Vice President, General Counsel and Secretary of Interline and Interline New Jersey since March 2009. Mr. Agliata previously served as Corporate Counsel for Interline and Interline New Jersey from July 2007 to March 2009 and as Assistant Secretary from March 2008 to March 2009. Prior to joining Interline, Mr. Agliata was a practicing attorney in the Jacksonville, Florida office of Holland & Knight LLP from April 2004 to April 2007 and in the Miami and Fort Lauderdale offices of Fowler White Burnett, P.A. from July 1999 through April 2004.
David C. Serrano has served as Chief Accounting Officer of Interline and Interline New Jersey since May 2010 and as Corporate Controller of Interline and Interline New Jersey since August 2001. Mr. Serrano previously served as Vice President of Finance of Interline and Interline New Jersey from September 2005 to May 2010, and as Divisional Controller of Interline New Jersey from September 2000 to August 2001. Prior to joining Interline, Mr. Serrano served as Corporate Controller of Barnett, Inc., one of our corporate predecessors, from 1990 to 2000, and as Assistant Controller of U.S. Lock Corporation, another one of our predecessor companies, from 1988 to 1990.
James A. Spahn has served as Vice President, Distribution of Interline and Interline New Jersey since 2002. Mr. Spahn previously served as General Manager and Regional Vice President of Sales of our Detroit distribution center from July 1999 to November 2002. Prior to joining Interline, Mr. Spahn served as the Director of Sales from 1996 to 1999 with The Crown Group (automotive) and as the Director of Operations and Vice President of Sales from 1989 to 1996 with Thermofil, Inc. Mr. Spahn also worked for the DuPont Company from 1976 to 1989, during which time he held various positions in the areas of sales, operations, technical service and personnel.
Committees
Our Board of Directors currently has two standing committees: the Audit Committee and the Compensation Committee.
The primary purposes of the Audit Committee are to assist the Board of Directors in monitoring the integrity of our financial statements, the qualifications and independence of our independent registered certified public accounting firm, the performance of our audit function and independent registered certified public accounting firm, and our compliance with legal and regulatory requirements. The Audit Committee also assists the Board of Directors in monitoring various controls implemented by the Company to address and reduce financial and legal risks. Messrs. Letham, Crampton, Gross and Paulson are currently serving on the Audit Committee. Mr. Letham serves as Chairman of the Audit Committee and also qualifies as an independent “audit committee financial expert,” as such term has been defined by the SEC in Item 407(d)(5)(ii) of Regulation S-K.
The Compensation Committee has the authority to approve salaries and bonuses and other compensation matters for our executive officers. In addition, the Compensation Committee has the authority to approve employee benefit plans as well as administer the 2012 Stock Option Plan and Employee Stock Purchase Plan. The Compensation Committee currently consists of Messrs. Gross, Crampton, Opdeweegh, and Paulson. Mr. Gross serves as Chairman of the Compensation Committee.
Code of Conduct and Ethics
Our Board of Directors and management have a strong commitment to ethical conduct and business practices. The Company has adopted a Code of Conduct and Ethics (the “Code”), which applies to all of the Company's directors, officers (including its Chief Executive Officer, Chief Financial Officer, Controller and any person(s) performing similar functions) and employees. The Code is periodically reviewed and updated to remain current with applicable legal requirements and best practices. The Code is posted on our website at www.interlinebrands.com and is available in print to any shareholder who requests it.
Section 16(A) Beneficial Ownership Reporting Compliance During Pre-Merger Period
During the period preceding the closing of our Merger transaction with our private equity sponsors, Section 16(a) of the Securities Exchange Act of 1934 required our executive officers and Directors, and persons who owned more than 10% of a registered class of our equity securities, to file reports of ownership on Forms 3, 4 and 5 with the SEC. We are required to disclose any failure to have filed these reports by the required due dates. All of the filing requirements were satisfied in a timely manner.
ITEM 11.
ITEM 11. Executive Compensation
Compensation Committee Interlocks and Insider Participation
None of our executive officers serves as a member of the Board of Directors or Compensation Committee of any entity that has one or more executive officers who serve on our Board of Directors or Compensation Committee.
DIRECTOR COMPENSATION
Prior to the closing of the Company's Merger transaction with its private equity sponsors on September 7, 2012 (the “Merger”), each of our non-employee Directors received an annual retainer of $40,000. In addition to the annual retainer, the Lead Independent Director, the Chair of the Audit Committee, the Chair of the Compensation Committee, and the Chair of the Nominating & Governance Committee received an annual fee of $15,000, $15,000, $7,500, and $6,000, respectively. All fees were paid in equal installments on a quarterly basis. At the election of the respective director, fees were paid in the form of cash, shares of our then publicly traded common stock or deferred stock units (“DSUs”). In addition to cash compensation, each non-employee Director received an annual award of stock options and DSUs with an aggregate approximate total award value of $100,000. Each stock option was scheduled to fully vest on the anniversary of the date of grant and had an exercise price of the fair market value of a share of our common stock on the date of grant. Each DSU would have converted into a share of our common stock upon vesting on the earlier of (i) a change in control and (ii) the anniversary of the date on which the Director leaves the Board. However, in connection with the Merger, each DSU that was outstanding immediately prior to the Merger became fully vested and converted into the right to receive a cash payment of the per share Merger consideration, and each outstanding stock option was canceled and converted into the right to receive a cash payment equal to the difference, if any, between the respective exercise price and the per share Merger consideration. As of the effective time of the Merger, Gideon Argov, Michael E. DeDomenico, John J. Gavin, Barry J. Goldstein, Randolph W. Melville, Drew T. Sawyer and David G. Zanca each resigned from his position on the Board.
Following the Merger, the Sponsors appointed Ann Berry, Christopher Crampton, Bradley Gross, Philip Grovit, Sanjeev Mehra, Claus J. Moller, and Joshua D. Paulson (together, the “Sponsor Appointees”) to serve on the Board with Michael J. Grebe and Kenneth D. Sweder. Mr. Grovit resigned from the Board effective as of February 1, 2013. None of the Sponsor Appointees, Mr. Grebe or Mr. Sweder is individually compensated by the Company for service on the Board.
Jozef Opdeweegh and Dennis J. Letham joined the Board as independent directors, effective as of February 1, 2013 and March 1, 2013, respectively. Mr. Opdeweegh and Mr. Letham each receive an annual retainer of $40,000. Mr. Letham also receives an annual fee of $20,000 for serving as the Chair of the Audit Committee, and Mr. Opdeweegh receives an annual fee of $7,500 for serving as a member of the Compensation Committee. All fees are payable in equal installments on a quarterly basis. Upon joining our Board, Messrs. Letham and Opdeweegh were also each granted 1,961 time-based stock options with an exercise price of $255.00 per share. These options will vest in equal increments of 20% of the total stock option grant on each of the first, second, third, fourth and fifth anniversaries of the date of grant, subject to continued service on our Board.
No additional fees are paid to Directors for attendance at Board or committee meetings. For the independent directors, all Director compensation is contingent upon a Director attending a minimum of 75% of our regular meetings (in person or telephonically) each year.
The following table summarizes the fees and other compensation that our non-employee Directors earned for services as members of the Board of Directors and any committee of the Board of Directors during the period beginning December 31, 2011 through September 7, 2012 (the “Pre-Merger Period”) or during the period beginning September 8, 2012 through December 28, 2012 (the “Post-Merger Period”) as indicated.
____________________
(1)
Represents the aggregate amount of grant date fair value (computed in accordance with FASB ASC Topic 718, Compensation-Stock Compensation). For a complete description of the valuation assumptions see Note 14. Share-Based Compensation to our audited consolidated financial statements included in this annual report.
(2)
Each of these non-employee directors resigned as of the effective time of the Merger. Amounts reported in the “Fees Earned or Paid in Cash” column represent the fees paid for services rendered from the period beginning December 31, 2011 through September 7, 2012.
(3)
As elected by Mr. Argov, this amount includes $11,864 paid in DSUs.
(4)
Represents the director's annual award of DSUs.
(5)
Represents the director's annual award of stock options.
(6)
As elected by Mr. DeDomenico, this amount includes $9,984 paid in DSUs.
(7)
This amount represents $70,000 paid to Mr. Gavin related to extensive additional work required in connection with the Merger.
(8)
The Company announced in its proxy statement issued to shareholders in connection with the May 10, 2012 annual shareholders meeting (the “2012 Shareholders Meeting”) that it would not renominate Mr. Santoro for reelection. Mr. Santoro served as a director of the Company and as a member of our Compensation Committee until his term expired at the conclusion of 2012 Shareholders Meeting. The amount reported in the “Fees Earned or Paid in Cash” column represent the fees paid for services rendered from the period beginning December 31, 2011 through May 10, 2012.
(9)
Each of these directors was appointed by the Sponsors to serve on the Board effective as of September 7, 2012. These directors were not compensated for the service on the Board in 2012. Mr. Opdeweegh and Mr. Letham are not included in the table above because they were not directors as of December 28, 2012.
COMPENSATION COMMITTEE REPORT
The following report of the Compensation Committee does not constitute soliciting material and shall not be deemed filed or incorporated by reference into any other filing by Interline under the Securities Act of 1933 or the Securities Exchange Act of 1934.
The Compensation Committee of the Board of Directors reviewed and discussed the Compensation Discussion and Analysis with management. Based on such review and discussions, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in the Company's Form 10-K for the year ended December 28, 2012, as filed with the SEC.
COMPENSATION COMMITTEE
Mr. Bradley Gross, Chairman
Mr. Christopher Crampton
Mr. Jozef Opdeweegh
Mr. Joshua D. Paulson
COMPENSATION DISCUSSION AND ANALYSIS
The following discussion describes our executive compensation philosophy and compensation programs, and how they are applied to our CEO, CFO and our other executive officers whose compensation is listed in the Summary Compensation Table and discussed below (our “named executive officers”). As part of our transition from being a publicly-held to a privately-held company, the Compensation Committee of our Board of Directors implemented changes to certain elements of our compensation, although our post-Merger executive compensation philosophy and objectives are generally consistent with those in place prior to the Merger. The following discussion begins with a description of certain pre-Merger compensation decisions relating to the compensation program in place during the Pre-Merger Period, and is followed by descriptions of our compensation-related arrangements following the closing of the Merger. To the extent certain portions of the named executive officers' compensation reported in the tabular disclosure for 2012 were based on pre-Merger compensation elements, we have so indicated. All references made herein to the “Compensation Committee” relating to the Pre-Merger Period shall refer to the Compensation Committee in place prior to the consummation of the Merger, and all references relating to the Post-Merger Period shall refer to the Compensation Committee in place following the consummation of the Merger.
General Compensation Philosophy
Both prior to and following the Merger, our compensation program was and continues to be designed to:
(i)
attract, retain, motivate and reward highly qualified executive management who drive the execution of our long-term business strategy and, in turn, generate shareholder value;
(ii)
create appropriate incentives for executive management without encouraging unnecessary risk-taking;
(iii)
maintain a simple, consistent, equitable and transparent framework that permits flexibility and room for judgment; and
(iv)
use compensation judiciously to achieve business objectives without undue transfer of value to employees.
