UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

The Hillman Companies, Inc.

(Exact name of registrant as specified in its charter)

Delaware		23-2874736
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		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		None

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES o           NO þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act of 1934. YES o           NO þ

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 o           NO þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one)

Large accelerated filer o Accelerated filer o Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act.           YES o           NO þ

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

On March 30, 2006, there were 6,212.9 Class A Common Shares issued and outstanding, 1,000.0 Class B Common Shares issued and outstanding, 2,787.1 Class C Common Shares issued and outstanding, 82,104.8 Class A Preferred Shares issued and outstanding by the Registrant and 57,282.4 Class A Preferred Shares issued and outstanding by the Hillman Investment Company 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. The aggregate market value of the Trust Preferred Securities held by non-affiliates at June 30, 2005 was $121,892,224.

 

 

PART I

Item 1 – Business.

General

The Hillman Companies, Inc. (“Hillman” or the “Company”) is one of the largest providers of hardware-related products and related merchandising services to retail markets in North America. The Company’s principal business is operated through its wholly-owned subsidiary, The Hillman Group, Inc. (the “Hillman Group”) which had sales of approximately $382.5 million in 2005. The Hillman Group sells its products to hardware stores, home centers, mass merchants, pet supply stores, and other retail outlets principally in the United States, Canada, Mexico and South America. Product lines include thousands of small parts such as fasteners and related hardware items; keys, key duplication systems and accessories; and identification items, such as, tags and letters, numbers, and signs. The Company supports its product sales with value added services including design and installation of merchandising systems and maintenance of appropriate in-store inventory levels.

The Company headquarters is located at 10590 Hamilton Avenue, Cincinnati, Ohio. The Company maintains a website at http://www.hillmangroup.com. Information contained or linked on our website is not incorporated by reference into this annual report, and you should not consider any such information to be a part of this annual report.

Background

On March 18, 2002, SunSource Inc., a Delaware corporation (“SunSource”), as a result of the acquisition of a majority of SunSource common stock by Allied Capital Corporation in September 2001, changed its name to The Hillman Companies, Inc., which reflects its predominant business as one of the largest providers of hardware-related products and related merchandising services to the retail markets in North America. In connection with the SunSource name change, SunSource Capital Trust, which has 4.2 million Trust Preferred Securities outstanding and trading on the American Stock Exchange under the symbol “HLM.Pr”, changed its name to the Hillman Group Capital Trust.

On March 31, 2004, Hillman was acquired by an affiliate of Code Hennessy & Simmons LLC (“CHS”). Pursuant to the terms and conditions of the related Agreement and Plan of Merger (“Merger Agreement”), dated as of February 14, 2004, the Company was merged with an affiliate of CHS with the Company surviving the merger (“Merger Transaction”). The total consideration paid in the Merger Transaction was $511.6 million including the repayment of outstanding debt and the value of the Company’s outstanding Trust Preferred Securities.

As a result of the change of control, an affiliate of CHS owns 49.1% of the Company’s common stock and 54.5% of the Company’s voting common stock, Ontario Teacher’s Pension Plan (“OTPP”) owns 27.9% of the Company’s common stock and 31.0% of the Company’s voting common stock and HarbourVest Partners VI owns 8.7% of the Company’s common stock and 9.7% of the Company’s voting common stock. OTPP’s voting rights with respect to the election of directors to the Board of Directors is limited to the lesser of 30.0% or the actual percentage of voting common stock held. Certain members of management own 14.1% of the Company’s common stock and 4.5% of the Company’s voting common stock. For a discussion of the Company’s capital stock, see Note 12, Common and Preferred Stock, of Notes to Consolidated Financial Statements.

On January 5, 2006, the Company’s Hillman Group, Inc. subsidiary purchased certain assets of The SteelWorks Corporation (“Steelworks”), a Denver, Colorado based manufacturer and distributor of metal shapes, threaded rod and metal sheet to the retail hardware and home improvement industry. Annual revenues of the SteelWorks customer base acquired are approximately $31 million. The aggregate purchase price was $34.2 million paid in cash at closing.

For additional information on certain of the transactions, see “Item 7 — Management’s Discussion and Analysis of Financial Conditions and Results of Operations.”

