Form: 10-Q/A

Quarterly report pursuant to Section 13 or 15(d)

March 29, 2004

 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q/A

AMENDMENT NO. 1


QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2003

Commission file number 1-13293


The Hillman Companies, Inc.


(Exact name of registrant as specified in its charter)
     
Delaware   23-2874736

 
 
 
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
10590 Hamilton Avenue    
Cincinnati, Ohio   45231

 
 
 
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (513) 851-4900

Securities registered pursuant to Section 12(b) of the Act:

         
Title of Class
  Name of Each Exchange on Which Registered
11.6% Junior Subordinated Debentures
  None
Preferred Securities Guaranty
Preferred Share Purchase Rights
       

Securities registered pursuant to Section 12(g) of the Act: None

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

     YES [X] NO [  ]

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

     YES [  ] NO [X]

On November 12, 2003 there were 7,118,665 Common Shares issued and outstanding by the Registrant and 4,217,724 Trust Preferred Securities issued and outstanding by the Hillman Group Capital Trust. The Trust Preferred Securities trade on the American Stock Exchange under symbol HLM.Pr.

Page 1 of 32


 

Explanatory Note:

This amendment includes changes from the previous report to reflect the impact of a restatement due to the accounting for income taxes and the valuation of a note receivable as described herein. The income tax provision for the nine months ended September 30, 2003 was increased by $2.1 million as a result of the restatement. An additional write-down of a note receivable of $1.4 million was recorded for the three months ended September 30, 2003. See additional disclosure in Note 1 of the Notes to Consolidated Financial Statements.

Page 2 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

INDEX

                 
            PAGE(S)
PART I.  
FINANCIAL INFORMATION
       
Item 1.  
Consolidated Financial Statements
       
       
Consolidated Balance Sheets as of September 30, 2003 (restated)(Unaudited) and December 31, 2002
    4  
       
Consolidated Statements of Operations for the Three Months ended September 30, 2003 (restated) and 2002 (Unaudited)
    5  
       
Consolidated Statements of Operations for the Nine Months ended September 30, 2003 (restated) and 2002 (Unaudited)
    6  
       
Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2003 (restated) and 2002 (Unaudited)
    7  
       
Notes to Consolidated Financial Statements (Unaudited)
    8-17  
Item 2.  
Management’s Discussion and Analysis of Financial Conditions and Results of Operations
    18-29  
Item 3.  
Quantitative and Qualitative Disclosures about Market Risk
    30  
Item 4.  
Controls and Procedures
    30  
PART II.  
OTHER INFORMATION
    31  
SIGNATURES  
 
    32  

Page 3 of 32


 

Item 1.

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
                 
    September 30,    
    2003   December 31,
    (Unaudited)
  2002
    (Restated)        
ASSETS                
Current assets:
               
Cash and cash equivalents
  $ 1,015     $ 2,768  
Restricted investments
    948       1,142  
Accounts receivable, net
    46,276       31,855  
Inventories, net
    65,215       59,783  
Deferred income taxes
    6,654       7,663  
Other current assets
    2,736       3,249  
 
   
 
     
 
 
Total current assets
    122,844       106,460  
Property and equipment, net
    66,722       68,596  
Goodwill
    135,535       132,677  
Other intangibles, net
    9,952       11,068  
Deferred income taxes, net
    17,647       19,226  
Restricted investments
    5,724       5,923  
Note receivable
    3,600       11,258  
Deferred financing fees, net
    6,065       5,774  
Other assets
    1,129       2,212  
 
   
 
     
 
 
Total assets
  $ 369,218     $ 363,194  
 
   
 
     
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY                
Current liabilities:
               
Accounts payable
  $ 19,763     $ 20,373  
Current portion of senior term loans
    9,268       9,268  
Current portion of capitalized lease obligations
    52       55  
Accrued expenses:
               
Salaries and wages
    3,178       5,523  
Pricing allowances
    6,788       6,118  
Acquisition related costs
    5,822       3,395  
Income and other taxes
    1,644       1,329  
Deferred compensation
    948       1,142  
Other accrued expenses
    9,821       12,797  
 
   
 
     
 
 
Total current liabilities
    57,284       60,000  
Long term senior term loans
    53,607       60,559  
Bank revolving credit
    51,308       34,532  
Long term capitalized lease obligations
    157       194  
Long term unsecured subordinated notes to related party
    43,561       42,108  
Deferred compensation
    5,724       5,923  
Other non-current liabilities
    5,506       5,258  
 
   
 
     
 
 
Total liabilities
    217,147       208,574  
 
   
 
     
 
 
Guaranteed preferred beneficial interests in the Company’s junior subordinated debentures
    102,331       102,234  
 
   
 
     
 
 
Commitments and contingencies
               
Stockholders’ equity:
               
Preferred stock, $.01 par, 1,000,000 shares authorized, none outstanding
    —       —  
Common stock, $.01 par, 20,000,000 shares authorized, 7,118,665 issued and outstanding
    71       71  
Additional paid-in capital
    52,310       52,310  
Accumulated Deficit
    (2,547 )     —  
Accumulated other comprehensive (loss) income
    (94 )     5  
 
   
 
     
 
 
Total stockholders’ equity
    49,740       52,386  
 
   
 
     
 
 
Total liabilities and stockholders’ equity
  $ 369,218     $ 363,194  
 
   
 
     
 
 

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Page 4 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
FOR THE THREE MONTHS ENDED,
(dollars in thousands)
                 
    September 30,   September 30,
    2003
  2002
    (Restated)        
Net sales
  $ 86,055     $ 75,707  
Cost of sales
    38,818       33,071  
 
   
 
     
 
 
Gross profit
    47,237       42,636  
 
   
 
     
 
 
Operating expenses:
               
Selling, general and administrative expenses
    31,126       27,584  
Depreciation
    3,480       3,048  
Amortization
    373       371  
Management fee to related party
    450       450  
 
   
 
     
 
 
Total operating expenses
    35,429       31,453  
 
   
 
     
 
 
Other income, net
    459       109  
 
   
 
     
 
 
Income from operations
    12,267       11,292  
Interest expense, net
    4,101       3,268  
Distributions on guaranteed preferred beneficial interests
    3,058       3,058  
Write-down of note receivable
    1,400       —  
 
   
 
     
 
 
Income before income taxes
    3,708       4,966  
Income tax provision
    1,988       2,177  
 
   
 
     
 
 
Net income
  $ 1,720     $ 2,789  
 
   
 
     
 
 

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Page 5 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
FOR THE NINE MONTHS ENDED,
(dollars in thousands)
                 
    September 30,   September 30,
    2003
  2002
    (Restated)        
Net sales
  $ 240,307     $ 214,910  
Cost of sales
    108,772       95,564  
 
   
 
     
 
 
Gross profit
    131,535       119,346  
 
   
 
     
 
 
Operating expenses:
               
Selling, general and administrative expenses
    90,315       82,333  
Depreciation
    10,443       8,753  
Amortization
    1,116       1,114  
Management fee to related party
    1,350       1,350  
 
   
 
     
 
 
Total operating expenses
    103,224       93,550  
 
   
 
     
 
 
Other income, net
    643       1,571  
 
   
 
     
 
 
Income from operations
    28,954       27,367  
Interest expense, net
    11,656       10,039  
Distributions on guaranteed preferred beneficial interests
    9,174       9,172  
Write-down of note receivable
    7,657       —  
 
   
 
     
 
 
Income before income taxes
    467       8,156  
Income tax provision
    3,014       3,529  
 
   
 
     
 
 
Net (loss) income
  $ (2,547 )   $ 4,627  
 
   
 
     
 
 

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Page 6 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE NINE MONTHS ENDED,
(dollars in thousands)
                 
    September 30,   September 30,
    2003
  2002
    (Restated)        
Cash flows from operating activities:
               