Our compensation program is also designed to align management's incentives with the long-term interests of our shareholders. We believe we can best increase our shareholders' value over the long-term by attaining earnings growth through increased sales, improved gross margins and lower operating costs. Accordingly, our 2012 annual non-equity incentive compensation program in place prior to the Merger for our named executive officers was designed to reward achievement of earnings growth-based performance targets as well as achievement by each individual of his or her personal performance objectives.
Oversight
Our executive compensation objectives, policies and programs are established by the Compensation Committee. The Compensation Committee is responsible for the following:
•
reviewing and approving annually the goals and objectives relevant to compensation of all executive officers;
•
reviewing and approving the individual elements of all executive officers' annual compensation;
•
reviewing and approving all employment agreements, severance agreements, retirement arrangements, and change in control agreements/provisions for the Company's executive officers;
•
administering the Company's 2012 Stock Option Plan (the "2012 Plan") and Employee Stock Purchase Plan ("ESPP");
•
periodically reviewing the compensation paid to non-employee and independent Directors and recommending changes to the full Board, as appropriate;
•
planning for executive development and succession; and
•
assisting the Board in its oversight of the development, effectiveness and implementation of our compensation policies and strategies.
Compensation Program
The primary elements of compensation for our named executive officers are base salary, annual non-equity incentive compensation (also referred to herein as annual cash bonuses) and equity compensation. We do not maintain any post-retirement benefit plans solely for our named executive officers and we provide limited perquisites to our named executive officers. There are no benefit plans that are available to our named executive officers that are not also available on the same terms to our other employees.
Pre-Merger Compensation Decisions
Outside Compensation Consultant
Prior to the consummation of the Merger, the Compensation Committee engaged Frederic W. Cook & Co., Inc. (the “Consultant”) as its compensation consultant to assist the Compensation Committee in assessing best practices with respect to compensation trends and to recommend a relevant group of peer companies against which to assess, among other things, the competitiveness and appropriateness of our executive compensation. We refer to the Consultant's assessment as the “annual competitive compensation assessment.”
In addition to the annual competitive compensation assessment, the Consultant provided assistance to us with the following projects and activities relating to our 2012 fiscal year:
•
designing the 2012 annual bonus and long-term incentive compensation programs;
•
reviewing the Company's annual proxy statement disclosure pertaining to executive compensation;
•
reviewing new hire executive compensation packages;
•
reviewing and complying with the Dodd-Frank Wall Street Reform and Consumer Protection Act; and
•
advising on risk oversight of our compensation program.
Benchmarking
Our compensation package for our named executive officers is designed to be competitive with comparable employers. Prior to the Merger, the Compensation Committee, after taking into account recommendations from the Consultant, selected a peer group from among a group of companies of a similar size and business (our “2012 peer group”) for the purpose of assessing the competitiveness of the compensation package provided to our named executive officers. Our 2012 peer group included: American Woodmark Corp., Apogee Enterprises, Inc., Applied Industrial Technologies, Inc., Beacon Roofing Supply, Inc., Builders Firstsource, Inc., Comfort Systems USA, Gibraltar, H&E Equipment Services, Kaman Corp., Pool Corp., PSS World Medical, RSC Holdings, and United Rentals. The Consultant provided the Compensation Committee with information regarding the 25th percentile, median and 75th percentile levels of total direct compensation (salary, annual bonus and long-term incentive) provided by the 2012 peer group companies to their respective named executive officers. The Compensation Committee reviewed this information with the Consultant and the CEO. Our belief was that compensation that fell within the 25th percentile and 75th percentile was generally competitive in comparison to the 2012 peer group companies, taking into account the Company's revenues, net income, market capitalization and employees as compared to the 2012 peer group companies, with compensation below the median being at the lower end of the competitive range and compensation above the median being at the higher end of the competitive range. The Company used this range of compensation levels to assess the extent to which the compensation provided to the Company's named executive officers was generally consistent with (or significantly inconsistent with) that offered by the 2012 peer group companies to their named executive officers, but the Company did not tie any particular element of compensation (or total compensation) to any specific targeted peer group level. The Compensation Committee also reviewed specific relevant factors for each named executive officer (including his or her performance and accomplishments, the extent to which the position was deemed critical to the Company, the length of service and difficulty of recruiting, and other factors described below under “Compensation Program - Base Salaries” and “Compensation Program - Equity Compensation” in making its determinations that the compensation level was appropriate for the named executive officer.
Our CEO recommended to the Compensation Committee annual compensation levels for executive officers other than himself, as well as any new employment contracts or changes to existing contracts.
Base Salaries
Base salaries are intended to establish a level of compensation which, together with the other components of the compensation program, will help us attract and retain the talent needed to meet the challenges of the competitive industry in which we operate while maintaining an acceptable level of fixed costs.
The Company generally determines base salaries and other cash compensation for the Company's named executive officers based upon consideration of the following material factors: (1) the Company's evaluation of the named executive officer's performance in the preceding fiscal year; (2) the anticipated contribution by the named executive officer in the upcoming fiscal year, taking into account the role, responsibility and scope of each position; (3) any extraordinary changes that have occurred (such as a significant change in responsibilities or a promotion); (4) any specific requirements set forth in a named executive officer's employment agreement; (5) the named executive officer's length of service and his performance over an extended period of time; (6) general economic conditions; and (7) the value and potential value to the executive of the other elements of the Company's compensation program. All of the above considerations are addressed collectively in the determination of the named executive officer's base salary level.
For 2012, the base salaries for our named executive officers were increased, or otherwise remained unchanged, as set forth below and, except in the case of Mr. Grebe, were implemented in the normal course in 2012 (prior to the Merger):
____________________
(1)
Upon the request and recommendation of Mr. Grebe, the Compensation Committee did not increase Mr. Grebe's base salary in 2012. However, Mr. Grebe received a base salary increase in connection with his agreement to remain as CEO of the Company following the consummation of the Merger.
(2)
Mr. McDonald resigned from the Company effective October 19, 2012.
We believe our base salary structure provides a framework for an equitable compensation ratio between executives, with higher salaries for jobs having greater duties and responsibilities. The amount of base salary is taken into account and affects the amount of annual bonuses for our named executive officers, because the target annual bonus for each of our named executive officers is expressed as a specified percentage of his or her base salary.
Annual Non-Equity Incentive Compensation (Annual Bonus)
Our annual non-equity incentive compensation awarded under the 2012 Executive Cash Incentive Plan (the “ECIP”) is intended to motivate and reward performance by providing cash bonus payments based upon meeting or exceeding performance goals. Upon achievement of the established performance goals, individual awards are determined as variable percentages of the executives' base salaries, depending on the extent to which performance goals are attained. The Compensation Committee determines achievement of performance under the ECIP based on achievement of (i) Company performance targets and (ii) individual performance goals. With respect to the Pre-Merger Period, the ECIP Company performance targets were based on the Company's adjusted earnings per share (“EPS”).
Following the consummation of the Merger, the Company ceased to have publicly traded equity. However, the Compensation Committee determined that the EPS component of the ECIP would apply to both the Pre-Merger Period and the Post-Merger Period, with the Post-Merger Period based upon Company performance over the entire fiscal year.
The Compensation Committee confirms achievement of performance goals before payment of any bonus amounts, and any such bonus payments are typically made on or before March 15 of the year following the year in which the bonuses are earned. The Compensation Committee approves the performance goals for the then-current fiscal year typically on or around the same time that the Compensation Committee confirms the achievement of the prior year's performance goals.
Pre-Merger Metrics
The Compensation Committee determined that, for the Pre-Merger Period, the annual bonus would be earned based on two separate components: (1) 75% of the annual bonus would be dependent upon achieving certain targets relating to EPS, adjusted for certain non-recurring items as approved by the Compensation Committee, or adjusted EPS (the “adjusted EPS component”); and (2) the remaining 25% of the annual bonus would be determined by the Compensation Committee in its discretion (the “discretionary component”), primarily based on individual performance goals to be determined in the sole discretion of the Compensation Committee (upon recommendation of the CEO for those named executive officers other than himself).
The Compensation Committee believed that each of the adjusted EPS component (which is tied to creation of shareholder value) and the discretionary component (which is intended to balance the focus on financial measures with a combination of individual performance and a targeted assessment by the CEO and the Compensation Committee of 2012 performance beyond formulaic targets) were important. However, the Compensation Committee determined, with the input and support of the Consultant, that the separate components of the annual bonus should be appropriately balanced and weighted so as to: (i) focus more on EPS growth as market conditions gradually improve; and (ii) provide the Committee with a level of flexibility to incentivize and reward superlative individual performance on key long-term projects and initiatives, as well as address specific retention issues, given continuing global economic uncertainty existing at the time the plan was adopted.
Under the terms of the ECIP applicable during the Pre-Merger Period, bonus amounts for an executive could not exceed the lowest of (x) 200% of such executive's base salary, (y) $5,000,000 and (z) 2.5% of adjusted EBITDA in the case of Mr. Grebe, 2% of adjusted EBITDA in the case of Messrs. Sweder and Ebner, 1.5% of adjusted EBITDA in the case of Mr. McDonald, and 1% of adjusted EBITDA in the case of Ms. Doblado and Mr. Agliata. Thus, if there was no positive adjusted EBITDA, no annual bonus would have been payable. For this purpose, “adjusted EBITDA” meant the Company's net income plus interest expense (income), net change in fair value of interest rate swaps, cumulative effect of change in accounting principle, (gain) loss on extinguishment of debt, loss on impairment of assets (including but not limited to goodwill and intangibles), (gain) loss on sale of assets, equity or debt offering and related expenses, provision for income taxes and depreciation and amortization, but excluding any impairment of goodwill or intangibles and any gains or losses on the sale of assets.
For the 2012 fiscal year, the target and maximum bonuses (as a percentage of base salary) that could have been earned by our named executive officers were as follows:
The maximum percentages above superseded the maximum bonus that is provided for in the employment agreements for our named executive officers (which are described under “Employee Agreements” following the Grants of Plan-Based Awards Table). The Compensation Committee sets target and maximum annual bonus amounts, as a percentage of base salary, for each of our named executive officers, based on recommendations by the CEO. Our annual competitive compensation assessment was used to confirm the appropriateness of the target bonus percentages. The different target bonus percentages among the named executive officers reflect their relative duties and responsibilities as well as the Compensation Committee's consideration of the factors described above in “Compensation Program - Base Salaries.”
Based upon performance during the Pre-Merger Period, our named executive officers could have earned payout of the adjusted EPS component according to the following schedule:
The payout percentages set forth above are linearly interpolated if adjusted EPS is between $1.13 and $1.26 or between $1.26 and $1.51. To encourage the management team to broaden its focus and to work on strategic acquisitions, EPS arising from acquisitions was included in EPS for purposes of this bonus component, subject to the discretion of the Compensation Committee. For the Pre-Merger Period, adjusted EPS was computed by dividing net income by the weighted-average number of shares of common stock and participating securities outstanding during the period as adjusted for the potential dilutive effect of stock options and non-vested shares of restricted stock and restricted share units using the treasury stock method.