Industry Overview

Hillman operates in multiple channels of the retail marketplace such as hardware stores, national and regional home centers and mass merchants. Hillman focuses on delivering merchandising systems, point-of-sale displays, product support and sales installation services through its nationwide field sales and service force to the retail sector.

These retail channels have experienced significant change as a result of the growth of the large national big box (“Big Box”) chains (defined as mass merchants, home centers and large-format grocery/drug centers), which have taken market share from the regional home centers and independent hardware dealers and cooperatives. Hillman has developed sales, marketing, merchandising and service specifically to meet the needs of the Big Box chains. Hillman believes that its market knowledge, merchandising skills, breadth of inventory, and value-added services, including support and fulfillment capabilities, will enable the Company to maintain its good relationships with the Big Box chains.

The Hillman Group

The Company is organized as a single business segment, the Hillman Group. With annualized sales of approximately $382.5 million, the Hillman Group believes it is a leading provider of fasteners and related small hardware items; keys, key duplication systems and related accessories, and identification items, such as tags and letters, numbers and signs to retail outlets in North America. Retail outlets served by Hillman include hardware stores, home centers, mass merchants, pet supply stores, grocery stores and drug stores. Through its field sales and service organization, Hillman complements its extensive product selection with value-added services for the retailer.

Sales and service representatives regularly visit retail outlets to review stock levels, reorder items in need of replacement, and interact with the store management to offer new product and merchandising ideas. Thousands of items can be actively managed with the retailer experiencing a substantial reduction in paperwork and labor costs. Service representatives also assist in organizing the products in a consumer-friendly manner. Hillman complements its broad range of products with value-added merchandising services such as displays, product identification stickers, retail price stickers, store rack and drawer systems, assistance in rack positioning and store layout, and inventory restocking services. Hillman regularly introduces new products and package designs with color-coding for ease of shopping by consumers and modifies rack designs to improve the attractiveness of individual store displays. Hillman functions as a merchandising manager for retailers, supporting these services with high order fill rates and rapid delivery from its 12 distribution centers across the United States and Canada. Currently, orders are shipped within 48 hours with a 97% order fill rate.

The Company ships its products from 12 strategically located distribution centers in the United States and Canada (See Item 2 – Properties). In 2002, Hillman invested $9.8 million in a state of the art distribution facility in Cincinnati, Ohio. In addition to improving order turnaround time and reducing labor costs, the new facility provides additional capacity to accommodate future sales growth. In 2004, the Company moved into a new facility in Lewisville, Texas, and the implementation of warehouse management technology was completed in December. In June 2005, warehouse management software was implemented in the Shafter, California facility. Hillman utilizes a third party logistics provider to warehouse and ship customer orders in Mexico.

Hillman also manufactures and markets a value-added mix of high-tech and conventional products in two core product categories: key duplication systems and identification systems. The patent-protected Axxess Precision Key Duplication System™ has proven to be a profitable revenue source within Big Box retailers. The technology developed for this system revolutionized the key duplicating process utilizing computer aided alignment, indexing and duplication of keys. This system has been placed in over 14,000 retail locations to date and is supported by Hillman sales and service representatives.

In addition, Hillman offers a commercialized, consumer-operated vending system, Quick-Tag™, which provides custom engraved specialty items, such as pet identification tags, luggage tags and other engraved identification tags. To date, more than 3,450 Quick-Tag™ machines have been placed in retail locations which are being supported by Hillman’s sales and service representatives.

     Products and Suppliers

Currently, Hillman purchases its products from approximately 650 vendors, the largest of which accounted for approximately 9% of Hillman’s annual purchases and the top five of which accounted for 32.7% of its purchases. About 42% of its purchases are from overseas suppliers, with the balance from domestic manufacturers and master distributors. Hillman’s vendor quality control procedures include on-site evaluations and frequent product testing. Vendors are also evaluated based on delivery performance and the accuracy of their shipments.

     Fasteners

Hillman’s fastener product line encompasses standard and specialty nuts, bolts, washers, screws, anchors and picture hanging items. The line also includes brass, nylon, stainless steel, chrome and galvanized and other miscellaneous fasteners. The depth of the line, over 40,000 products, is believed to be the largest among suppliers servicing the hardware retail segment. Fasteners generated 58.7% of total revenue in 2005.