Net income
  $ (2,547 )   $ 4,627  
Adjustments to reconcile net income to net cash (used for) provided by operating activities:
               
Depreciation and amortization
    11,559       9,867  
Deferred income tax
    2,588       3,467  
PIK interest on unsecured subordinated notes
    1,453       1,389  
Write-down of note receivable
    7,657       -  
Changes in current operating items:
               
Increase in accounts receivable
    (14,421 )     (11,884 )
(Increase) decrease in inventories
    (5,432 )     4,713  
Decrease in other current assets
    939       2,122  
(Decrease) increase in accounts payable
    (610 )     3,499  
Decrease in other accrued liabilities
    (4,633 )     (1,505 )
Other items, net
    1,393       (553 )
 
   
 
     
 
 
Net cash (used for) provided by operating activities
    (2,054 )     15,742  
 
   
 
     
 
 
Cash flows from investing activities:
               
Proceeds from sale of property and equipment
    20       104  
Capital expenditures
    (8,537 )     (17,714 )
R&B acquisition
    —       (6,225 )
Other, net
    471       1,037  
 
   
 
     
 
 
Net cash used for investing activities
    (8,046 )     (22,798 )
 
   
 
     
 
 
Cash flows from financing activities:
               
(Repayments) borrowings of senior term loans
    (6,952 )     12,022  
Borrowings (repayments) of revolving credit loans, net
    16,776       (3,707 )
Principal payments under capitalized lease obligations
    (40 )     (59 )
Financing fees, net
    (1,437 )     (749 )
 
   
 
     
 
 
Net cash provided by financing activities
    8,347       7,507  
 
   
 
     
 
 
Net (decrease) increase in cash and cash equivalents
    (1,753 )     451  
Cash and cash equivalents at beginning of period
    2,768       2,059  
 
   
 
     
 
 
Cash and cash equivalents at end of period
  $ 1,015     $ 2,510  
 
   
 
     
 
 

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Page 7 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)

1. Basis of Presentation:

The accompanying financial statements include the consolidated accounts of The Hillman Companies, Inc. (“Hillman” or the “Company”), and its wholly owned subsidiaries including an investment trust, Hillman Group Capital Trust (the “Trust”). All significant intercompany balances and transactions have been eliminated. The Company is organized as an independently managed portfolio company of Allied Capital Corporation (“Allied Capital”). Allied Capital owns approximately 96.8% of Hillman’s common stock with the remainder being held primarily by Company Management. Allied Capital’s stock ownership is subject to dilution by management options.

The accompanying unaudited consolidated financial statements present information in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and applicable rules of Regulation S-X. Accordingly, they do not include all information or footnotes required by generally accepted accounting principles for complete financial statements. Management believes the financial statements include all normal recurring accrual adjustments necessary for a fair presentation. Operating results for the three and nine months ended September 30, 2003 do not necessarily indicate the results that may be expected for the full year. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s annual report filed on Form 10-K for the year ended December 31, 2002.

This Form 10-Q/A (Amendment No. 1) amends our previously filed Form 10-Q to restate the write-down of a note receivable for the three months ended September 30, 2003 and the income tax provision and the write-down of the note receivable from G-C Sun Holdings, L.P. (“G-C”) for the nine months ended September 30, 2003. The Company has valued the G-C Note as of September 30, 2003 using the same methodology as applied in the first six months of 2003. This methodology assumed the sale of the remaining G-C business and provided for a decline in the estimated expected sale proceeds that would be available to pay our subordinated note. As a result, an additional $1,400 write-down in the value of the G-C Note has been recorded in the three month period ended September 30, 2003. The write-down of the note results in an increase to the valuation allowance with no related tax benefit for the book-tax basis difference. As more fully described in Note 7, the Company recorded a $6,257 charge to income during the six months ended June 30, 2003 to write-down the value of a note receivable from G-C Sun Holdings, L.P. and recognized an income tax benefit of $2,565. As of December 31, 2002, the Company had $36,708 of federal capital loss carryforwards available to offset future capital gains. A valuation allowance of $9,078 had been established for $27,298 of the capital loss carryforwards. Recognition of the remaining $9,410 of capital loss carryforwards was deemed more likely than not based on the capital gain expected upon the proceeds from the repayment of the G-C Note. However, the reduction in the value of the G-C Note reduced the expected utilization of the capital loss carryforwards by the amount of the write-down and a valuation allowance should have been recorded. Accordingly, the income tax provision in the accompanying Consolidated Statements of Operations for the nine month period ended September 30, 2003 has been restated to increase the valuation allowance by $2,050. In addition, deferred tax asset amounts have been reclassified for the pro-rata allocation of the valuation allowance between current and long-term deferred tax assets.

Page 8 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)

1. Basis of Presentation (continued):

The impact of the restatement on the restated components of the Company’s consolidated balance sheet is as follows (in thousands):

                 
    As Reported
  As Restated
September 30, 2003:
               
Deferred income tax assets - current (a)
  $ 10,285     $ 6,654  
Current assets
    126,475       122,844  
Deferred income tax assets - long-term (a)
    21,829       17,647  
Note receivable
    5,000       3,600  
Total assets
    378,431       369,218  
Deferred income tax liabilities - long-term (a)
    5,763       —  
Total liabilities
    222,910       217,147  
Retained earnings (accumulated deficit)
    903       (2,547 )
Total stockholders’ equity
    53,190       49,740  
Total liabilities and stockholders’ equity
    378,431       369,218  

The impact of the restatement on the restated components of the Company’s consolidated statement of operations is as follows (in thousands):

                 
    As Reported
  As Restated
For the three months ended September 30, 2003:
               
Write-down of note receivable
  $ —     $ 1,400  
Income before income taxes
    5,108       3,708  
Net income
    3,120       1,720  
For the nine months ended September 30, 2003:
               
Write-down of note receivable
    6,257       7,657  
Income before income taxes
    1,867       467  
Income tax provision
    964       3,014  
Net income (loss)
    903       (2,547 )


(a)   A reclassification in the amount of $5,763 has been recorded to present the restated deferred income tax assets - long-term net of deferred income tax liability as of September 30, 2003.

Page 9 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)

1. Basis of Presentation (continued):

Other Intangible Assets

Intangible assets subject to amortization consisted of the following as of September 30, 2003:

                 
    Carrying   Accumulated
    Amount
  Amortization
Trademarks
  $ 6,500     $ 910  
Patents
    6,700       2,931  
Proprietary software
    1,000       438  
Non-compete agreements
    1,250       1,219  
 
   
 
     
 
 
 
  $ 15,450     $ 5,498  
 
   
 
     
 
 

Amortization expense for intangible assets for the three and nine months ended September 30, 2003 was $373 and $1,116, respectively. Amortization expense for the next five years is estimated to be as follows:

                 
    Year Ended    
    December 31
  Amount
 
    2003     $ 1,437  
 
    2004     $ 1,238  
 
    2005     $ 1,223  
 
    2006     $ 1,222  
 
    2007     $ 1,223  

Page 10 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)

2. Summary of Significant Accounting Policies:

Cash Equivalents:

Cash equivalents consist of commercial paper, U.S. Treasury obligations and other liquid securities purchased with initial maturities less than 90 days and are stated at cost which approximates market value.

Restricted Investments:

Restricted investments represent assets held in a Rabbi Trust to fund deferred compensation liabilities due to certain Company employees.

Inventories:

Inventories consisting predominantly of finished goods are valued at the lower of cost or market, cost being determined principally on the first-in, first-out method.

Property and Equipment:

Property and equipment, including assets acquired under capital leases, are carried at cost and include expenditures for new facilities and major renewals. Maintenance and repairs are charged to expense as incurred. The cost and related accumulated depreciation are removed from their respective accounts when assets are sold or otherwise disposed of and the resulting gain or loss is reflected in current operations.