The discretionary component of the annual bonus was based on the achievement of individual objectives for each named executive officer, which objectives were agreed upon with the CEO (other than the CEO's own objectives, which were set by the Compensation Committee). Individual performance objectives generally focused on:
•
completion of various long-term strategic operational, information technology, and financial improvements to enhance long-term shareholder profitability;
•
increased sales and profitability in certain brands and business areas;
•
specific cost-savings measures; and
•
operational improvements in the areas of sales, distribution, customer service, product quality and sourcing, and information technology infrastructure.
Based upon the Company's performance through the Merger closing date, the Compensation Committee determined that our named executive officers had achieved 100% of their adjusted EPS targets through September 28, 2012, thereby entitling them to pro-rata payment of annual bonus amount attributable to achievement of the Company performance component, i.e., 75%, applicable during the Pre-Merger Period.
Post-Merger Metrics
For the Post-Merger Period, our Compensation Committee measured Company performance using the same EPS targets established during the Pre-Merger Period based upon Company performance over the entire fiscal year. As a result of the Company's performance during fiscal 2012, our named executive officers were determined to have achieved 80.8% of the EPS component of their annual bonuses for the Post-Merger Period. The Compensation Committee did not implement any changes to the discretionary component of the ECIP for the Post-Merger Period.
After determining the extent to which the individual performance goals under the ECIP's discretionary component were met, the Compensation Committee determined to pay annual bonus amounts as set forth in the Summary Compensation Table below. The threshold, target and maximum amounts of the 2012 annual bonus that were possible to be earned during the Pre-Merger Period and Post-Merger Period are set forth in the Grants of Plan-Based Awards Table, and the actual amounts earned are set forth in the Summary Compensation Table.
Equity Compensation
We believe that superior results can be achieved through an ownership culture that encourages long-term performance by our executive officers through the use of equity-based awards. Prior to our Merger, our equity compensation program for our named executive officers consisted generally of annual grants of time-vesting and performance-vesting restricted share units and time-vesting stock options granted under our 2004 Equity Incentive Plan (the "2004 Plan"). The performance-vesting restricted share units would vest, if at all, after the second and third anniversaries of the date of grant, subject to achievement of established adjusted EPS targets. The stock options were to vest upon the second and third anniversaries of the date of grant, subject to continued employment.
In determining the size of annual equity awards to each named executive officer prior to the Merger, the Compensation Committee began with a target dollar award value, rather than a target number of shares subject to the award. The target value was set based upon the responsibilities inherent in each named executive officer's position and relative to overall compensation. For example, the target value for our CEO was larger than for the other named executive officers because our CEO is in the position that has the most direct impact on corporate performance. Although target equity award sizes are set for each position, the actual size of annual dollar award value was a subjective determination based on the anticipated contribution of the executive officer to our long-term value and on many of the same material factors that the Company considered when setting other elements of compensation, including (1) the Company's evaluation of the named executive officer's performance in the preceding fiscal year; (2) the anticipated contribution by the named executive officer in the upcoming fiscal year, taking into account the role, responsibility and scope of each position; (3) the extent to which the long-term equity award grant value and resulting total direct compensation was within (or outside) the 2012 peer group's 25th-75th percentile levels range for long-term equity award grants for comparable positions (and whether it was at the lower end or the upper end of such range); (4) any extraordinary changes that have occurred (such as a significant change in responsibilities or a promotion); (5) the value and potential value to the executive of the other elements of the Company's compensation program; (6) the companywide equity budget, which was taken into account in determining the relative size of awards granted to the named executive officers to ensure there was sufficient value available for grants to the other eligible employees of the Company; and (7) the named executive officer's wealth accumulation from previous grants (with an emphasis on the extent to which outstanding equity
grants were still unvested and thus continued to represent substantial retentive value) and other factors that may detract from the award's desired incentive (such as the proximity of the executive to retirement). Similar to the determinations with respect to other elements of compensation, the Company considered all relevant factors taken as a whole in determining equity grant amounts.
In connection with the closing of the Merger, each of our named executive officers had his or her respective restricted share units (including the performance-based restricted share units) which were outstanding immediately prior to the consummation of the Merger become fully vested and canceled in exchange for a cash payment equal to $25.50 per share (the per share Merger consideration), and had certain (all, in the case of Mr. Ebner and Mr. McDonald) of his or her respective outstanding options canceled and converted into the right to receive an amount in cash equal to the product of (i) the excess, if any, of $25.50 over the per share exercise price of the applicable stock option and (ii) the aggregate number of shares of common stock underlying the applicable stock option. Each of Mr. Grebe, Mr. Sweder, Ms. Doblado and Mr. Agliata also entered into an option rollover agreement effective September 7, 2012, under which certain of his or her respective options to acquire common stock which were outstanding immediately prior to the consummation of the Merger replaced with options to acquire membership units of Parent and ultimately converted into options to acquire common stock of the Company.
Following the closing of the Merger, equity compensation continues to be a primary element of our overall compensation program for our named executive officers. In connection with the closing of the Merger, the Compensation Committee adopted the 2012 Plan pursuant to which it granted time-based and performance-based stock options to our named executive officers and other members of the Company's management. The time-based stock options vest in equal increments of 20% on each of the first, second, third, fourth and fifth anniversaries of the date of grant, subject to continued employment. The performance-based stock options vest 20% annually based upon achievement of 95% of the Company's annual Adjusted EBITDA targets for the Company's 2012, 2013, 2014, 2015 and 2016 fiscal years (each, an “Annual Performance Period”). For the 2012 Annual Performance Period, the Compensation Committee established an adjusted EBITDA target of $25.3 million. A description of the effect of a change of control or a termination of employment on these time-based and performance-based stock options is below under the heading “Potential Payments Upon Termination or Change in Control.” The number of shares subject to the time-based stock options and performance-based stock options are intended to provide a significant long-term incentive opportunity. The Compensation Committee does not expect to make grants on an annual basis; however, the Committee may, either directly or through limited authority granted to the CEO, approve special equity grants from time to time for key new hires, superlative performance of existing employees, and such other reasons as the Committee may determine to be in the best interests of the Company.
Other Compensation
Executive officers also participate in our benefit plans on the same terms as other employees. These plans, which include medical, dental and life insurance, participation in a 401(k) plan and discounts on our products, are designed to enable us to attract and retain our workforce in a competitive marketplace.
Medical, dental and life insurance benefits help ensure that we have a productive and focused workforce through reliable and competitive health and other welfare benefit coverage. Participation in a 401(k) plan helps employees save and prepare financially for retirement. Discounts on our products help employees save on purchases of home improvement, maintenance and repair goods.
The only perquisite we provide to our executive officers as part of our competitive compensation package is a monthly automotive allowance. The cost of this benefit constitutes only a small percentage of each executive officer's total compensation. We furnish this benefit because our executive officers are required to travel extensively as part of their responsibilities and providing the automotive allowance enables us to remain competitive in the general marketplace for executive talent.
Allocation of Elements
Under our compensation structure, the approximate relative allocations of base salary, annual bonus and equity compensation in 2012 (assuming target performance was attained) varied among our named executive officers as follows:
____________________
(1) Includes equity awards granted on October 1, 2012, as approved by the Compensation Committee.
The Company reviews the market positioning of each component of compensation for the named executive officers as part of the annual competitive compensation assessment. The mix shown above is reflective of the annual competitive compensation assessment, although adjustments are considered in the context of total compensation rather than a single component.
Severance and Change-in-Control Provisions and Agreements
We believe that companies should provide reasonable severance benefits to their executive officers due to the greater level of difficulty they face in finding comparable employment within a short period of time. We also believe that executive officers have a greater risk of job loss or modification, as a result of a change-in-control transaction, than other employees. For these reasons, we have entered into employment agreements and change-in-control agreements with our named executive officers.
The principal reason for providing our executive officers severance upon a termination by us without cause or a resignation by the executive for good reason following a change in control is to offer our executive officers appropriate incentive to remain with us before, during and after any change-in-control transaction by providing them with adequate security in the event that their employment is terminated. By reducing the risk of job loss or reduction in job responsibilities of the executive officer, these change-in-control provisions help ensure that the executive officers support any potential change-in-control transactions that may be in the best interests of our shareholders, even though the transaction may create uncertainty in the executive officer's personal employment situation. We believe that the severance and change-in-control provisions within our executive officers' employment agreements or change-in-control agreements are consistent with our objective of motivating and retaining talented employees. In addition, similar provisions are also part of the typical employment arrangements for executive officers within our peer group and within our industry generally, and are necessary to ensure that our total employment package for executive officers remains market-competitive. The change-in-control severance plan adopted in 2007 was recommended by the Consultant taking into account a peer group competitive assessment.
The severance provisions contained in each named executive officers' employment agreement (other than those contained in Mr. Grebe's employment agreement which was amended in connection with the Merger) were in effect as of the Company's IPO in December 2004 or as of such executive's start date with the Company. We believe these severance protections are appropriate, because we believe that it is in both the best interests of us and our shareholders to have: (i) severance provisions within our executive officers' employment agreements, under which the executive officers will receive certain benefits and compensation if their employment is terminated by us without cause or by the executive officer for good reason; and (ii) either change-in-control provisions within our executive officers' employment agreements or separate change-in-control agreements, under which the executive officers will receive certain benefits and compensation if their employment is terminated by us without cause or by the executive officer for good reason following a change in control. See “Potential Payments Upon Termination Or Change in Control” for a detailed discussion of the terms of these agreements.
Under our agreements with our named executive officers, in order for amounts to become payable, the change-in-control provisions contained in our employment agreements and change-in-control agreements generally require that (i) a change in control occurs and (ii) the executive officer's employment is terminated by us other than for cause or by the executive officer for good reason.
SUMMARY COMPENSATION TABLE
The following table summarizes the total compensation earned by each of our named executive officers during the fiscal years ended December 28, 2012, December 30, 2011 and December 31, 2010.
____________________
(1)
Represents the aggregate amount of grant date fair value (computed in accordance with FASB ASC Topic 718, Compensation-Stock Compensation). For a complete description of the valuation assumptions see Note 14. Share-Based Compensation to our audited consolidated financial statements included in this annual report.
(2)
Represents bonuses earned under our ECIP, which is a performance-based plan.
(3)
Consists of (i) annual automobile allowance of $15,000, (ii) matching contributions to 401(k) plan of $3,125, and (iii) a payment of $3,169,774 pursuant to the terms of his employment agreement, as amended in connection with Merger.
(4)
Upon the request of Mr. Grebe, the Compensation Committee did not award a discretionary bonus to Mr. Grebe for 2011.
(5)
Consists of annual automobile allowance of $12,000.
(6)
Consists of (i) annual automobile allowance of $12,000, (ii) matching contributions to 401(k) plan of $3,125, (iii) a transaction payment bonus of $225,000 and (iv) the first installment of his retention bonus payment of $95,834.
(7)
Consists of (i) annual automobile allowance of $7,200 and (ii) a transaction bonus payment of $75,000.
(8)
Consists of (i) annual automobile allowance of $6,000, (ii) matching contributions to 401(k) plan of $3,125, (iii) a transaction bonus payment of $200,000 and (iv) an employee referral bonus payment of $1,045.