     Keys and Key Accessories

Hillman provides a line of metal key products for major retailers and the automotive sector. Hillman manufactures two metal key duplication systems that are niche-marketed to retail outlets, primarily mass merchants and home centers, and a code cutting system for use in automotive dealerships and in vehicle fleet environments.

The Axxess Precision Key Duplication System™ produces duplicate keys with the precision of a locksmith while minimizing the technical skill required by operators. The system was developed in response to retailers’ needs for reducing the miscut rate on keys. Axxess keys provide retailers with nearly ten times more gross profit per square foot than the average of all products sold in grocery and mass merchant channels.

Hillman also markets a conventional key cutting system. The styles of keys marketed include standard brass keys, Wackeys™, NFL, MLB, NCAA logo keys, Color Plus™ keys, rubber head keys, and high security vehicle anti-theft key blanks. The conventional system is marketed to retailers who do not experience high employee turnover and therefore do not have the same labor constraints as mass merchants, home centers or grocery and drug retailers.

The key cutting system developed for the automotive industry, PC+ Code Cutter, produces automobile keys using alphanumeric codes based on a vehicle’s identification number. Utilizing a proprietary computer program, the PC+ Code Cutter identifies and then cuts keys based on the automobile’s original key pattern. The PC+ Code Cutter is distributed through Barnes Distribution, a distribution company serving vehicular and industrial markets. Since its introduction in February 1996, more than 7,900 PC+ Code Cutter and 4,100 of the new Flash Code Cutter systems have been sold.

Hillman also markets key accessories in conjunction with its key duplication systems. Popular accessories include the Key Light™, Valet KeyChain™, Fanatix™ key identifiers, key coils and key clips. The Key Mates™ line of key accessories includes a broad range of products such as key chains, tags, lights, floats, holders, whistles, and a host of other miscellaneous complementary items. Revenues for keys, key accessories, and the PC+ Code Cutter represented 24.3% of total revenues in 2005.

     Engraving

Quick-Tag™ is a patented, state-of-the-art consumer-operated vending system that custom engraves specialty products such as pet identification tags, military-style I.D. tags, holiday ornaments and luggage tags. Hillman initially targeted the pet identification

market with its Quick-Tag™ system, and has facilitated the process of obtaining a pet tag by providing pet owners with a quick and convenient means to custom engrave tags while shopping at large format retail stores such as Wal-Mart and PetSmart. Hillman has developed other high impact applications for its Quick-Tag™ interactive engraving technology, including luggage tags, key chains and military-style identification tags. The Company has placed over 3,450 Quick-Tag machines in retail outlets throughout the United States and Canada. Using an interactive touch screen, customers input information such as a pet name and telephone number, and the system’s proprietary technology engraves the tag in less than two minutes. The Quick-Tag system does not require incremental labor and generates high levels of customer satisfaction and attractive margins for the retailer. The Quick-Tag custom engraving systems generate retail profit per square foot over seven times the typical retail average. Revenues for engraving products represented 8.4% of total revenues in 2005.

Hillman purchases a wide variety of materials and components to manufacture the Axxess Key Duplication and Quick-Tag engraving machines, many of which are manufactured to its specifications. Management does not believe that it is overly dependent on any one supplier. The machine components do not generally require proprietary technology and Hillman has identified or used alternate suppliers for its primary sourcing needs.

     Letters, Numbers and Signs (“LNS”)

The LNS program offers an extensive collection of items for both domestic and commercial use such as packaged self-adhesive letters and numbers, mailbox numbers and accessories, house numbers and letters, contractor safety program signs, and driveway markers and reflectors. Typical retailers dedicate eight linear feet of retail space for this product and view it as a significant contributor to their retail offerings. Hillman also offers a variety of merchandisers and program configurations for this line. LNS sales accounted for 8.6% of 2005 revenues.

     Markets and Customers

Hillman sells its products to national accounts such as Wal-Mart, Home Depot, Lowe’s, Sears, Tractor Supply, PetSmart, and PETCO. Hillman’s status as a national supplier of unique, proprietary products to Big Box retailers allows it to develop a strong market position and high barriers to entry within its product categories. Management believes that the dynamics, which make its services attractive to hardware retailers, are present with these larger customers as well.