Depreciation:

For financial accounting purposes, depreciation, including that related to plant and equipment acquired under capital leases, is computed on the straight-line method over the estimated useful lives of the assets, generally three to ten years, or, if shorter, over the terms of the related leases.

Long-Lived Assets:

Under the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company has evaluated its long-lived assets for financial impairment and will continue to evaluate them based on the estimated undiscounted future cash flows as events or changes in circumstances indicate that the carrying amount of such assets may not be fully recoverable.

Income Taxes:

Deferred income taxes are computed using the asset and liability method. Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities (temporary differences) and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are provided for tax benefits where it is more likely than not that certain future tax benefits will not be realized. Adjustments to valuation allowances are recorded from changes in utilization of the tax related item.

Retirement Benefits:

Certain employees of the Company are covered under a profit-sharing and retirement savings plan (the “plan”). The plan provides for a matching contribution for eligible employees of 50% of each dollar contributed by the employee up to 6% of employee’s compensation. In addition, the plan provides an annual contribution in amounts authorized by the Board, subject to the terms and conditions of the plan.

Page 11 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)

2. Summary of Significant Accounting Policies (continued):

Revenue Recognition:

Revenue from sales of products is recorded upon the passing of title and risks of ownership which occurs upon the shipment of goods. Revenue is recorded net of pricing allowances such as customer rebates and discounts.

Shipping and Handling:

The costs incurred to ship product to customers, including freight and handling expenses, are included in selling, general and administrative (“SG&A”) expenses on the Company’s Statements of Operations. For the three months ended September 30, 2003 and 2002, shipping and handling costs included in SG&A were $4,044 and $3,704, respectively. For the nine months ended September 30, 2003 and 2002, shipping and handling costs included in SG&A were $11,906 and $10,380, respectively.

Research and Development:

The Company incurs research and development costs in connection with improvements to the key duplicating and engraving machines. For the three months ended September 30, 2003 and 2002, research and development expenses, consisting primarily of internal wages and benefits, were $424 and $413, respectively. For the nine months ended September 30, 2003 and 2002, research and development expenses were $1,148 and $1,166, respectively.

Translation of Foreign Currencies:

The translation of the Company’s Canadian foreign currency based financial statements into U.S. dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for revenue and expense accounts using an average exchange rate during the period.

Comprehensive Income:

The components of comprehensive income (loss) for the three and nine months ended September 30, 2003 and 2002 were as follows:

                                 
    Three Months Ended   Nine Months Ended
    September 30   September 30
    2003
  2002
  2003
  2002
    (Restated)           (Restated)        
Net income (loss)
  $ 1,720     $ 2,789     $ (2,547 )   $ 4,627  
Foreign currency translation adjustment
    1       7       (99 )     3  
 
   
 
     
 
     
 
     
 
 
Comprehensive income (loss)
  $ 1,721     $ 2,796     $ (2,646 )   $ 4,630  
 
   
 
     
 
     
 
     
 
 

Use of Estimates in the Preparation of Financial Statements:

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Page 12 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)

2. Summary of Significant Accounting Policies (continued):

Reclassifications:

Certain amounts in our 2002 consolidated financial statements have been reclassified to conform to the 2003 presentation.

3. Acquisitions:

On May 1, 2002, the Company purchased certain assets of the Lowe’s specialty fastener business from R&B, Inc. for cash consideration of $6,207. On October 3, 2002, the Company purchased the net assets of the DIY division (“DIY”) of the Fastenal Company for cash consideration of $15,218. The following disclosures indicate the Company’s estimate of pro forma financial results for the three and nine month periods ended September 30, 2002 had the acquisitions of the Lowe’s specialty fastener business and the DIY business been consummated on January 1, 2002:

                 
    Three months ended   Nine months ended
    September 30, 2002
  September 30, 2002
Net sales
  $ 80,734     $ 232,229  
Net income
  $ 2,909     $ 5,216  

In connection with the DIY acquisition, the Company developed an overall integration plan that included the elimination of redundant headcount and facilities. In accordance with ETIF No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination,” the Company accrued approximately $3,400 of estimated costs related to the integration plan in the fourth quarter of 2002. The estimated costs consisted of approximately $1,500 of fixed asset disposals, $900 of facilities costs, $500 of moving expenses and $500 for planned workforce reductions. The integration is expected to be implemented beginning in the fourth quarter of 2003 and be substantially completed by the end of the first quarter of 2004.

Additional reserves have been established in the second quarter of 2003 for costs associated with the integration of the DIY acquisition. Additional costs include severance of $207, inventory adjustments of $1,200, and customer conversion costs which include product buybacks of $1,450.

The following table provides a rollforward from December 31, 2002 to September 30, 2003 of the remaining liabilities and acquisition related charges recorded by the Company:

                                                 
                                 
    Severence &   Facility   Inventory   Fixed Asset   Customer    
    Related Costs
  Lease
  Adjustments
  Disposal
  Conversions
  Total
Balances at December 31, 2002
  $ 495     $ 900     $ 500     $ 1,500     $ —     $ 3,395  
Additions
    —       —       —       —       —       —  
Payments
    (13 )     —       —       —       —       (13 )
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Balances at March 31, 2003
    482       900       500       1,500       —       3,382  
Additions
    207       —       1,200       —       1,450       2,857  
Payments
    (14 )     —       —       —       —       (14 )
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Balances at June 30, 2003
    675       900       1,700       1,500       1,450       6,225  
Additions
    —       —       —       —       —       —  
Payments
    —       —       (122 )     —       (281 )     (403 )
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Balances at September 30, 2003
  $ 675     $ 900     $ 1,578     $ 1,500     $ 1,169     $ 5,822  
 
   
 
     
 
     
 
     
 
     
 
     
 
 

Page 13 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)

4. Contingencies:

Under the Company’s insurance programs, commercial umbrella coverage is obtained for catastrophic exposure and aggregate losses in excess of normal claims. Beginning in 1991, the Company has retained risk on certain expected losses from both asserted and unasserted claims related to worker’s compensation, general liability and automobile as well as the health benefits of certain employees. Provisions for losses expected under these programs are recorded based on an analysis of historical insurance claim data and certain actuarial assumptions. As of September 30, 2003, the Company has provided insurers letters of credit aggregating $3,857 related to certain insurance programs.

Legal proceedings are pending which are either in the ordinary course of business or incidental to the Company’s business. Those legal proceedings incidental to the business of the Company are generally not covered by insurance or other indemnity. In the opinion of management, the ultimate resolution of the pending litigation matters should not have a material adverse effect on the consolidated financial position, operations or cash flows of the Company.

5. Related Party Transactions:

On September 26, 2001, the Company was acquired by Allied Capital pursuant to the terms and conditions of an Agreement and Plan of Merger dated as of June 18, 2001. In connection with the Merger Transaction, the Company is obligated to pay management fees to a subsidiary of Allied Capital for management services rendered in the amount of $1,800 for calendar years subsequent to 2001. The Company has recorded a management fee charge of $450 for the three months and $1,350 for the nine months ended September 30, 2003 and 2002. Payment of management fees is due annually after delivery of the Company’s annual audited financial statements to the Board of Directors of the Company. The management fee for the year ended December 31, 2002 was paid in April 2003.

The Company incurs interest expense to Allied Capital on the subordinated debt at a fixed rate of 18.0% per annum. Cash interest payments are required on a quarterly basis at a fixed rate of 13.5% with the remaining 4.5% fixed rate (the “PIK Amount”) being added to the principal balance. As of September 30, 2003, the outstanding subordinated debt including the PIK amounts was $43,561.