(9)
Consists of (i) annual automobile allowance of $9,000, prorated through the date of his termination of employment effective October 19, 2012 and (ii) amounts paid under the Separation of Employment Agreement and General Release.
GRANTS OF PLAN-BASED AWARDS
The following table summarizes the awards granted to each of our named executive officers during the fiscal year ended December 28, 2012.
____________________
(1)
The Compensation Committee approved the October 1, 2012 equity awards to Mr. Grebe, Mr. Ebner, Mr. Sweder and Ms. Doblado by a unanimous written consent approved by all Committee members as of October 1, 2012. Mr. Ebner declined to accept his October 1, 2012 equity awards due to his impending departure from the Company.
(2)
Represents bonus awards that were granted under the ECIP, which is a performance-based plan.
(3)
Represents restricted share units granted under the 2004 Plan. Each restricted share unit represented a right to receive one share of the Company's common stock. These restricted share units were scheduled to vest in 50% increments subject to attainment of certain performance targets. In connection with the Merger, all of these restricted share units became fully vested and were canceled in exchange for a cash payment equal to $25.50 per share.
(4)
Represents option awards that were granted under the 2004 Plan. The options were scheduled to vest in 25% increments on each of the first, second, third and fourth anniversaries of the date of grant. In connection with the Merger, all of these options became fully vested and were canceled and converted into the right to receive a cash payment equal to the product of (i) the excess, if any, of $25.50 over the per share exercise price of the applicable stock option and (ii) the aggregate number of shares of common stock underlying the applicable stock option.
(5)
Represents option awards that were granted under the 2012 Plan. These stock options vest 20% annually based upon achievement of certain performance targets for the Company's 2012, 2013, 2014, 2015 and 2016 fiscal years.
(6)
Represents option awards that were granted under the 2012 Plan. These stock options vest in equal increments of 20% on each of the first, second, third, fourth and fifth anniversaries of the date of grant, subject to continued employment.
Employee Agreements
The following paragraphs summarize the principal provisions of the employment agreements and certain other agreements entered into in connection with the closing of the Merger with our named executive officers.
Michael J. Grebe
We have entered into an employment agreement with Mr. Grebe, which became effective August 13, 2004, and was amended effective as of December 2, 2004, December 31, 2008, March 31, 2011, and September 7, 2012. The term of the employment agreement is subject to automatic one-year extensions at the beginning of each calendar year unless we or Mr. Grebe give at least 90 days' written notice of non-extension. Mr. Grebe is entitled to a base salary, and he is eligible for an annual cash bonus based upon the achievement of annual performance targets established by our Compensation Committee. Effective on the closing of the Merger, Mr. Grebe's base salary was increased to $695,000, subject to additional increases at the discretion of our Compensation Committee. Mr. Grebe is also eligible to participate in the benefits plans and arrangements generally available to our senior executives, which includes a monthly automotive allowance. His employment agreement also provides for severance upon certain terminations of employment, as described under "Potential Payments upon Termination or Change in Control".
Pursuant to the September 7, 2012 amendment to his employment agreement, Mr. Grebe became entitled to a base salary increase (as discussed above) and a lump sum cash payment equal to $3,169,744, and Mr. Grebe agreed to certain changes to the definition of “good reason” and terms of the severance to which he would become entitled under certain termination events, as described under “Potential Payments upon Termination or a Change in Control.”
In connection with the closing of the Merger, all of Mr. Grebe's restricted share units (including his performance-based restricted share units) which were outstanding immediately prior to the consummation of the Merger became fully vested and were canceled in exchange for a cash payment equal to $25.50 per share (the per share Merger consideration), and certain of his outstanding options were canceled and converted into the right to receive an amount in cash equal to the product of (i) the excess, if any, of $25.50 over the per share exercise price of the applicable stock option and (ii) the aggregate number of shares of common stock underlying the applicable stock option. Pursuant to the terms of an option rollover agreement effective September 7, 2012, certain other of Mr. Grebe's options to acquire common stock which were outstanding immediately prior to the consummation of the Merger were replaced with options to acquire membership units of Parent and ultimately converted into options to acquire common stock of the Company.
On September 7, 2012, Mr. Grebe was awarded time-vesting and performance-vesting options under the 2012 Plan. Generally, the terms of the time-vesting option award agreement provide that subject to Mr. Grebe's continued employment, the options vest in equal installments of 20% on each of the first, second, third fourth, and fifth anniversaries of the grant date. The terms of Mr. Grebe's performance-vesting option award agreement provide that options will generally vest and become exercisable with respect to 20% of the shares subject to the option based upon the Company's achievement of specified EBITDA targets for the Company's 2012, 2013, 2014, 2015 and 2016 fiscal years (each, an “Annual Performance Period”), subject to Mr. Grebe's remaining employed through the date on which the audited financial statements for the applicable Annual Performance Period are presented to the board of directors. The treatment of Mr. Grebe's time-vesting and performance-vesting option awards upon a termination of employment or a change in control of the Company is described below in the section entitled “Potential Payments upon Termination or a Change in Control.”
John A. Ebner
We have entered into an employment agreement with Mr. Ebner, effective as of January 8, 2010 and subject to automatic one-year extensions unless we or Mr. Ebner give at least 60 days' prior written notice of non-extension. Mr. Ebner's annual base salary is currently $382,454, subject to increase at the discretion of our CEO. Mr. Ebner is eligible to receive an annual cash bonus based upon the achievement of annual performance targets established by our Compensation Committee. Mr. Ebner is also eligible to participate in the benefits plans and arrangements generally available to our senior executives, which include a monthly automotive allowance. His employment agreement also provides for severance upon certain terminations of employment, as described under "Potential Payments upon Termination or Change in Control".
In connection with the closing of the Merger, all of Mr. Ebner's restricted share units (including his performance-based restricted share units) which were outstanding immediately prior to the consummation of the Merger became fully vested and were canceled in exchange for a cash payment equal to $25.50 per share, and all of his outstanding options were canceled and converted into the right to receive an amount in cash equal to the product of (i) the excess, if any, of $25.50 over the per share exercise price of the applicable stock option and (ii) the aggregate number of shares of common stock underlying the applicable stock option.
On September 7, 2012, we and Interline New Jersey entered into a retention bonus agreement with Mr. Ebner (the “Retention Bonus Agreement”), the terms of which provide that, subject to his continued employment through the date that is six months following the consummation of the Merger, Mr. Ebner will be entitled to receive a retention bonus in the amount of $1,018,868 (the “Retention Bonus”). Notwithstanding the foregoing, if Mr. Ebner's employment is terminated prior to such date due to his death or disability, or by the Company without “cause” or by Mr. Ebner for “good reason” (as each such term is defined in his Change in Control Severance Agreement), Mr. Ebner will be entitled to the Retention Bonus within 30 days of such termination. Mr. Ebner's entitlement to the payment is also subject to his execution of a release of claims in respect of the Company and its affiliates and his waiver of any right to severance from the Company or Parent under the terms of his change of control agreement, employment agreement or any other agreement. The Retention Bonus Agreement also provides that Mr. Ebner will be entitled to an annual bonus with respect to 2012 regardless of whether he remains employed through the payment date, in accordance with the terms of the Retention Bonus Agreement, notwithstanding his termination of employment prior to the date of payment, and that any call right that the Company may have with respect to common stock held by Mr. Ebner will not be exercisable until one year following the date of the Retention Bonus Agreement, notwithstanding Mr. Ebner's earlier termination of employment.
On December 4, 2012, Mr. Ebner informed the Board of his intent to resign from his position as Chief Financial Officer of the Company in March 2013.
Kenneth D. Sweder
We have entered into an employment agreement with Mr. Sweder dated April 30, 2007, as amended on October 20, 2008, December 31, 2008 and December 31, 2012. The term of Mr. Sweder's employment agreement is subject to automatic one-year extensions unless we or Mr. Sweder give at least 60 days' prior written notice of non-extension. Mr. Sweder's annual base salary is currently $466,796, subject to increase at the discretion of our CEO. Mr. Sweder is eligible to receive an annual cash bonus based upon the achievement of annual performance targets established by our Compensation Committee. Mr. Sweder is also eligible to participate in the benefits plans and arrangements generally available to our senior executives, which include a monthly automotive allowance. His employment agreement also provides for severance upon certain terminations of employment, as described under "Potential Payments upon Termination or Change in Control".
In connection with the closing of the Merger, all of Mr. Sweder's restricted share units (including his performance-based restricted share units) which were outstanding immediately prior to the consummation of the Merger became fully vested and were canceled in exchange for a cash payment equal to $25.50 per share (the per share Merger consideration), and certain of his outstanding options were canceled and converted into the right to receive an amount in cash equal to the product of (i) the excess, if any, of $25.50 over the per share exercise price of the applicable stock option and (ii) the aggregate number of shares of common stock underlying the applicable stock option. Pursuant to the terms of an option rollover agreement effective September 7, 2012, certain other of Mr. Sweder's options to acquire common stock which were outstanding immediately prior to the consummation of the Merger were replaced with options to acquire membership units of Parent and ultimately converted into options to acquire common stock of the Company.
On September 7, 2012, we and Interline New Jersey entered into a transaction bonus agreement with Mr. Sweder pursuant to which he was entitled to a bonus payment in the amount of $225,000 upon the closing of the Merger. To receive payment, Mr. Sweder agreed to waive any right he may have had to resign for “good reason” under his employment agreement or change in control severance agreement due to (i) the consummation of the Merger, (ii) the Company ceasing to be a publicly-traded company, or (iii) any change in his duties or responsibilities due solely to the Company no longer being publicly traded.
Additionally, on September 7, 2012, Mr. Sweder was awarded time-vesting and performance-vesting options under the 2012 Plan. Generally, the terms of the time-vesting option award agreement provide that subject to Mr. Sweder's continued employment, the options vest in equal installments of 20% on each of the first, second, third fourth, and fifth anniversaries of the grant date. The terms of Mr. Sweder's performance-vesting option award agreement provide that options will generally vest and become exercisable with respect to 20% of the shares subject to the option based upon the Company's achievement of specified EBITDA targets for the Company's 2012, 2013, 2014, 2015 and 2016 Annual Performance Periods, subject to Mr. Sweder's remaining employed through the date on which the audited financial statements for the applicable Annual Performance Period are presented to the board of directors. The treatment of Mr. Sweder's time-vesting and performance-vesting option awards upon a termination of employment or a change in control of the Company is described below in the section entitled “Potential Payments upon Termination or a Change in Control.”
On September 14, 2012, we and Interline New Jersey entered into a retention bonus agreement with Mr. Sweder (the “Sweder Retention Bonus Agreement”). In light of Mr. Sweder's position and responsibilities, and his value to the organization, the Board of Directors of the Company approved the Sweder Retention Bonus Agreement to encourage Mr. Sweder to remain with the Company on a long-term basis and to add additional shareholder value. The Sweder Retention Bonus Agreement provides that, subject to Mr.