Hillman services approximately 15,000 franchise and independent (“F&I”) retail outlets. These individual dealers are typically members of the larger cooperatives, such as True Value, Ace and Do-it-Best. The Company sells directly to the cooperative’s retail locations and also supplies many fastener items to the cooperative’s central warehouses. These central warehouses distribute to their members that do not have a requirement for Hillman’s in-store service. These arrangements reduce credit risk and logistic expense for Hillman and reduce central warehouse inventory and delivery costs for the cooperatives.

A typical hardware store maintains in inventory thousands of different items, many of which generate small dollar sales but large profits. It is difficult for a retailer to economically monitor all stock levels and to reorder the products from multiple vendors. The problem is compounded by the necessity of receiving small shipments of inventory at different times and having to stock the goods. However, failure to have these small items available will have an adverse effect on store traffic, thereby denying the retailer the opportunity to sell items that generate higher dollar sales.

Hillman sells its products to approximately 21,500 customers, the top five of which accounted for 44.3% of its annualized sales. Lowe’s is the single largest customer, representing 18.4% of total sales, Home Depot is the second largest at 10.9% and Wal-Mart is the third largest at 9.5%. No other customer accounted for more than 5% of the Company’s total sales in 2005.

Hillman’s telemarketing activity sells to thousands of smaller hardware outlets and non-hardware accounts. New business is also being pursued internationally in such places as Canada, Mexico, South and Central America, and the Caribbean.

     Sales and Marketing

Management believes that Hillman provides excellent product support, customer service and profit opportunities for its retail distribution partners. It also believes that a significant source of its competitive advantage rests in its ability to provide a greater level of customer service than its competitors. Hillman products are covered directly by the combined field service organization, which provides service support through field visits. These field visits provide Hillman with critical information relating to consumer buying patterns and retailing trends, and complements their new product development efforts. Field service representatives also help retail customers to improve the efficiency and profitability of Hillman’s on-site merchandising systems by consulting with customers in the areas of EDI, product planning, inventory control, systems interface and store operations.

The national accounts field service organization consists of over 440 service people and 28 field managers focusing on Big Box retailers, pet super stores, large national discount chains and grocery stores. This organization reorders products, details store shelves and sets up in-store promotions.

Management believes the Company consistently is able to be responsive to the needs of the F&I retailers because it employs the largest direct sales organization in the retail home industry. This organization consists of 224 people, managed by 16 field managers. Each sales representative is responsible for approximately 50 full service accounts that they call on approximately every two weeks. Coupled with the efforts of the Marketing Department, the sales force not only sells products, but can sell merchandising and technological support capabilities as well. The Marketing Department provides support through the development of new products, sales collateral material, promotional items, merchandising aids and marketing services such as advertising and trade show management. Its electronic data interchange (“EDI”) system is used by a number of its large customers for handling of orders and invoices.

     Competition

The primary competitors in the national accounts marketplace for fasteners are Crown-Bolt, ITW Inc., R&B, Inc. and the Newell Group. Competition is based primarily on in-store service and price. Other competitors are local and regional distributors.

The principal competitors for Hillman’s F&I business are Midwest Fasteners, Serv-A-Lite and Hyko in the hardware store marketplace. The first two carry mainly fastener products, while the latter is the major competitor in LNS products and keys. Hillman competes primarily on field service, merchandising, as well as product availability, price and breadth of product line.

Management estimates that Hillman sells to approximately 65% of the full service hardware stores in the F&I marketplace. The hardware outlets that purchase products but not services from Hillman also purchase products from local and regional distributors and cooperatives. Competition in the F&I marketplace is primarily on the basis of price and availability.

Hillman competes with Hyko for LNS sales in hardware stores, home centers and mass merchants. Competitors in the pet tag market are specialty retailers, direct mail order and retailers with in-store mail order capability. The Quick-Tag system has patent protected proprietary technology that is a major barrier to entry and preserves this market segment.

Insurance Arrangements

Under the Company’s current insurance programs, commercial umbrella coverage is obtained for catastrophic exposure and aggregate losses in excess of expected claims. Since October 1991, the Company has retained the exposure on certain expected losses related to worker’s compensation, general liability and automobile. The Company also retains the exposure on expected losses related to health benefits of certain employees. The Company believes that its present insurance is adequate for its businesses. See Note 17, Commitments and Contingencies, of Notes to Consolidated Financial Statements of the Company as of and for the three years ended December 31, 2005.