6. Recent Accounting Pronouncements:

In November 2002, the FASB issued Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 requires that a guarantor must recognize, at the inception of a guarantee, a liability for the fair value of the obligation that it has undertaken in issuing a guarantee. FIN No. 45 also addresses the disclosure requirements that a guarantor must include in its financial statements for guarantees issued. The disclosure requirements in this interpretation are effective for financial statements ending after December 15, 2002. The initial recognition and measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company adopted the provisions of FIN No. 45 effective January 1, 2003. The adoption of FIN 45 did not have an impact on the Company’s consolidated financial position, results of operations or cash flows.

Page 14 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)

6. Recent Accounting Pronouncements (continued):

In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities” (an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements”). FIN No. 46 addresses consolidation by business enterprises of variable interest entities that possess certain characteristics. FIN No. 46 requires that if a business enterprise has a controlling financial interest in a variable interest entity, the assets, liabilities, and results of the activities of the variable interest entity must be included in the consolidated financial statements with those of the business enterprise. On October 8, 2003, the FASB deferred the effective date for variable interest entities that existed prior to January 31, 2003. FASB Staff Position FIN 46-6 (“FIN 46-6”) establishes the first interim or annual period ending after December 15, 2003 as the new effective date for variable interest entities that existed prior to January 31, 2003. The Company has elected to defer adoption of FIN No. 46 pending final resolution of the issues currently under discussion at the FASB.

In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS No. 145”). Among other items, SFAS No. 145 updates and clarifies existing accounting pronouncements related to reporting gains and losses from the extinguishment of debt and certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of SFAS No. 145 are generally effective for fiscal years beginning after May 15, 2002, with earlier adoption of certain provisions encouraged. The Company adopted the provisions of SFAS No. 145 effective January 1, 2003. The adoption of SFAS No. 145 did not have an impact on the Company’s consolidated financial position, results of operations or cash flows.

In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS No. 146”). SFAS No. 146 nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF Issue 94-3, a liability for an exit cost as defined in EITF Issue 94-3 was recognized at the date of an entity’s commitment to an exit plan. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002, with earlier application encouraged. Under SFAS No. 146, an entity may not restate its previously issued financial statements and the new statement grandfathers the accounting for liabilities that an entity had previously recorded under EITF Issue 94-3. The Company adopted the provisions of SFAS No. 146 effective January 1, 2003. The adoption of SFAS No. 146 did not have an impact on the Company’s consolidated financial position, results of operations, or cash flows.

In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“SFAS No. 148”). SFAS No. 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the prior disclosure guidance and requires prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The provisions of SFAS No. 148 are generally effective for fiscal years ending after December 15, 2002. At this time the Company does not plan to adopt the accounting provisions of SFAS No. 123 and will continue to account for stock options in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.”

Page 15 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)

6. Recent Accounting Pronouncements (continued):

In May 2003, the FASB issued SFAS No. 149,“Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have an impact on the Company’s consolidated financial position, results of operations, or cash flows.

In May 2003, the FASB issued SFAS No. 150,“Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” The statement requires that an issuer classify financial instruments that are within its scope as a liability. Many of those instruments were classified as equity under previous guidance. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for certain mandatorily redeemable financial instruments. On November 7, 2003, the FASB indefinitely deferred the effective date of SFAS No. 150 for certain mandatorily redeemable financial instruments and therefore the Company has elected to defer adoption.

7. Note Receivable:

On April 13, 2002, the Company entered into a Unit Repurchase Agreement with GC-Sun Holdings, L.P., pursuant to which G-C exercised its call right under the G-C partnership agreement to purchase the Company’s interest in G-C. The Unit Repurchase Agreement closed on June 25, 2002. In exchange for its interest in G-C, the Company received a $10,000 subordinated note from G-C. Interest on the note is payable quarterly at a rate of 18% from May 1, 2002 to April 30, 2003, 17% from May 1, 2003 to April 30, 2004, and 16% thereafter. G-C’s payment of interest on the note is subject to certain restrictions under the terms of the subordinated note agreement. If such restrictions do not permit the current payment of interest in cash when due, accrued interest is added to the principal.

In February 2003, G-C sold the assets of its largest operating division, Kar Products. The proceeds of the sale were primarily used to pay down G-C’s senior creditors. Following the sale of Kar Products, the Company estimated the enterprise value of G-C based on the cash flows and book value of the remaining operating division under a held for sale methodology. The excess of the estimated enterprise value less debt obligations senior to the G-C note were determined to be insufficient to support the value of the G-C note. Accordingly, the Company recorded a $5,657 charge to income in the first quarter of 2003 to write-down the face value of the note and accrued interest thereon to its estimated future cash flows. The Company recorded additional charges to income of $600 in the second quarter of 2003 and $1,400 in the third quarter of 2003 for changes in the assessments of the estimated amounts recoverable under the note.

Page 16 of 32


 

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)

8. Financing Fees:

On September 28, 2001, the Company entered into a $105,000 senior secured credit facility (the “Credit Agreement”) consisting of $50,000 revolving credit (the “Revolver”), a $20,000 term loan (the “Term Loan A”), and a $35,000 term loan (the “Term Loan B”). This Credit Agreement has a five-year term for the Revolver and Term Loan A and a seven-year term for Term Loan B.

On May 1, 2002 the Credit Agreement was amended to provide an additional $10,000 of availability under the revolving credit facility and to increase Term Loan A by $15,000. Proceeds were used to fund the expansion and automation of the Company’s Cincinnati distribution center and to purchase certain assets of the Lowe’s specialty fastener business from R&B, Inc.

On December 23, 2002 the Credit Agreement was amended to provide an additional $4,780 of availability under the revolving credit agreement and to increase Term Loan A by $2,500 and Term Loan B by $2,720. The proceeds were used to fund the previously completed acquisition of the DIY Business.

In May 2003, the Company made additional payments in the amount of $1,420 in connection with the Company’s 2001 Credit Agreement. The payments were capitalized as deferred financing fees and are being amortized over the remaining term of the Revolver, Term Loan A and Term Loan B.

Page 17 of 32


 

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

As discussed in Note 1, the impact of the restatement on the restated components of the Company’s consolidated balance sheet is as follows (in thousands):

                 
    As Reported
  As Restated
September 30, 2003:
               
Deferred income tax assets - current (a)
  $ 10,285     $ 6,654  
Current assets
    126,475       122,844  
Deferred income tax assets - long-term (a)
    21,829       17,647  
Note receivable
    5,000       3,600  
Total assets
    378,431       369,218  
Deferred income tax liabilities - long-term (a)
    5,763       —  
Current liabilities
    222,910       217,147  
Retained earnings (accumulated deficit)
    903       (2,547 )
Total stockholders’ equity
    53,190       49,740  
Total liabilities and stockholders’ equity
    378,431       369,218  

The impact of the restatement on the restated components of the Company’s consolidated statement of operations is as follows (in thousands):

                 
    As Reported
  As Restated
For the three months ended September 30, 2003:
               
Write-down of note receivable
  $ —     $ 1,400  
Income before income taxes
    5,108       3,708  
Net income
    3,120       1,720  
For the nine months ended September 30, 2003:
               
Write-down of note receivable
    6,257       7,657  
Income before income taxes
    1,867       467  
Income tax provision
    964       3,014  
Net income (loss)
    903       (2,547 )

(a)   A reclassification in the amount of $5,763 has been recorded to present the restated deferred income tax assets — long-term net of deferred income tax liability as of September 30, 2003.

The following discussion provides information which management believes is relevant to an assessment and understanding of the Company’s operations and financial condition. This discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere herein.

General

The Hillman Companies, Inc. (“Hillman” or the “Company”), is one of the largest providers of value-added merchandising services and hardware-related products to retail markets in North America.

The Company, through its wholly owned subsidiary, The Hillman Group, Inc. (the “Hillman Group”) provides merchandising services and hardware and related products, such as, fasteners and similar items, key duplication equipment, keys and related accessories and identification equipment and items to retail outlets, primarily hardware stores, home centers and mass merchants.