Sweder's continued employment with Interline New Jersey through the applicable payment date, Mr. Sweder will be entitled to cash payments in the aggregate amount of $575,000 (the “ Sweder Retention Bonus”), payable in six installments in accordance with the following schedule: (i) $95,834 payable on December 1, 2012; (ii) $95,834 payable on April 1, 2013; (iii) $95,833 payable on July 1, 2013; (iv) $95,833 payable on October 1, 2013; (v) $95,833 payable on January 1, 2014; and (vi) $95,833 payable on April 1, 2014. Notwithstanding the foregoing, if Mr. Sweder's employment is terminated prior to April 1, 2014 due to his death or disability, by Interline New Jersey without cause or by Mr. Sweder for good reason (as each such term is defined in his Change in Control Severance Agreement), Mr. Sweder will be entitled to receive in a single lump sum all then-unpaid installments in respect of the Sweder Retention Bonus within thirty (30) days following the date of such termination.
Lucretia D. Doblado
We have entered into an employment agreement with Ms. Doblado dated October 30, 2006, as amended on March 23, 2007 and December 31, 2008. The term of Ms. Doblado's employment agreement term is subject to automatic one-year extensions unless we or Ms. Doblado give at least 60 days' prior written notice of non-extension. Ms. Doblado's annual base salary is currently $283,548, subject to increase at the discretion of our CEO. Ms. Doblado is eligible to receive an annual cash bonus based upon the achievement of annual performance targets established by our Compensation Committee. Ms. Doblado is also eligible to participate in the benefits plans and arrangements generally available to our senior executives, which include a monthly automotive allowance. Her employment agreement also provides for severance upon certain terminations of employment, as described under "Potential Payments upon Termination or Change in Control."
In connection with the closing of the Merger, all of Ms. Doblado's restricted share units (including her performance-based restricted share units) which were outstanding immediately prior to the consummation of the Merger became fully vested and were canceled in exchange for a cash payment equal to $25.50 per share (the per share Merger consideration), and certain of her outstanding options were canceled and converted into the right to receive an amount in cash equal to the product of (i) the excess, if any, of $25.50 over the per share exercise price of the applicable stock option and (ii) the aggregate number of shares of common stock underlying the applicable stock option. Pursuant to the terms of an option rollover agreement effective September 7, 2012, certain other of Ms. Doblado's options to acquire common stock which were outstanding immediately prior to the consummation of the Merger were replaced with options to acquire membership units of Parent and ultimately converted into options to acquire common stock of the Company.
On September 7, 2012, we and Interline New Jersey entered into a transaction bonus agreement with Ms. Doblado pursuant to which she was entitled to a bonus payment in the amount of $75,000 upon the closing of the Merger. To receive payment, Ms. Doblado agreed to waive any right she may have had to resign for “good reason” under her employment agreement or change in control severance agreement due to (i) the consummation of the Merger, (ii) the Company ceasing to be a publicly-traded company, or (iii) any change in her duties or responsibilities due solely to the Company no longer being publicly traded.
Additionally, on September 7, 2012, Ms. Doblado was awarded time-vesting and performance-vesting options under the 2012 Plan. Generally, the terms of the time-vesting option award agreement provide that subject to Ms. Doblado's continued employment, the options vest in equal installments of 20% on each of the first, second, third fourth, and fifth anniversaries of the grant date. The terms of Ms. Doblado's performance-vesting option award agreement provide that options will generally vest and become exercisable with respect to 20% of the shares subject to the option based upon the Company's achievement of specified EBITDA targets for the Company's 2012, 2013, 2014, 2015 and 2016 Annual Performance Periods, subject to Ms. Doblado's remaining employed through the date on which the audited financial statements for the applicable Annual Performance Period are presented to the board of directors. The treatment of Ms. Doblado's time-vesting and performance-vesting option awards upon a termination of employment or a change in control of the Company is described below in the section entitled “Potential Payments upon Termination or a Change in Control.”
Michael Agliata
We have entered into an employment agreement with Mr. Agliata dated April 8, 2009. The term of Mr. Agliata's employment agreement term is subject to automatic one-year extensions unless we or Mr. Agliata give at least 60 days' prior written notice of non-extension. Mr. Agliata's annual base salary is currently $273,182, subject to increase at the discretion of our CEO. Mr. Agliata is eligible to receive an annual cash bonus based upon the achievement of annual performance targets established by our Compensation Committee. Mr. Agliata is also eligible to participate in the benefits plans and arrangements generally available to our senior executives, which include a monthly automotive allowance. His employment agreement also provides for severance upon certain terminations of employment, as described under "Potential Payments upon Termination or Change in Control."
In connection with the closing of the Merger, all of Mr. Agliata's restricted share units (including his performance-based restricted share units) which were outstanding immediately prior to the consummation of the Merger became fully vested and were
canceled in exchange for a cash payment equal to $25.50 per share (the per share Merger consideration), and certain of his outstanding options were canceled and converted into the right to receive an amount in cash equal to the product of (i) the excess, if any, of $25.50 over the per share exercise price of the applicable stock option and (ii) the aggregate number of shares of common stock underlying the applicable stock option. Pursuant to the terms of an option rollover agreement effective September 7, 2012, certain other of Mr. Agliata's options to acquire common stock which were outstanding immediately prior to the consummation of the Merger were replaced with options to acquire membership units of Parent and ultimately converted into options to acquire common stock of the Company.
On September 7, 2012, we and Interline New Jersey entered into a transaction bonus agreement with Mr. Agliata pursuant to which he was entitled to a bonus payment in the amount of $200,000 upon the closing of the Merger. To receive payment, Mr. Agliata agreed to waive any right he may have had to resign for “good reason” under his employment agreement or change in control severance agreement due to (i) the consummation of the Merger, (ii) the Company ceasing to be a publicly-traded company, or (iii) any change in his duties or responsibilities due solely to the Company no longer being publicly traded.
Additionally, on September 7, 2012, Mr. Agliata was awarded time-vesting and performance-vesting options under the 2012 Plan. Generally, the terms of the time-vesting option award agreement provide that, subject to Mr. Agliata's continued employment, the options vest in equal increments of 20% on each of the first, second, third, fourth, and fifth anniversaries of the grant date. The terms of Mr. Agliata's performance-vesting option award agreement provide that options will generally vest and become exercisable with respect to 20% of the shares subject to the option based upon the Company's achievement of specified EBITDA targets for the Company's 2012, 2013, 2014, 2015 and 2016 Annual Performance Periods, subject to Mr. Agliata's remaining employed through the date on which the audited financial statements for the applicable Annual Performance Period are presented to the board of directors. The treatment of Mr. Agliata's time-vesting and performance-vesting option awards upon a termination of employment or a change in control of the Company is described below in the section entitled “Potential Payments upon Termination or a Change in Control.”
John M. McDonald
Mr. McDonald ceased to be Senior Vice President of Sales of the Company and his employment with the Company terminated effective October 19, 2012. Previously, we entered into an employment agreement with Mr. McDonald dated June 13, 2011. The term of Mr. McDonald's employment agreement was from June 13, 2011 to June 12, 2012, subject to automatic one-year extensions unless we or Mr. McDonald gave at least 60 days' prior written notice of non-extension. Mr. McDonald's annual base salary at the time of his departure was $365,000. Mr. McDonald was also eligible to receive an annual cash bonus based upon the achievement of annual performance targets established by our Compensation Committee. Mr. McDonald was also eligible to participate in the benefits plans and arrangements generally available to our senior executives, including a monthly automotive allowance. His employment agreement also provided for severance upon certain terminations of employment, as described under “Potential Payments upon Termination of Change in Control.”
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
The following table summarizes the number of securities underlying the equity awards held by each of our named executive officers as of the fiscal year ended December 28, 2012.
____________________
(1)
Represents stock options awarded prior to the Merger, which were rolled over into vested options of Parent and ultimately converted into options of the Company, effective September 7, 2012.
(2)
Represents performance-vesting stock options that were granted to our named executive officers on October 1, 2012 following the Merger. The performance-vesting stock options vest 20% annually based upon achievement of certain performance targets for the Company's 2012, 2013, 2014, 2015 and 2016 fiscal years (each period, an “Annual Performance Period”). Upon the occurrence of a change in control of us (i) prior to the first anniversary of the date of grant, the options will become fully vested and (ii) prior to the end of any of the other Annual Performance Periods, a number of options will vest equal to the number of unvested options multiplied by a fraction, the numerator of which is the number of performance periods in which the targets have been achieved and the denominator of which is the number of periods that have elapsed since the date of grant.
(3)
Represents time-vesting stock options that were granted to our named executive officers on October 1, 2012 following the Merger. The time-vesting stock options vest in equal increments of 20% on each of the first, second, third, fourth and fifth anniversaries of the date of grant, subject to continued employment. Upon a change of control of the Company, these time-vesting options become fully vested, subject to continued employment through the date of the change of control.
(4)
Mr. McDonald resigned from the Company effective October 19, 2012.
OPTION EXERCISES AND STOCK VESTED
The following table summarizes the stock options exercised and stock vested by each of our named executive officers during the fiscal year ended December 28, 2012.
____________________
(1)
All of the option award exercises during 2012 occurred in connection with the Merger. All options outstanding immediately prior to the consummation of the Merger became fully vested and were canceled, except for options which were rolled over by management into vested options of Parent and were ultimately converted into options of the Company. The value realized on exercise was determined by multiplying the number of shares underlying the options by the difference, if any, between $25.50 (the per share Merger consideration) and the applicable exercise price.
(2)
All of the stock awards that vested during 2012 occurred in connection with the Merger. All outstanding restricted share units were accelerated immediately prior to the closing of the Merger. The value realized on vesting was determined by multiplying the number of shares acquired upon vesting by $25.50 (the per share Merger consideration).
POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL
The following summaries set forth potential payments payable to our executive officers upon termination of employment or a change in control of us under their current employment agreements, option award agreements or change-in-control agreements.
Michael J. Grebe
Mr. Grebe's employment may be terminated by us for "cause" (as defined below) or by Mr. Grebe for any reason upon 30 days' prior written notice, which notice must be authorized by a majority of the members of our Board of Directors in the case of a termination for cause. Upon either such termination, we are required to pay his accrued and unpaid base salary and benefits through the date of termination.
If Mr. Grebe's employment terminates due to disability or death, he or his estate will be entitled to receive (i) any accrued and unpaid base salary and benefits, (ii) continuation of his base salary for a period of two years following the date of termination and (iii) a prorated bonus for the calendar year in which termination occurs. Mr. Grebe's time-vesting option award agreement provides that upon termination of his employment as a result of disability or death, Mr. Grebe's unvested equity awards will be forfeited, and he or his estate will have until the earlier of (x) the stock option's expiration date and (y) the later of two years following the date of grant and one year following the date of termination to exercise any vested stock options.