Employees

As of December 31, 2005, the Company had 1,853 full time and part time employees. In the opinion of management, employee relations are good.

Backlog

The Company’s sales backlog from ongoing operations was $5.8 million as of December 31, 2005, and $5.7 million as of December 31, 2004.

Where You Can Find More Information

The Company files quarterly reports on Form 10-Q, annual reports on Form 10-K and special reports on Form 8-K, and other information with the Securities and Exchange Commission (the “Commission”). You may read and copy any reports, statements, or other information filed by the Company at the Commission’s public reference rooms at 100 F Street, N.E., Washington, D.C. 20549. Please call the Commission at 1-800-SEC-0330 for more information on the public reference rooms. The Commission also maintains an Internet site at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers, like Hillman, that file electronically with the Commission. Copies may also be obtained, after paying a duplicating fee, by electronic request to publicinfo@sec.gov or by written request to Public Reference Section, Washington, D.C. 20549-0102.

You can inspect reports, proxy statements, and other information about the Company at the offices of The American Stock Exchange, 86 Trinity Place, New York, NY 10006.

Item 1A — Risk Factors.

An investment in the Company’s securities involves certain risks as discussed below. However, the risks set forth below are not the only risks the Company faces, and it faces other risks which have not yet been identified or which are not yet otherwise predictable. If any of the following risks occur or are otherwise realized, the Company’s business, financial condition and results of operations could be materially adversely affected. You should consider carefully the risks described below and all other information in this annual report, including the Company’s financial statements and the related notes and schedules thereto, prior to making an investment decision with regard to the Company’s securities.

The Company operates in a highly competitive industry, which may have a material adverse effect on its business, financial condition and results of operations.

The retail industry is highly competitive, with the principal methods of competition being price, quality of service, quality of products, product availability, credit terms and the provision of value-added services, such as merchandising design, in-store service and inventory management. The Company encounters competition from a large number of regional and national distributors, some of which have greater financial resources than the Company and may offer a greater variety of products. If these competitors are successful, the Company’s business, financial condition and results of operations may be materially adversely affected.

The Company’s business, financial condition and results of operations may be materially adversely affected by seasonality and general economic conditions affecting its sales.

Hillman has, in the past, experienced seasonal fluctuations in sales and operating results from quarter to quarter. Typically, the first calendar quarter is the weakest due to the effect of weather on home projects and the construction industry.

Large customer concentration and the inability to penetrate new channels of distribution could adversely affect the business.

The Company’s three largest customers constituted approximately 38.8% of sales for 2005. The loss of one of these customers or a material adverse change in the relationship with these customers could have a negative impact on business. The Company’s inability to penetrate new channels of distribution may also have a negative impact on its future sales and business.

The success of the Company’s efforts to grow its business depends on the contributions and abilities of key executives, its sales force and other personnel, including the ability of its sales force to achieve adequate customer coverage. The Company must therefore continue to recruit, retain and motivate management, sales and other personnel to maintain its current business and support its projected growth. A shortage of these key employees might jeopardize the Company’s ability to implement its growth strategy.

The Company is exposed to adverse changes in currency exchange rates.

The Company imports a significant portion of its product from the Far East including China, Taiwan and India. As a result, the Company is exposed to movements in the exchange rates of these countries versus the United States Dollar.

The Company’s results of operations could be negatively impacted by inflation in the cost of raw materials, freight and energy.

The Company’s products are manufactured of metals, including but not limited to steel, aluminum, zinc, and copper. Additionally, the Company uses other commodity based materials in the manufacture of LNS that are resin based and subject to fluctuations in the price of oil. As described in more detail in Item 7 hereto, the Company has been negatively impacted by commodity and freight inflation in recent years, and it expects energy and certain commodity prices, particularly non-ferrous metals, may increase. If the Company is unable to mitigate these inflation increases through various customer pricing actions and cost reduction initiatives, its profitability may be adversely affected.

The Company’s business is subject to risks associated with sourcing product from overseas.

The Company imports large quantities of its fastener products. Substantially all of its import operations are subject to customs requirements and to tariffs and quotas set by governments through mutual agreements or bilateral actions. In addition, the countries from which the Company’s products and materials are manufactured or imported may from time to time impose additional quotas, duties, tariffs or other restrictions on its imports or adversely modify existing restrictions. Imports are also subject to unpredictable foreign currency variation which may increase the Company’s cost of goods sold. Adverse changes in these import costs and restrictions, or the Company’s suppliers’ failure to comply with customs regulations or similar laws, could harm the Company’s business.