Hillman is organized as an independently managed portfolio company of Allied Capital Corporation (“Allied Capital”). Allied Capital owns approximately 96.8% of Hillman’s common stock with the remainder being held primarily by Company Management.

Page 18 of 32


 

Financing Arrangements

On December 28, 2000, the Company issued $30 million of unsecured subordinated notes to Allied Capital and issued an additional $10 million of these notes to Allied Capital on September 28, 2001 (the “Amended Subordinated Debt Issuance”). The majority of the cash proceeds generated from the Amended Subordinated Debt Issuance were used to repay at a discount an unsecured subordinated note issued in connection with the acquisition of Axxess Technologies, Inc. on April 7, 2000 (the “Axxess Subordinated Note Repayment”).

On September 28, 2001, the Company refinanced its $115 million bank revolving credit and $21.5 million term loan with $105 million in senior secured credit facilities (the “Refinancing”). The new senior debt agreement (“Credit Agreement”) has a $50 million revolving credit line, a $20 million term loan that expires on September 27, 2006, and a $35 million term loan that expires on September 27, 2008.

On May 1, 2002, the Credit Agreement was amended to provide an additional $10.0 million of availability under the revolving credit facility and to increase the term loans by $15.0 million. Proceeds of the additional financing were used to finance the purchase of the specialty fastener business of Lowe’s, Inc. from R&B, Inc., the settlement of litigation with R&B, Inc. and the expansion and automation of the Company’s distribution facilities.

On December 23, 2002, the Credit Agreement was amended to provide an additional $4.8 million of availability under the revolving credit agreement and to increase the term loans by $5.2 million. As of September 30, 2003, the outstanding balance of the term loans aggregated $62.9 million.

The Company pays interest to the Trust on the Junior Subordinated Debentures underlying the Trust Preferred Securities at the rate of 11.6% per annum on their face amount of $105.4 million, or $12.2 million per annum in the aggregate. The Trust distributes an equivalent amount to the holders of the Trust Preferred Securities.

Acquisitions

On May 1, 2002, the Company purchased certain assets of the Lowe’s specialty fastener business from R&B, Inc. for cash consideration of $6,207. On October 3, 2002, the Company purchased the net assets of the DIY division (“DIY”) of the Fastenal Company for cash consideration of $15,218.

Page 19 of 32


 

Results of Operations

Three Months Ended September 30, 2003 and 2002

Net sales increased $10.4 million or 13.7% in the third quarter of 2003 to $86.1 million from $75.7 million in 2002. Sales to national accounts represented $2.7 million of the $10.4 million total sales increase in the third quarter primarily as a result of increased fastener sales to Lowe’s and increased keys and letters, numbers, and signs (“LNS”) sales to Home Depot. In October 2002, Hillman acquired the DIY division (“DIY”) of the Fastenal Company which contributed fastener related sales of $4.3 million in the third quarter of 2003. Other sales, including regional accounts and engraving products were up $2.3 million compared to the third quarter of 2002. In addition, franchise and independent (“F&I”) accounts increased $1.1 million from the comparable period in 2002. The F&I accounts are typically individual hardware dealers who are members of larger cooperatives, such as TruServ, Ace, and Do-It-Best.

The Hillman Group’s gross profit was 54.9% in the third quarter of 2003 compared to 56.3% in the third quarter of 2002. The margin rate decrease from the prior year was the result of lower margins on the newly acquired DIY business.

The Company’s consolidated selling, general and administrative expenses (“S,G&A”) increased $3.5 million or 12.7% from $27.6 million in the third quarter of 2002 to $31.1 million in the third quarter of 2003. Selling expenses increased $1.7 million or 12.9% primarily as a result of an increase in displays, fixtures and service labor for newly opened national account locations and conversion of merchant displays in existing locations. Warehouse and delivery expenses increased $1.8 million or 20.9% primarily as a result of increased freight and labor of $1.4 million on increased sales volume and labor and other costs of $0.4 million related to operation of the new distribution facility in 2003. General and administrative expenses increased by $0.1 million or 1.8% primarily as a result of an increase in the Company’s medical claims cost.

Total S,G&A expenses in the third quarter of 2003 expressed as a percentage of sales compared with the third quarter of 2002 are as follows:

                 
    Three Months ended Sept. 30,
As a % of Sales
  2003
  2002
Selling Expenses
    17.3 %     17.5 %
Warehouse and Delivery Expenses
    12.1 %     11.4 %
General and Administrative Expenses
    6.8 %     7.5 %
 
   
 
     
 
 
Total S,G&A Expenses
    36.2 %     36.4 %
 
   
 
     
 
 

Income from operations for the third quarter of 2003 was $12.3 million compared with $11.3 million for the same prior-year period, representing an increase of 8.8%.

The Company’s consolidated operating profit margin (income from operations as a percentage of sales) decreased to 14.3% in the third quarter of 2003 compared with 14.9% in 2002. The operating profit margin decrease was the result of the decrease in gross profit which was partially offset by a decrease in operating expenses and an increase in other income expressed as a percentage of sales. The gross profit rate decrease from the comparable prior year period was the result of lower margins on the newly acquired DIY business. Other income increased in the third quarter of 2003 from a $0.4 million gain recorded as a result of a payout received from the Company’s former insurance company upon its demutualization.

Depreciation expense increased $0.5 million to $3.5 million in the third quarter of 2003 from $3.0 million in the same quarter of 2002.

Amortization expense of $0.4 million in the third quarter of 2003 was equal to the amortization in the same quarter of 2002.

The Company has recorded a management fee charge of $0.45 million for the third quarters of 2003 and 2002, respectively. The Company is obligated to pay management

Page 20 of 32


 

fees to a subsidiary of Allied Capital for management services rendered in the amount of $1.8 million for calendar years subsequent to 2001. The payment of management fees is due annually after delivery of the Company’s annual audited financial statements to the Board of Directors of the Company. The management fee for the year ended December 31, 2002 was paid in April, 2003.

In February 2003, G-C Sun Holdings, L.P. (“G-C”) sold the assets of its largest operating division, Kar Products. The proceeds of the sale were primarily used to pay down G-C’s senior creditors. Following the sale of Kar Products, the Company estimated the enterprise value of G-C based on the cash flows and book value of the remaining operating division. The excess of the estimated enterprise value less debt obligations senior to the G-C note were determined to be insufficient to support the value of the G-C note. Accordingly, the Company recorded a $5.7 million charge to income in the first quarter of 2003 to write-down the face value of the note and accrued interest thereon to its estimated future cash flows. The Company recorded additional charges to income of $0.6 million in the second quarter of 2003 and $1.4 million in the third quarter of 2003 for changes in the assessments of the estimated amounts recoverable under the note.

Interest expense from credit facilities, net of interest income, increased $0.8 million to $4.1 million in the third quarter of 2003 from $3.3 million in the same period of 2002. The interest expense increase was the result of additional borrowings used to finance the expansion and automation of the Company’s distribution facility and to purchase two businesses in 2002. A reduction in interest income of $0.5 million resulted from the suspension of interest income on the subordinated note received from G-C.

For the three months ended September 30, 2003 and 2002, the Company paid $3.1 million in interest on the Junior Subordinated Debentures, equivalent to the amounts distributed by the Trust on the Trust Preferred Securities.

The Company is subject to federal, state and local income taxes on its domestic operations and foreign income taxes on its Canadian operation as accounted for in accordance with Statement of Financial Accounting Standard (SFAS) No. 109, “Accounting for Income Taxes.” Deferred income taxes represent differences between the financial statement and tax basis of assets and liabilities as classified on the Company’s balance sheet. The Company recorded a tax provision for income taxes of $2.0 million on pre-tax income of $3.7 million in the third quarter of 2003. The effective tax rate in the third quarter of 2003 was 53.6% compared to 43.8% in the third quarter of 2002. The change in the effective tax rate resulted from the increase in income before taxes in the third quarter of 2003 compared with the third quarter of 2002 and a decrease in the change of permanent tax items in 2003, which includes the write-down on the face of the G-C Note, when compared to 2002.