If Mr. Grebe's employment is terminated by us without “cause," or by Mr. Grebe for "good reason" (as defined below), upon 10 days' prior written notice, Mr. Grebe will be entitled to receive any accrued and unpaid base salary and benefits and severance equal to one (1.5 in the case of any such termination upon or following a Change in Control that occurs following the second anniversary of the consummation of the Merger (a “Qualifying Change in Control”)) times the sum of (a) his base salary as of the date of termination and (b) the average of the bonus amounts paid for the prior three year period, such amount payable in a lump sum upon the date of termination; provided, that Mr. Grebe shall be deemed to have been terminated upon or following a Qualifying Change in Control (1) if he reasonably demonstrates that his employment was terminated prior to a Qualifying Change in Control without “cause” (x) at the request of an individual, entity or group who has entered into an agreement with the Company (a “Person”), the consummation of which will constitute a Qualifying Change in Control (or who has taken other steps reasonably calculated to effect a
Qualifying Change in Control) or (y) otherwise in connection with, as a result of or in anticipation of a Qualifying Change in Control, or (2) if he terminates his employment for “good reason” prior to a Qualifying Change in Control and he reasonably demonstrates that the circumstance(s) or event(s) which constitute such “good reason” occurred at the request of such Person or otherwise in connection with, as a result of or in anticipation of a Qualifying Change in Control. Mr. Grebe will also be entitled to continuation of certain health and welfare benefits at our expense for a period of one year (18 months in the case of any such termination following a Qualifying Change in Control) following his termination. In addition, Mr. Grebe's employment agreement provides for a tax gross-up for any amounts due or paid to him under the employment agreement or any of our other plans or arrangements that are considered an "excess parachute payment" under the Internal Revenue Code. All severance payments under this agreement are conditioned upon and subject to Mr. Grebe's execution of a general waiver and release.
Upon Mr. Grebe's termination for “cause,” any unexercised portion of his time-vesting option, whether or not vested, will terminate. Upon his termination of employment other than by the Company for “cause” or by Mr. Grebe without “good reason” (i) prior to the first year anniversary of the date of grant, Mr. Grebe will become vested as to 40% of the shares subject to the option and (ii) at any time on or following the first anniversary of the date of grant, he will become vested in an additional 20% of the shares subject to the option. Upon termination of employment of Mr. Grebe other than by the Company for “cause” or by him without “good reason,” the unvested portion of the option will expire on the date of termination and the vested portion will remain exercisable through the earlier of (y) the expiration date of the option or (z) the later of two years following the date of grant and one year following the date of termination. Upon Mr. Grebe's resignation other than for “good reason,” the unvested portion of the option will expire and the vested portion will remain exercisable until the earlier of the expiration date and the date that is 90 days following the date of termination.
Upon Mr. Grebe's termination for “cause,” any unexercised portion of his performance-vesting option, whether or not vested, will terminate. Upon termination of Mr. Grebe other than by the Company for “cause” or by him without “good reason” (i) prior to December 31, 2013, the option with respect to the option shares attributable to the 2013 and 2014 Annual Performance Periods will remain outstanding until the performance determination date for the 2014 Annual Performance Period and eligible to vest based on the attainment of the EBITDA targets for such period and (ii) at any time following December 31, 2013, the option with respect to option shares attributable to the Annual Performance Period in which such termination occurs will remain outstanding until the performance determination date for such period and become eligible to vest subject to the attainment of the EBITDA target for such period. Any portion of the option which becomes vested in accordance with the preceding sentence will remain exercisable through the first anniversary of the date on which such portion(s) become vested and exercisable, and any portion of the option which was already vested as of the date of the termination will remain exercisable through the earlier of (x) the expiration date of the option and (y) the later of two years following the date of grant and one year following the date of termination of employment. If Mr. Grebe resigns without “good reason,” the unvested portion of the option will expire on the resignation date and the vested portion would remain exercisable through the earlier of (x) the expiration date of the option and (y) a period of 90 days following the termination.
If Mr. Grebe's employment agreement is not renewed on account of us giving notice to Mr. Grebe of our desire not to extend his employment term, this termination will be treated as a termination "without cause" entitling Mr. Grebe to the severance outlined above.
Mr. Grebe is subject to a non-compete agreement during his employment and for a period of (i) one year following the termination of his employment by us for cause or by Mr. Grebe without good reason and (ii) two years following the termination of his employment by us without cause or by Mr. Grebe for good reason. Following the termination of his employment by us for cause or by Mr. Grebe without good reason, Mr. Grebe is also subject to a one-year prohibition against the solicitation of (i) clients who were our clients within the six-month period prior to his termination of employment and (ii) any of our employees. Mr. Grebe is also subject to a confidentiality agreement during and after his employment with us, as well as certain restrictive covenants contained in his time-vesting option agreement and performance-vesting option agreement.
Upon a change in control of us, Mr. Grebe's time-vesting options will become fully vested and exercisable. With respect to his performance-vesting options, upon the occurrence of a change in control of us (i) prior to the first anniversary of the date of grant, the options will become fully vested and (ii) prior to the end of any of the other Annual Performance Periods, a number of options will vest equal to the number of unvested options multiplied by a fraction, the numerator of which is the number of performance periods in which the targets have been achieved and the denominator of which is the number of periods that have elapsed since the date of grant.
In the event of a change in control of us, Mr. Grebe will also be entitled to a "success" bonus in an amount which will be negotiated in good faith and agreed upon between Mr. Grebe and us. This success bonus will be paid in cash to Mr. Grebe in a lump sum on the date of the closing of such change in control.
For purposes of Mr. Grebe's employment agreement, "cause" is defined as (1) conviction of, or pleading nolo contendere to, a felony or any other crime involving the trading of securities, mail or wire fraud, theft or embezzlement of our property, (2) gross negligence in performance of duties, (3) willful misconduct or material breach of the employment agreement or (4) failure to follow lawful instructions of the Board. "Good reason" is defined as any of the following actions, taken without Mr. Grebe's prior express written consent, and which are not cured by us within 30 days of receiving notice of the event from Mr. Grebe: (1) a material reduction in position, duties, responsibilities, title or authority, including reporting rights and obligations, provided that a material reduction shall not be deemed to have occurred solely due to the fact that the Company is no longer a reporting company under the Securities Exchange Act of 1934, (2) a reduction in compensation or a material reduction in aggregate benefits (other than generally applicable benefit reductions), (3) a failure by us to pay compensation or benefits to Mr. Grebe when due, (4) a change in Mr. Grebe's principal employment location by more than 35 miles, if this would materially increase his commute, (5) removal of Mr. Grebe as Chairman of the Board of Directors (other than for cause or Mr. Grebe's resignation or inability to serve as a result of his incapacity), or (6) any material breach by us of Mr. Grebe's employment agreement.
For purposes of Mr. Grebe's employment agreement, "change in control" generally means (1) the acquisition by an unrelated third party, pursuant to a sale, merger, consolidation, reorganization or similar transaction, of more than 50% of our common stock, (2) the liquidation or dissolution of us or a sale of substantially all of our assets, or (3) at any time after August 13, 2006, a change in a majority of the membership of our Board of Directors as such membership was constituted on August 13, 2004 (the "Incumbent Board"), excluding membership changes approved by a two-thirds majority of the Incumbent Board. Notwithstanding the foregoing, a "change in control" will not be deemed to occur unless it is a qualifying change in control event under Section 409A of the Internal Revenue Code.
John A. Ebner, Kenneth D. Sweder, Lucretia D. Doblado, Michael Agliata and John M. McDonald
The executive's employment may be terminated by us for "cause" (as defined in each executive's employment agreement). Upon termination of the executive's employment for "cause," we will pay his or her accrued and unpaid base salary and benefits (as defined in his or her employment agreement) through the date of termination.
If the executive's employment terminates due to disability or death, the executive or his or her estate will be entitled to receive (i) any accrued and unpaid base salary and benefits and (ii) a prorated bonus for the calendar year in which termination occurs. Unless otherwise provided by the award agreement entered into by the executive at the time the executive was granted a particular equity award, upon termination of the executive's employment as a result of disability or death, the executive will forfeit any outstanding unvested equity awards and the executive or the executive's estate will have until the earlier of the stock option's expiration date or one year from date of termination to exercise any vested stock options.
If the executive's employment is terminated by us "without cause", or by the executive for "good reason" (as defined in his or her employment agreement), the executive (excluding Mr. Ebner, who waived all severance and benefits rights pursuant to his Retention Bonus Agreement) will be entitled to receive (i) any accrued and unpaid base salary and benefits, (ii) continuation of his or her base salary for a period of one year (eighteen months for Mr. Sweder) from the date of termination, (iii) continuation of his or her medical and dental benefits at our expense for a period of one year (eighteen months for Mr. Sweder) following his or her termination and (iv) a prorated bonus for the calendar year in which termination occurs. All severance payments are conditioned upon and subject to the executive's execution of a general waiver and release. The executive is required to provide us 30 days' advance written notice in the event the executive terminates the executive's employment other than for "good reason."
The executive's employment agreement provides that the executive is subject to a non-compete agreement during his or her employment and for one year (two years for Messrs. Ebner, Sweder and McDonald) thereafter. The executive is subject to a non-solicitation agreement during his or her employment and for two years (three years for Messrs. Ebner, Sweder and McDonald) thereafter. The executive is subject to a confidentiality agreement during and after his or her employment with us.
For each of the executives, upon termination for “cause,” any unexercised portion of either the executive's time-vesting and performance-vesting options, whether or not vested, will terminate. With respect to each of Mr. Ebner, Ms. Doblado and Mr. Agliata, upon the termination by the Company without “cause” or due to death or disability, or by the executive for any reason, the unvested portion of the time-vesting option will expire on the date of termination and the vested portion of the option would remain exercisable until the earlier of the expiration date or 90 days (180 days in the case of death or disability) following the termination date. With respect to Mr. Sweder, upon his termination of employment other than by the Company for “cause” or by him for “good reason” (i) prior to the first year anniversary of the date of grant, Mr. Sweder will become vested as to 40% of the shares subject to the time-vesting option and (ii) at any time on or following the first anniversary of the date of grant, he will become vested in an additional 20% of the shares subject to the time-vesting option. Upon termination of employment of Mr. Sweder other than by the Company for “cause” or by him without “good reason,” the unvested portion of the time-vesting option will expire on the date of termination and
the vested portion will remain exercisable through the earlier of (y) the expiration date of the option or (z) the later of two years following the date of grant and one year following the date of termination. Upon Mr. Sweder's resignation without “good reason,” the unvested portion of the time-vesting option will expire and the vested portion will remain exercisable until the earlier of the expiration date and the date that is 90 days following the date of termination.
With respect to each of Mr. Ebner, Ms. Doblado and Mr. Agliata, upon the executive's termination by the Company without cause or by the executive, the unvested portion of the performance-vesting option will terminate, provided, that, the unvested portion attributable to a completed Annual Performance Period with respect to which the performance determination date has not yet occurred will remain outstanding until the performance determination date and, if the applicable EBITDA targets are achieved, will be eligible to vest and will remain outstanding for 90 days following the determination date. Any portion of the performance-vesting option that was vested as of the date of termination will remain exercisable until the earlier of the expiration date of the option or the 90th day following such termination.