The Company’s ability to import products in a timely and cost-effective manner may also be affected by conditions at ports or issues that otherwise affect transportation and warehousing providers, such as port and shipping capacity, labor disputes, severe weather or increased homeland security requirements in the U.S. and other countries. These issues could delay importation of products or require the Company to locate alternative ports or warehousing providers to avoid disruption to customers. These alternatives may not be available on short notice or could result in higher transit costs, which could have an adverse impact on the Company’s business and financial condition.

If the Company were required to write down all or part of its goodwill or indefinite-lived tradenames, its net income could be materially adversely affected.

As a result of the Merger Transaction the Company has $241.5 million of goodwill and $44.7 million of indefinite-lived tradenames recorded on its Consolidated Balance Sheet at December 31, 2005. The Company is required to periodically determine if its goodwill or indefinite-lived tradenames have become impaired, in which case it would write down the impaired portion of the intangible asset. If the Company were required to write down all or part of its goodwill or indefinite-lived tradenames, its net income could be materially adversely affected.

The Company’s success is highly dependent on information and technology systems.

The Company believes that its proprietary computer software programs are an integral part of its business and growth strategies. Hillman depends on its information systems to process orders, to manage inventory and accounts receivable collections, to purchase, sell and ship products efficiently and on a timely basis, to maintain cost-effective operations and to provide superior service to its customers. There can be no assurance that the precautions which the Company has taken against certain events that could disrupt the operations of its information systems will prevent the occurrence of such a disruption. Any such disruption could have a material adverse effect on the Company’s business and results of operations.

The inability to make timely and cost effective acquisitions may adversely affect the Company’s business.

One element of Hillman’s future growth strategy is to pursue selected acquisitions that either expand or complement its businesses in new or existing markets. However, there can be no assurance that the Company will be able to identify or acquire acceptable acquisition candidates on terms favorable to the Company and in a timely manner, if at all, to the extent necessary to fulfill Hillman’s growth strategy.

The process of integrating acquired businesses into the Company’s operations may result in unforeseen difficulties and may require a disproportionate amount of resources and management’s attention, and there can be no assurance that Hillman will be able to successfully integrate acquired businesses into its operations, including the Steelworks acquisition in January 2006.

The Company is subject to fluctuations in interest rates.

A significant portion of the Company’s outstanding debt has variable rate interest. Increases in borrowing rates will increase the Company’s cost of borrowing, which may affect the Company’s results of operations and financial condition.

Item 1B — Unresolved Staff Comments.

None.

Item 2 – Properties.

The Company’s principal office, manufacturing and distribution properties are as follows:

		Approximate
Location		Square Footage				Description
Cincinnati, Ohio			240,000			Office, Distribution
Forest Park, Ohio			335,000			Distribution
Tempe, Arizona			185,000			Office, Mfg., Distribution
Shafter, California			84,000			Distribution
Lewisville, Texas			72,000			Distribution
Wilsonville, Oregon			29,000			Distribution
Charlotte, North Carolina			40,000			Distribution
Green Island, New York			56,000			Distribution
LaCrosse, Wisconsin			48,000			Distribution
Riviera Beach, Florida			37,000			Distribution
Goodlettsville, Tennessee			72,000			Mfg., Distribution
Mississauga, Ontario			11,000			Distribution

With the exception of Goodlettsville, Tennessee, all of the Company’s facilities are leased. In the opinion of management, the Company’s existing facilities are in good condition.

Item 3 – Legal Proceedings.

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 will not have a material adverse effect on the consolidated financial position, operations or cash flows of the Company.

Item 4 – Submission of Matters to a Vote of Security Holders.

The Company did not submit any matters to a vote of Trust Preferred holders during the quarter ended December 31, 2005.

Part II

Item 5 – Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Stock Exchange Listing

The Company’s common stock does not trade and is not listed on or quoted in an exchange or other market. However, the Trust Preferred Securities trade under the ticker symbol HLM.Pr on the American Stock Exchange. The following table sets forth the high and low closing sale prices on the American Stock Exchange composite tape for the Trust Preferred Securities.