Nine Months Ended September 30, 2003 and 2002

Net sales increased $25.4 million or 11.8% in the first nine months of 2003 to $240.3 million from $214.9 million in 2002. Sales to national accounts represented $9.2 million of the $25.4 million total sales increase in the first nine months primarily as a result of increased fastener sales to Lowe’s and increased keys and letters, numbers, and signs (“LNS”) sales to Home Depot. In October 2002, Hillman acquired the DIY division (“DIY”) of the Fastenal Company which contributed fastener related sales of $12.8 million in the first nine months of 2003. Other sales, including regional accounts and engraving products were up $5.0 million compared to the first nine months of 2002. Franchise and independent (“F&I”) accounts decreased $1.6 million from the comparable period in 2002. The F&I accounts are typically individual hardware dealers who are members of larger cooperatives, such as TruServ, Ace, and Do-It-Best. The F&I business decline was primarily the result of the unseasonal weather conditions, consumer uncertainties related to the war in Iraq and unfavorable economic conditions during the first half of the year. The F&I sales decline in the first half of 2003 compared to 2002 reversed direction as the economy began to show signs of recovery.

Page 21 of 32


 

The Hillman Group’s gross profit was 54.7% in the first nine months of 2003 compared to 55.5% in the first nine months of 2002. The margin rate decrease from the prior year was the result of lower margins on the newly acquired DIY business.

The Company’s consolidated selling, general and administrative expenses (“S,G&A”) increased $8.0 million or 9.7% from $82.3 million in the first nine months of 2002 to $90.3 million in the first nine months of 2003. Selling expenses increased $1.4 million or 3.4% primarily as a result of an increase in displays, fixtures and service labor for newly opened national account locations and conversion of merchant displays in existing locations. Warehouse and delivery expenses increased $5.8 million or 23.8% primarily as a result of increased freight and labor of $3.4 million on increased sales volume and labor and other costs of $1.6 million related to start up of the new distribution facility in 2003. The start up costs associated with the new distribution facility moderated in the second and third quarters and management does not expect these costs to be material in the fourth quarter. General and administrative expenses increased by $0.7 million or 4.2% primarily as a result of an increase in the Company’s medical claims cost which was partially offset by a reduction in corporate overhead costs following elimination of the Philadelphia corporate office in May 2002. Medical expenses for the first nine months of 2003 include $1.5 million of claims paid under the Company’s group medical insurance plan, which involved claims by an employee for medical services performed at the end of 2002. Management does not anticipate further medical expense of a material amount in connection with these claims.

Total S,G&A expenses in the first nine months of 2003 expressed as a percentage of sales compared with the first nine months of 2002 are as follows:

                 
    Nine Months ended Sept. 30,
As a % of Sales
  2003
  2002
Selling Expenses
    17.8 %     19.3 %
Warehouse and Delivery Expenses
    12.6 %     11.3 %
General and Administrative Expenses
    7.2 %     7.7 %
 
   
 
     
 
 
Total S,G&A Expenses
    37.6 %     38.3 %
 
   
 
     
 
 

Income from operations for the first nine months of 2003 was $29.0 million compared with $27.4 million for the same prior-year period, representing an increase of 5.8%.

The Company’s consolidated operating profit margin (income from operations as a percentage of sales) was 12.0% in the first nine months of 2003 compared with 12.7% in 2002. The operating profit margin reduction was due primarily to the decrease in gross profit and the increase in depreciation expense expressed as a percentage of sales. In addition, the favorable effect of a reduction in S,G&A expenses as a percentage of sales was offset by a corresponding decrease in other income compared to the prior year. The gross profit rate decrease from the comparable prior year period was the result of lower margins on the newly acquired DIY business. The increase in depreciation expense for the first nine months of 2003 compared to the prior year period was due to the increase in depreciable fixed assets for the new distribution facility placed into service in January 2003 and increased key machine placements. The smaller S,G&A expense as a percentage of sales in 2003 was due to a reduction in costs associated with promotional marketing materials and corporate overhead expenses. Other income was reduced in the first nine months of 2003 as a result of the $1.2 million gain on termination of the STS pension plan recorded in the prior year compared to the $0.4 gain from the payment received in 2003 from General American Insurance Company upon its demutualization.

Depreciation expense increased $1.6 million to $10.4 million in the first nine months of 2003 from $8.8 million in the same period of 2002.

Amortization expense of $1.1 million in the first nine months of 2003 was equal to the amortization in the same period of 2002.

The Company has recorded a management fee charge of $1.4 million for the first nine months of 2003 and 2002, respectively. The Company is obligated to pay management fees

Page 22 of 32


 

to a subsidiary of Allied Capital for management services rendered in the amount of $1.8 million for calendar years subsequent to 2001. The payment of management fees is due annually after delivery of the Company’s annual audited financial statements to the Board of Directors of the Company. The management fee for the year ended December 31, 2002 was paid in April, 2003.

In February 2003, G-C sold the assets of its largest operating division, Kar Products. The proceeds of the sale were primarily used to pay down G-C’s senior creditors. Following the sale of Kar Products, the Company estimated the enterprise value of G-C based on the cash flows and book value of the remaining operating division. The excess of the estimated enterprise value less debt obligations senior to the G-C note were determined to be insufficient to support the value of the G-C note. Accordingly, the Company recorded a $5.7 million charge to income in the first quarter of 2003 to write-down the face value of the note and accrued interest thereon to its estimated future cash flows. The Company recorded additional charges to income of $0.6 million in the second quarter of 2003 and $1.4 million in the third quarter of 2003 for changes in the assessments of the estimated amounts recoverable under the note.

Interest expense from credit facilities, net of interest income, increased $1.7 million to $11.7 million in the first nine months of 2003 from $10.0 million in the same period of 2002. The increase was primarily the result of additional borrowings to finance the expansion and automation of the Company’s distribution facility, to purchase the Lowe’s specialty fastener business from R&B, Inc. in May 2002, and to purchase the DIY business from Fastenal Company in October 2002. A reduction in interest income of $0.8 million resulted from the suspension of interest income on the subordinated note received from G-C.

For the nine months ended September 30, 2003 and 2002, the Company paid $9.2 million in interest on the Junior Subordinated Debentures, equivalent to the amounts distributed by the Trust on the Trust Preferred Securities.

The Company is subject to federal, state and local income taxes on its domestic operations and foreign income taxes on its Canadian operation as accounted for in accordance with Statement of Financial Accounting Standard (SFAS) No. 109, “Accounting for Income Taxes.” Deferred income taxes represent differences between the financial statement and tax basis of assets and liabilities as classified on the Company’s balance sheet. The Company recorded a tax provision for income taxes of $3.0 million on pre-tax income of $0.5 million in the first nine months of 2003. The effective tax rate in the first nine months of 2003 was 645.4% compared to 43.3% in the first nine months of 2002. The increase in the effective tax rate was the result of the decrease in income before taxes in 2003 as compared to 2002 together with an increase in the permanent tax items which include the write-down on the face of the G-C Note.

Cash Flows

The statements of cash flows reflect the changes in cash and cash equivalents for the nine months ended September 30, 2003 and 2002 by classifying transactions into three major categories: operating, investing and financing activities.

Operating Activities

The Company’s main source of liquidity is cash generated from operating activities consisting of net earnings from operations adjusted for non-cash operating items such as depreciation and changes in operating assets and liabilities such as receivables, inventories and payables.