With respect to Mr. Sweder, upon termination other than by the Company for “cause” or by him without “good reason” (i) prior to December 31, 2013, the performance-vesting option with respect to the option shares attributable to the 2013 and 2014 Annual Performance Periods will remain outstanding until the performance determination date for the 2014 Annual Performance Period and eligible to vest based on the attainment of the EBITDA targets for such period and (ii) at any time following December 31, 2013, the performance-vesting option with respect to option shares attributable to the Annual Performance Period in which such termination occurs will remain outstanding until the performance determination date for such period and become eligible to vest subject to the attainment of the EBITDA target for such period. Any portion of the option which becomes vested in accordance with the preceding sentence will remain exercisable through the first anniversary of the date on which such portion(s) become vested and exercisable, and any portion of the option which was already vested as of the date of the termination will remain exercisable through the earlier of (x) the expiration date of the option and (y) the later of two years following the date of grant and one year following the date of termination of employment. If Mr. Sweder resigns without “good reason,” the unvested portion of the option will expire on the resignation date and the vested portion would remain exercisable through the earlier of (x) the expiration date of the option and (y) a period of 90 days following the termination.
For purposes of the executive's employment agreement, "cause" is defined as (1) gross neglect or willful failure to perform duties, (2) a willful act by the executive against us or which causes or is intended to harm us, (3) conviction of, or plea of no contest or guilty to, a felony, or lesser offence involving dishonesty, the theft of our property or moral turpitude, or (4) a material breach of the employment agreement by the executive which is not cured within 20 days of receipt of notice from us. For purposes of the executive's employment agreement, "good reason" is defined as (1) a material breach of the terms of the employment agreement by us, (2) a change in the executive's place of employment by more than 35 miles, if this would materially increase the executive's commute, or (3) a material diminution of the executive's responsibility which is not cured by us within 20 days of receipt of notice from the executive.
In March 2007, we entered into a change-in-control agreement with Ms. Doblado. On April 30, 2007, we entered into a change-in-control agreement with Mr. Sweder, which was then amended on October 20, 2008. On January 8, 2010, we entered into a change-in-control agreement with Mr. Ebner, which was amended on March 2, 2011. On March 16, 2009, we entered into a change-in-control agreement with Mr. Agliata. On June 13, 2011, we entered into a change-in-control agreement with Mr. McDonald, which was terminated at the time of Mr. McDonald's termination of employment on October 19, 2012. These change-in-control agreements have a perpetual term, although we may unilaterally amend them with one year's notice. The change-in-control agreements provide that in the event that the executive is terminated by us "without cause" (as defined in the change-in-control agreement), or by the executive for "good reason" (as defined in the change-in-control agreement) within two years following a change in control of us, the executive will be entitled to receive in a cash lump sum (i) any accrued and unpaid base salary and benefits, (ii) a prorated bonus for the calendar year in which termination occurs, (iii) an amount equal to 1.5 times (1.75 times for Mr. Sweder) the sum of the executive's base salary and the average of the annual bonus earned over the prior three fiscal years, and (iv) continuation of his or her medical benefits at our expense for a period of 18 months (21 months for Mr. Sweder) following his or her termination. Effective as of October 19, 2012, in connection with his resignation, Mr. McDonald entered into a Separation of Employment Agreement and General Release pursuant to which he received the severance benefits that are consistent with those provided under his change-in-control agreement. As described above in the section entitled “Employee Agreements,” pursuant to the terms of his Retention Bonus Agreement entered into in connection with the Merger, Mr. Ebner waived his right to any payments under his employment agreement and change-in-control agreement and is entitled to payment of the Retention Bonus.
In the event of a change in control of us, the executive's time-vesting options will become fully vested and exercisable. With respect to the executive's performance-vesting options, upon the occurrence of a change in control of us (i) prior to the first anniversary of the date of grant, the options will become fully vested and (ii) prior to the end of any of the other Annual Performance Periods, a number of options will vest equal to the number of unvested options multiplied by a fraction, the numerator of which is the
number of performance periods in which the targets have been achieved and the denominator of which is the number of periods that have elapsed since the date of grant.
In addition, and with the exception of Mr. Ebner (whose change-in-control agreement was amended to remove any right to a tax gross-up) and Mr. McDonald, the executive's change-in-control agreement provides for a tax gross-up for any amounts due or paid to him or her under the change-in-control agreement or any of our other plans or arrangements that are considered an "excess parachute payment" under the Internal Revenue Code, provided that the "excess parachute payments" are at least 110% of the "safe harbor" amount that would result in no excise tax liability. All severance payments under the change-in-control agreement are conditioned upon and subject to the executive's execution of a general waiver and release.
The executive is subject to restrictive covenants under the executive's change-in-control agreement that are the same as those under his or her employment agreement. The executive is also subject to a confidentiality agreement during and after his employment with us. The executive is also subject to certain restrictive covenants contained in his or her time-vesting option agreement and performance-vesting option agreement.
For purposes of the executive's change-in-control agreement:
"cause" is defined as (1) the executive's conviction of, or pleading nolo contendere to, a felony, (2) gross neglect of duties, (3) willful misconduct in connection with the performance of duties, which results in material and demonstrable damage to us or (4) failure to follow the lawful directions of the Board, consistent with the executive's position with us; "good reason" is defined as (1) a material and adverse change in duties and responsibilities, (2) a material breach the terms of the executive's employment agreement by us, (3) a reduction in annual base salary or target annual bonus, (4) a change in the executive's principal employment location by more than 35 miles, if this would increase his or her commute by more than 20 miles, (5) substantially greater business travel, (6) a reduction of more than 5% in aggregate benefits, (7) failure to provide paid vacation, (8) termination of employment in a manner inconsistent with the notice provisions of the change-in-control agreement, or (9) failure by us to obtain the assumptions and guarantees from any successor or parent corporation; and "change in control" generally means (1) the acquisition by an unrelated third party, pursuant to a sale, merger, consolidation, reorganization or similar transaction, of more than 50% of our common stock, (2) the liquidation or dissolution of us or a sale of substantially all of our assets, (3) during any 24-month period, a change in a majority of the membership of our Board of Directors (the "Incumbent Board"), excluding membership changes approved by a majority of the Incumbent Board, or (4) a merger, reorganization or consolidation of us; notwithstanding the foregoing, a "change in control" will not be deemed to occur unless it is a qualifying change in control event under Section 409A of the Internal Revenue Code.
Incremental Payments Associated with an Involuntary Termination without Cause or for Good Reason in the Absence of a Change in Control
The following table summarizes the incremental payments associated with the termination of each of our named executive officers by us without cause or by such named executive officers for good reason on December 28, 2012, in the absence of a change in control. The values in this table assume a stock price of $255.00, and include all outstanding grants. Actual values will depend on the actual stock price and the actual compensation figures at the time of termination of employment.
____________________
(1)
Represents one times the sum of (a) Mr. Grebe's base salary as of the date of termination and (b) the average of the bonus amounts paid for the prior three year period, such amount payable in a lump sum upon the date of termination.
(2)
The time-vesting options would become 40% vested upon a termination of employment. The performance-vesting option with respect to the option shares attributable to the 2013 and 2014 Annual Performance Periods would remain outstanding until the performance determination date for the 2014 Annual Performance Period and eligible to vest based on the attainment of the EBITDA targets for such period.
(3)
Represents the value of twelve months of continued health and welfare benefits.
(4)
Represents the retention bonus pursuant to the Retention Bonus Agreement entered into at the closing of the Merger.
(5)
Unvested time-vesting stock and performance-vesting options are forfeited for no consideration.
(6)
Represents eighteen months of base salary continuation, the annual target bonus under the ECIP for 2012, and $479,166 which represents an amount equal to the total of the retention bonus payments unpaid as of December 28, 2012.
(7)
Represents the value of eighteen months of continued health and welfare benefits.
(8)
Represents twelve months of base salary continuation and the annual target bonus under the ECIP for 2012.
(9)
Mr. McDonald resigned from the Company effective October 19, 2012. See the table under the sub-heading “Incremental Payments Associated With a Change-in-Control Termination” for actual payments received by Mr. McDonald in connection with his resignation pursuant to terms of his Separation of Employment Agreement and General Release effective as of October 19, 2012.
Incremental Payments Associated With an Involuntary Termination as a Result of Disability or Death
The following table summarizes the incremental payments associated with the termination of each of our named executive officers as a result of disability or death on December 28, 2012. The values in this table assume a stock price of $255.00, and include all outstanding grants. Actual values will depend on the actual stock price and compensation figures at the time of termination of employment.
___________________
(1)
Represents 24 months of base salary continuation and the annual target bonus under the ECIP for 2012.
(2)
Unvested time-vesting stock options are forfeited for no consideration. The performance-vesting option with respect to the option shares attributable to the 2013 and 2014 Annual Performance Periods would remain outstanding until the performance determination date for the 2014 Annual Performance Period and eligible to vest based on the attainment of the EBITDA targets for such period.
(3)
Represents the retention bonus pursuant to the Retention Bonus Agreement entered into at the closing of the Merger.
(4)
Unvested time-vesting stock and performance-vesting options are forfeited for no consideration.
(5)
Represents the annual target bonus under the ECIP for 2012 and $479,166 which represents an amount equal to the total of the retention bonus payments unpaid as of December 28, 2012.
(6)
Represents the annual target bonus under the ECIP for 2012.
(7)
Mr. McDonald resigned from the Company effective October 19, 2012. See the table under the sub-heading “Incremental Payments Associated With a Change-in-Control Termination” for actual payments received by Mr. McDonald in connection with his resignation pursuant to terms of his Separation of Employment Agreement and General Release effective as of October 19, 2012.
Incremental Payments Associated With a Change-in-Control Termination
The following table summarizes the incremental payments associated with a termination in connection with a change in control for each of our named executive officers if the change in control had occurred as of December 28, 2012. The values in this table assume a stock price of $255.00, and include all outstanding grants. Actual values will depend on the actual stock price and compensation figures at the time of termination of employment.
____________________
(1)
Represents one times the sum of (a) Mr. Grebe's base salary as of the date of termination and (b) the average of the bonus amounts paid for the prior three year period, such amount payable in a lump sum upon the date of termination.
(2)
Represents the value of time-vesting and performance-vesting options that would automatically vest upon a change in control.
(3)
Represents the value of twelve months of continued health and welfare benefits.
(4)
Represents the retention bonus pursuant to the Retention Bonus Agreement entered into at the closing of the Merger.
(5)
Calculated as 1.75 times the sum of (a) base salary and (b) the average of the annual bonuses paid during the three fiscal years prior to termination plus the annual target bonus under the ECIP for 2012 and $479,166 which represents an amount equal to the total of the retention bonus payments unpaid as of December 28, 2012.
(6)
Represents the value of twenty-one months of continued health and welfare benefits.
(7)
Calculated as 1.5 times the sum of (a) base salary and (b) the average of the annual bonuses paid during the three fiscal years prior to termination plus the annual target bonus under the ECIP for 2012.
(8)
Represents the value of eighteen months of continued health and welfare benefits.
(9)
Mr. McDonald resigned from the Company effective October 19, 2012. Amounts represent payments received in connection with the execution of his Separation of Employment Agreement and General Release effective as of October 19, 2012.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the number and percentage of our outstanding shares of common stock beneficially owned by (i) our named executive officers and each of our Directors individually, (ii) all executive officers and Directors as a group and (iii) principal shareholders who are known to us to be the beneficial owner of more than five percent of our common stock as of March 8, 2013. Unless otherwise indicated in the table or footnotes below, the address for each beneficial owner is c/o Interline Brands, Inc., 701 San Marco Boulevard, Jacksonville, Florida, 32207.