Cash used by operating activities for the first nine months of 2003 was $2.1 million compared to cash provided of $15.7 million in the same prior year period. The negative net change of $17.8 million in the current nine months compared to the same period in 2002 was primarily due to the use of $13.9 million more operating cash to fund the increased inventory, accounts receivable, and other asset requirements. The increased inventory was used to facilitate the transition of sales order volume from the Company’s Tempe facility to the new Cincinnati distribution facility and to support the Company’s increased sales volume. The transition of sales order volume was

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substantially complete as of September 30, 2003. The accounts receivable increase in 2003 compared to 2002 was also a function of higher sales levels. An additional $2.1 million more operating cash was used this year to fund the higher customer pricing allowances earned and accrued in 2002, but paid in 2003. The sales improvement recorded in 2002 produced the increased amount of customer allowances paid in 2003.

Investing Activities

The principal recurring investing activities are property additions primarily for key duplicating machines. Net property additions for the first nine months of 2003 were $8.5 million compared to $17.7 million in the comparable prior year period. The decrease in capital expenditures in the first nine months of 2003 compared to the prior year period results from a decrease in the amount of expenditures for the automated distribution center in Cincinnati which was completed in November 2002 and placed into service in January 2003.

Financing Activities

Net borrowings under the Company’s senior credit facilities of $8.3 million for the nine months ended September 30, 2003 increased $0.8 million from the comparable prior year period as a result primarily of cash flow used for operations.

Liquidity and Capital Resources

The Company’s working capital position (defined as current assets less current liabilities) of $65.6 million at September 30, 2003 represents an increase of $19.1 million from the December 31, 2002 level of $46.5 million primarily as a result of the seasonal increase in accounts receivable of $14.4 million and an inventory increase of $5.4 million resulting from seasonal requirements as well as a build up of stock to facilitate the transition of sales order volume from the Company’s Tempe facility to the new Cincinnati distribution center. The Company’s current ratio (defined as current assets divided by current liabilities) increased to 2.14x at September 30, 2003 from 1.77x at December 31, 2002.

The Company’s contractual obligations in thousands of dollars as of September 30, 2003 are summarized below:

                                 
                    Payments Due
   
            Less Than   1 to 3   More Than
Contractual Obligations   Total
  One Year
  Years
  3 Years
Guaranteed Preferred Beneficial Interests
                               
in the Company’s Junior Subordinated Debentures
  $ 105,446       —       —     $ 105,446  
Long Term Senior Term Loans
    62,875     $ 9,268     $ 18,537       35,070  
Bank Revolving Credit Facility
    51,308       —       —       51,308  
Long Term Unsecured Subordinated Notes
    43,561       —       —       43,561  
Operating Leases
    32,509       6,756       10,015       15,738  
Deferred Compensation Obligations
    6,672       948       1,896       3,828  
Capital Lease Obligations
    209       66       105       38  
Other Long Term Obligations
    6,902       1,696       1,955       3,251  
 
   
 
     
 
     
 
     
 
 
Total Contractual Cash Obligations
  $ 309,482     $ 18,734     $ 32,508     $ 258,240  
 
   
 
     
 
     
 
     
 
 

All of the obligations noted above are reflected on the Company’s Consolidated Balance Sheet as of September 30, 2003, except for the Operating Leases.

As of September 30, 2003, the Company had $9.6 million available under its secured credit facilities. The Company had approximately $114.4 million of outstanding debt under its secured credit facilities at September 30, 2003, consisting of $62.9 million in term loans, $51.3 million in revolving credit borrowings and $0.2 million in capitalized lease obligations. The term loans consisted of a $36.7 million Term B Loan (the “Term Loan B”) currently at a three (3) month LIBOR rate of 4.94% and a $26.2 million Term A loan (the “Term Loan A”) at a one (1) month LIBOR rate of 4.625%. The

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revolver borrowings (the “Revolver”) consist of $20.0 million currently at a two (2) month LIBOR rate of 4.625%, $14.0 million at a three (3) month LIBOR rate of 4.6875%, $15.0 million at a three (3) month LIBOR rate of 4.625% and $2.3 million at the prime rate of 6.00%. The capitalized lease obligations were at various interest rates.

As of September 30, 2003 the Company had no material purchase commitments for capital expenditures.

Interest on the Amended Subordinated Debt Issuance of $40 million which matures September 29, 2009 is at a fixed rate of 18.0% per annum, with cash interest payments being required on a quarterly basis at a fixed rate of 13.5% commencing November 15, 2001. The outstanding principal balance of the Amended Subordinated Debt Issuance shall be increased on a quarterly basis at the remaining 4.5% fixed rate (the “PIK Amount”). All of the PIK Amounts are due on the fifth anniversary of the Amended Subordinated Debt Issuance. As of September 30, 2003, the outstanding Amended Subordinated Debt Issuance including the PIK Amounts was $43.6 million.

The Senior Credit Agreement, among other provisions, contains financial covenants requiring the maintenance of specific ratios and levels of financial position, restricts the incurrence of additional debt, and the sale of assets, and permits acquisitions only with the consent of the lenders. The Company was in full compliance with all provisions of the Senior Credit Agreement as of September 30, 2003.

The Company has net deferred tax assets aggregating $24.3 million as of September 30, 2003, as determined in accordance with SFAS 109. Management believes that the Company’s deferred tax assets will be realized through the reversal of existing temporary differences between the financial statement and tax basis, as well as through future taxable income.

Critical Accounting Policies and Estimates

The Company’s accounting policies are more fully described in Note 2, Summary of Significant Accounting Policies, of Notes To Consolidated Financial Statements. As disclosed in Note 2, the preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results may differ from those estimates, and such differences may be material to the consolidated financial statements.

The most significant accounting estimates inherent in the preparation of the Company’s consolidated financial statements include estimates associated with its evaluation of the recoverability of goodwill as well as those used in the determination of liabilities related to insurance programs, litigation, and taxation. In addition, significant estimates form the basis for the Company’s reserves with respect to sales and returns allowances, collectibility of accounts receivable, inventory valuations, deferred tax assets, and certain benefits provided to current employees. Various assumptions and other factors underlie the determination of these significant estimates. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, current and expected economic conditions and product mix. The Company constantly re-evaluates these significant factors and makes adjustments where facts and circumstances dictate. Specific factors are as follows: recoverability of goodwill and intangible assets are subject to annual impairment testing; litigation is based on projections provided by legal counsel; realization of certain deferred tax assets are based on the Company’s projections of future taxable income; sales and returns and allowances are based on historical activity and customer contracts; accounts receivable reserves are based on doubtful accounts and aging of outstanding balances; inventory reserves are based on expected obsolescence and excess inventory levels; and employee benefits are based on benefit plan requirements and severance agreements. Historically, actual results have not significantly deviated from those determined using the estimates described above.

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Revenue Recognition:

Revenue from sales of products is recorded upon the passing of title and risks of ownership to the customer, which occurs upon the shipment of goods.

The Company offers a variety of sales incentives to its customers primarily in the form of discounts and rebates. Discounts are recognized in the financial statements at the date of the related sale. Rebates are estimated based on the anticipated rebate to be paid and a portion of the estimated cost of the rebate is allocated to each underlying sales transaction. Rebates and discounts are included in the determination of net sales.

The Company also establishes reserves for customer returns and allowances. The reserve is established based on historical rates of returns and allowances. The reserve is adjusted quarterly based on actual experience.

Inventory Realization:

Inventories consisting predominantly of finished goods are valued at the lower of cost or market, cost being determined principally on the first-in, first-out method. Excess and obsolete inventories are carried at net realizable value. The historical usage rate is the primary factor used by the Company in assessing the net realizable value of excess and obsolete inventory. A reduction in the carrying value of an inventory item from cost to market is recorded for inventory with no usage in the preceding twelve month period or with on hand quantities in excess of twenty-four months average usage.

Property and Equipment:

Property and equipment, including assets acquired under capital leases, are carried at cost and include expenditures for new facilities and major renewals. Maintenance and repairs are charged to expense as incurred. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and the resulting gain or loss is reflected in current operations.

Depreciation:

For financial accounting purposes, depreciation, including that related to plant and equipment acquired under capital leases, is computed on the straight-line method over the estimated useful lives of the assets, generally three to ten years, or, if shorter, over the terms of the related leases.

Goodwill and Other Intangible Assets:

Prior to January 1, 2002, the Company recorded goodwill related to the excess of acquisition cost over the fair value of net assets acquired and amortized the goodwill on a straight-line basis over twenty-five to forty years. The Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets” and accordingly, goodwill is no longer amortized, but is reviewed periodically for impairment. Other intangible assets arising principally from acquisitions are amortized on a straight-line basis over periods ranging from three to twenty-five years.

Long-Lived Assets:

Under the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company has evaluated its long-lived assets for financial impairment and will continue to evaluate them based on the estimated undiscounted future cash flows as events or changes in circumstances indicate that the carrying amount of such assets may not be fully recoverable.

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Income Taxes:

Deferred income taxes are computed using the asset and liability method. Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities (temporary differences) and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are provided for tax benefits where it is more likely than not that certain future tax benefits will not be realized. Adjustments to valuation allowances are recorded from changes in utilization of the tax related item.

Self-insurance Reserves:

The Company purchases third party insurance for worker’s compensation, automobile, product and general liability claims that exceed a certain level. However, the Company is responsible for the payment of claims under these insured limits. In estimating the obligation associated with incurred losses, the Company utilizes loss development factors prepared by consulting insurance carriers. These development factors utilize historical data to project the future development of incurred losses. Loss estimates are adjusted based upon actual claims settlements and reported claims.

The Company also purchases third party insurance for group medical claims that exceed a certain level on an individual claim basis and in the aggregate for a plan year. The Company is responsible for the payment of claims under the specific and aggregate insured limits. Reserves for the incurred, but not reported losses are estimated based on several factors including historical claims experience and claims payment lag time information.

Retirement Benefits:

Certain employees of the Company are covered under a profit-sharing and retirement savings plan (the “plan”). The plan provides for a matching contribution for eligible employees of 50% of each dollar contributed by the employee up to 6% of employee’s compensation. In addition, the plan provides an annual contribution in amounts authorized by the Board, subject to the terms and conditions of the plan.

Shipping and Handling

The costs incurred to ship product to customers, including freight and handling expenses, are included in selling, general and administrative (“SG&A”) expenses on the Company’s Statements of Operations. For the three months ended September 30, 2003 and 2002, shipping and handling costs included in SG&A were $4,044 and $3,704, respectively. For the nine months ended September 30, 2003 and 2002, shipping and handling costs included in SG&A were $11,906 and $10,380, respectively.

Research and Development:

The Company incurs research and development costs in connection with improvements to the key duplicating and engraving machines. For the three months ended September 30, 2003 and 2002, research and development expenses, consisting primarily of internal wages and benefits, were $424 and $413, respectively. For the nine months ended September 30, 2003 and 2002, research and development expenses were $1,148 and $1,166, respectively.

Fair Value of Financial Instruments:

Cash, accounts receivable, short-term borrowings, accounts payable, accrued liabilities and bank revolving credit are reflected in the consolidated financial statements at fair value due to short-term maturity or revolving nature of these instruments.

Translation of Foreign Currencies:

The translation of the Company’s Canadian foreign currency based financial statements into U.S. dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for revenue and expense accounts using an average exchange rate during the period.

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Comprehensive Income:

The components of comprehensive income (loss) for the three and nine month periods ended September 30, 2003 and 2002 were as follows:

                                 
    Three Months Ended   Nine Months Ended
    September 30   September 30
    2003
  2002
  2003
  2002
    (Restated)           (Restated)        
Net income (loss)
  $ 1,720     $ 2,789     $ (2,547 )   $ 4,627  
Foreign currency translation adjustment
    1       7       (99 )     3  
 
   
 
     
 
     
 
     
 
 
Comprehensive income (loss)
  $ 1,721     $ 2,796     $ (2,646 )   $ 4,630  
 
   
 
     
 
     
 
     
 
 

Use of Estimates in the Preparation of Financial Statements:

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Please reference Note 2, Summary of Significant Accounting Policies, of Notes To Consolidated Financial Statements for additional related information.

Reclassifications:

Certain amounts in our 2002 consolidated financial statements have been reclassified to conform to the 2003 presentation.

Inflation

Inflation in recent years has had a modest impact on the operations of the Company. Continued inflation, over a period of years at higher than current rates, would result in significant increases in inventory costs and operating expenses. However, such higher cost of sales and operating expenses can generally be offset by increases in selling prices, although the ability of the Company’s operating divisions to raise prices is dependent on competitive market conditions.

Forward Looking Statements

Certain disclosures related to acquisitions, refinancing, capital expenditures, resolution of pending litigation and realization of deferred tax assets contained in this report involve risks and uncertainties and may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We have based these forward-looking statements on our current expectations, assumptions and projections about future events. These forward-looking statements are subject to known and unknown risks, uncertainties and assumptions that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. Actual results could differ materially from those currently anticipated as a result of a number of factors, including the risks and uncertainties discussed under captions “Risk Factors” set forth in Item 1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. Given these uncertainties, current or prospective investors are cautioned not to place undue reliance on any such forward-looking statements.

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In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” “project” or the negative of such terms or other similar expressions. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements included in this Report. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Report might not occur.

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Item 3.

Quantitative and Qualitative Disclosures About Market Risk

The Company is exposed to the impact of interest rate changes as borrowings under the senior credit facility bear interest at variable interest rates. It is Hillman’s policy to enter into interest rate transactions only to the extent considered necessary to meet objectives. On March 31, 2002, the Company entered into an interest rate cap agreement on a notional amount of $26.6 million of senior term debt. The interest rate cap agreement, which expires September 30, 2004, caps the LIBOR interest rate at 6% plus the senior credit facility LIBOR margin of between 3.25% and 3.75%. Based on Hillman’s exposure to variable rate borrowings at September 30, 2003, a one percent (1%) change in the weighted average interest rate would change the annual interest expense by approximately $1.0 million.

The Company is exposed to foreign exchange rate changes of the Canadian currency as it impacts the $0.8 million net asset value of its Canadian subsidiary, The Hillman Group Canada, Ltd., as of September 30, 2003. Management considers the Company’s exposure to foreign currency translation gains or losses to be minimal.

Item 4.

Controls and Procedures

(a) As of the end of the period covered by this quarterly report on Form 10-Q, the Company’s chief executive officer and chief financial officer conducted an evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15 and 15d-15 of the Securities Exchanges Act of 1934). Based upon this evaluation, the Company’s chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them of any material information relating to the Company that is required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act of 1934.

(b) There have been no changes in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2003, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II
OTHER INFORMATION

Items 1, 2, 3, 4 & 5 - None

Item 6 - Exhibits and Reports on Form 8-K

      a) Exhibits, Including Those Incorporated by Reference.

     
31.1
  * Certification of chief executive officer pursuant to rule 13a-14(a) or 15d- 14(a) under the Securities Exchange Act of 1934.
 
   
31.2
  * Certification of chief financial officer pursuant to rule 13a-14(a) or 15d-14(a) under Securities Exchange Act of 1934.
 
   
32.1
  + Certification of chief executive officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
   
32.2
  + Certification of chief financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
*
  Filed herewith.
+
  Submitted herewith.

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SIGNATURES

Pursuant to the requirements 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.

THE HILLMAN COMPANIES, INC.

     
  /s/ James P. Waters
    /s/ Harold J. Wilder

 
  James P. Waters
    Harold J. Wilder
  Vice President - Finance
    Controller
  (Chief Financial Officer)
    (Chief Accounting Officer)

DATE: March 26, 2004

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