____________________
*
Indicates less than 1% ownership.
(1)
GS Capital Partners VI Fund, L.P., GS Capital Partners VI Parallel, L.P., GS Capital Partners VI Offshore Fund, L.P., GS Capital Partners VI GmbH & Co. KG, MBD 2011 Holding, L.P., Bridge Street 2012 Holdings, L.P. own 373,203; 102,624; 310,417; 13,264; 25,490; and 29,412 shares of our common stock, respectively (the “Goldman Sachs Funds”). The Goldman Sachs Group, Inc., and Goldman, Sachs & Co. may be deemed to beneficially own indirectly, in the aggregate, all of the common stock owned by the Goldman Sachs Funds because affiliates of Goldman, Sachs & Co. and The Goldman Sachs Group, Inc. are the general partner, managing general partner, managing partner, managing member or member of the Goldman Sachs Funds. Goldman, Sachs & Co. is a direct and indirect wholly owned subsidiary of The Goldman Sachs Group, Inc. Goldman, Sachs & Co. is the investment manager of certain of the Goldman Sachs Funds. The Goldman Sachs Group, Inc. and Goldman, Sachs & Co. each disclaim beneficial ownership of the shares of common stock owned directly or indirectly by the Goldman Sachs Funds, except to the extent of their pecuniary interest therein, if any. Messrs. Crampton, Gross and Mehra are managing directors of Goldman, Sachs & Co., and Ms. Berry is a vice president of Goldman, Sachs & Co., and each may be deemed to beneficially own indirectly, in the aggregate, all of the common stock owned by the Goldman Sachs Funds; each disclaim beneficial ownership of the shares of common stock owned directly or indirectly by the Goldman Sachs Funds, except to the extent of their pecuniary interest therein, if any. The address of the Goldman Sachs Funds, The Goldman Sachs Group, Inc. and Goldman, Sachs & Co. is 200 West Street, New York, NY 10282.
(2)
P2 Capital Master Fund I, L.P. and P2 Capital Master Fund VII, L.P (collectively, the “P2 Funds”) own 136,078 and 452,157 shares of our common stock, respectively. Mr. Moller is a managing partner and Mr. Paulson is a partner of P2 Capital Partners, and each may be deemed to beneficially own indirectly, in the aggregate, all of the common stock
owned by the P2 Funds; each disclaim beneficial ownership of the shares of common stock owned directly or indirectly by the P2 Funds, except to the extent of their pecuniary interest therein, if any. The address of the principal office is 590 Madison Avenue, 25th Floor, New York, NY 10022.
(3)
Includes 1,662 shares of common stock issuable pursuant to stock options.
(4)
Includes 4,854 shares of common stock issuable pursuant to stock options.
(5)
Includes 32,358 shares of common stock issuable pursuant to stock options.
(6)
Includes 1,233 shares of common stock issuable pursuant to stock options.
(7)
Includes 2,325 shares of common stock issuable pursuant to stock options.
(8)
Includes 10,638 shares of common stock issuable pursuant to stock options.
EQUITY COMPENSATION PLANS
The following table sets forth information as of December 28, 2012 regarding compensation plans under which the Company's equity securities are authorized for issuance:
____________________
(1)
Includes time-vesting and performance-vesting options granted to management and non-employee Directors, respectively, pursuant to the 2012 Plan, and options which had been granted under the 2004 Plan and were replaced with rollover options in connection with the Merger.
(2)
These securities are available for future issuance under the 2012 Plan. Each of these securities is available for issuance as a full value award or otherwise.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions, and Director Independence
Independence of Board Members
As a private company whose securities are not listed on any national securities exchange, we are not required to have a majority of, or any, independent directors. However, the rules of the SEC require us to disclose which of our directors would be considered independent within the meaning of the rules of a national securities exchange that we may choose. Messrs. Mehra, Gross and Crampton and Ms. Berry are employed by GS Capital Partners, and Messrs. Moller and Paulson are employed by P2 Capital Partners. Our Board of Directors also includes two members of the Company's management - Messrs. Grebe and Sweder. We currently have two directors, Messrs. Letham and Opdeweegh, who would be considered independent within the definition of the rules of the New York Stock Exchange.
Related Party Transactions
We recognize that related party transactions may present potential or actual conflicts of interest and may create the appearance that Company decisions are based on considerations other than the best interests of Interline and its shareholders. Therefore, the Board has adopted a written policy which provides that prior to entering into any related party transaction, a formal written notice has to be submitted to the Chief Financial Officer and General Counsel, disclosing all relevant terms of the proposed transaction. If the Chief Financial Officer or General Counsel determines that the proposed transaction is a related party transaction, he or she shall refer such transaction to the Audit Committee for review. The Audit Committee shall approve only those related party transactions that are in, or are not inconsistent with, the best interests of the Company. For purposes of this policy, a “related party transaction” is a transaction, arrangement or relationship in which the Company and/or any of its subsidiaries participate and in which any related party has a direct or indirect interest. Related parties include executive officers, directors, vice presidents, director nominees, beneficial owners of more than 5% of the Company's voting securities, immediate family members of any of the foregoing
persons, and any firm, corporation or other entity in which any of the foregoing persons is employed and in which such person has a beneficial ownership interest.
Item 404(a) of SEC Regulation S-K requires disclosure of various transactions with related persons since the beginning of the last fiscal year, or that are currently proposed, and in which the Company was or is to be a participant, the amount involved exceeds $120,000 and any related person had or will have a direct or indirect material interest in the transaction.
Stockholders Agreement
The Stockholders Agreement among GS Capital Partners and its affiliates, P2 Capital and its affiliates and certain stockholders of the Company described in Item 10 above provides that GS Capital Partners has the right to designate five members of our Board of Directors and P2 Capital Partners has the right to designate two members of our Board of Directors, unless otherwise agreed by GS Capital Partners and P2 Capital Partners. In addition, the Stockholders Agreement includes limitations on the transferability of the parties' respective holdings of our equity securities as well as certain drag-along and tag-along rights.
Equity Registration Rights Agreement
In connection with the Merger, we entered into an equity registration rights agreement with GS Capital Partners and its affiliates and P2 Capital and its affiliates, and certain stockholders of the Company (the “Equity Registration Rights Agreement”). The Equity Registration Rights Agreement grants GS Capital Partners and P2 Capital the right to require us to register under the Securities Act of 1933 for public resale of their shares of our stock that constitute “registrable securities,” whether owned at the closing of the Merger or acquired thereafter. The term “registrable securities” includes any shares of our stock, including any shares issued upon conversion or exercise of all options, warrants or other securities convertible into, or exchangeable or exercisable for, shares of our stock. Shares of our stock will cease to be “registrable securities” when a registration statement relating to the shares has been declared effective and the shares have been disposed of, or when the shares may be sold in compliance with the requirements of Rule 144 under the Securities Act.
Subject to certain exceptions, our stockholders have been granted piggyback rights on any registration statement that we may file on behalf of itself or on behalf of another stockholder. The ability of stockholders to utilize piggyback rights is subject to certain notice requirements specified in the Equity Registration Rights Agreement as well as such stockholder's ability to provide certain information for inclusion in any registration statement.
Indemnification Agreements
We have entered into indemnification agreements with each of our directors, pursuant to which we have agreed to indemnify each of them against certain liabilities that may arise by reason of their status or service as a director of the Company, and to advance each of them the expenses incurred as a result of a proceeding as to which they may be indemnified. The indemnification agreement is intended to provide rights of indemnification to the fullest extent permitted and is in addition to any other rights each indemnitee may have under our certificate of incorporation, its by-laws and applicable law. The indemnification agreements also requires us to maintain directors' and officers' liability insurance with respect to each indemnitee for so long as each indemnitee continues to serve as a director and shall continue thereafter so long as each indemnitee shall be subject to any proceeding by reason of his or her former or current capacities at the Company.
Other Transactions with Related Persons
In connection with the Merger, we entered into a transaction fee agreement with GS Capital Partners and P2 Capital pursuant to which we paid a one-time $10.0 million transaction fee at the closing of the Merger. In addition, Goldman, Sachs & Co., one of the initial purchasers of the Holdco Notes, is an affiliate of GS Capital Partners, and therefore an affiliate of us. We entered into a registration rights agreement with respect to the Holdco Notes pursuant to which we agreed to file a “market-making prospectus” in order to allow Goldman, Sachs & Co. to engage in market-making activities for the Holdco Notes. Also, an affiliate of Goldman, Sachs & Co. acts as an arranger for our ABL Facility. In connection with the Merger, we also paid approximately $10.9 million in various financing fees associated with the HoldCo Notes and ABL Facility to Goldman, Sachs & Co.
ITEM 14.
ITEM 14. Principal Accounting Fees and Services
During our 2011 fiscal year and through the second quarter of our 2012 fiscal year, Deloitte & Touche LLP ("Deloitte") served as our independent registered accounting firm. In connection with the Merger Transaction, we changed to PricewaterhouseCoopers LLP ("PwC") as our independent registered accounting firm during the third quarter of the 2012 fiscal year. Deloitte rendered an unqualified opinion on our consolidated financial statements as of and for the years ended December 30, 2011 and December 31, 2010, and PwC has rendered unqualified opinions for the year ended December 28, 2012, which included both the Predecessor and Successor periods.
The following table is a summary of the fees billed to us by PwC and Deloitte for professional services rendered for the fiscal years ended December 28, 2012 and December 30, 2011 (in thousands):
Audit Fees. Consists of fees billed for professional services rendered for the audits of our annual consolidated financial statements and internal control over financial reporting (for Predecessor Period), review of interim condensed consolidated financial statements included in quarterly reports on Form 10-Q, and other services provided in connection with our statutory and regulatory filings or engagements.
Audit-Related Fees. Consists of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our consolidated financial statements and are not reported under "Audit Fees". These services include employee benefit plan audits and various attest services.
Tax Fees. Consists of fees for tax services including compliance, planning and advice.
Our Audit Committee pre-approves and is responsible for the engagement of all services provided by our independent registered certified public accountants.
PART IV
ITEM 15.
ITEM 15. Exhibits, Financial Statement Schedules
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated and on the dates indicated.
EXHIBIT INDEX
*Attached as Exhibit 101 to this report are the following items formatted in XBRL (Extensible Business Reporting Language):
Consolidated Balance Sheets as of December 28, 2012 and December 30, 2011;
Consolidated Statements of Operations for the period September 8, 2012 through December 28, 2012, period December 30, 2011 through September 7, 2012, and the fiscal years ended December 30, 2011 and December 31, 2010;
Consolidated Statements of Comprehensive (Loss) Income for the period September 8, 2012 through December 28, 2012, period December 30, 2011 through September 7, 2012, and the fiscal years ended December 30, 2011 and December 31, 2010;
Consolidated Statements of Cash Flows for the period September 8, 2012 through December 28, 2012, period December 31, 2011 through September 7, 2012, and the fiscal years ended December 30, 2011 and December 31, 2010;
Notes to the Consolidated Financial Statements.
In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Annual Report on Form 10-K is furnished and shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.