2005		High				Low
First Quarter		$	29.44			$	27.55
Second Quarter			29.25				28.15
Third Quarter			29.29				28.75
Fourth Quarter			29.28				28.61

2004		High				Low
First Quarter		$	27.50			$	26.15
Second Quarter			27.55				26.50
Third Quarter			27.70				26.80
Fourth Quarter			29.45				27.40

The Trust Preferred Securities have a liquidation value of $25.00 per security. As of March 17, 2006, there were 687 holders of Trust Preferred Securities and fifteen (15) common stockholders. The total number of Trust Preferred Securities outstanding as of March 30, 2006, was 4,217,724. The total number of shares of Common Stock outstanding as of March 30, 2006, was 10,000.

Distributions

The Company pays interest to the Hillman Group Capital Trust (“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. For the years ended December 31, 2005 and 2004, the Company paid $12.2 million per year in interest on the Junior Subordinated Debentures, which was equivalent to the amounts distributed on the Trust for the same periods.

The interest payments on the Junior Subordinated Debentures underlying the Trust Preferred Securities are deductible for federal income tax purposes by the Company under current law and will remain an obligation of the Company until the Trust Preferred Securities are redeemed or upon their maturity in 2027.

For more information on the Trust and Junior Subordinated Debentures, see “Item 7-Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Issuer Purchases of Equity Securities

The Company made no repurchases of its equity securities during 2005.

Item 6 – Selected Financial Data.

As a result of the Merger Transaction, the Company’s operations for the periods presented subsequent to the September 30, 2001 acquisition by Allied Capital but prior to March 31, 2004 are referenced herein as the predecessor operations (the “Predecessor” or “Predecessor Operations”). The Company’s operations for the periods presented since the Merger Transaction are referenced herein as the successor operations (the “Successor” or “Successor Operations”) and include the effects of the Company’s debt refinancing. Periods prior to the acquisition by Allied Capital are referred to below as the pre-predecessor operations (the “Pre-predecessor” or “Pre-predecessor Operations”).

The following table sets forth selected consolidated financial data of the Pre-predecessor for the nine months ended September 30, 2001; and consolidated financial data of the Predecessor as of and for the three months ended March 31, 2004, the years ended December 31, 2003 and 2002 and the three months ended December 31, 2001; and consolidated financial data of the Successor as of and for the nine months ended December 31, 2004 and the year ended December 31, 2005. See the accompanying Notes to Consolidated Financial Statements and “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” for information regarding the acquisition of the Company by CHS and the Company’s debt refinancing as well as other acquisitions that affect comparability.

(dollars in thousands)

																												Pre-
		Successor									Predecessor																	Predecessor
						Nine					Three
						Months					Months												Three					Nine Months
		Year Ended				Ended					Ended				Year Ended				Year Ended				Months Ended					Ended 9/30/01
		12/31/05				12/31/04					03/31/04				12/31/03				12/31/02				12/31/01					(3)
Income Statement Data:
Net sales		$	382,512			$	273,374				$	78,190			$	317,671			$	286,599			$	61,538				$	340,426
Gross profit			206,290				150,402					42,807				174,316				160,503				35,249					142,986
Non-recurring expense (2)			—				—					30,707				—				—				—					—
Net (loss) income			(3,654	)			779					(20,366	)			(5,709	)			5,243				(2,128	)				(1,097	)
Balance Sheet Data at December 31:
Total assets		$	631,336			$	628,899					N/A			$	354,253			$	375,653			$	352,960					N/A
Long-term debt and
capitalized lease obligations (1)			263,508				264,101					N/A				150,338				147,175				130,836					N/A

(1)		Includes current portion of long-term debt and capitalized lease obligations.
(2)		Non-recurring expenses incurred in connection with CHS merger including $24,353 for stock options granted at an exercise price below fair market value, $4,035 in investment banking and legal fees, $1,922 in management bonuses and $397 in payroll taxes. See the Notes to the Consolidated Financial Statements for further details.
(3)		Financial data for the nine months ended September 30, 2001 include the operating results of the SunSource Technology Services business, the assets of which were sold pursuant to an Asset Purchase Agreement on September 28, 2001.

Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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 related notes and schedules thereto appearing elsewhere herein.

General

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

The Company’s principal business is operated through its wholly-owned subsidiary, The Hillman Group, which had sales of approximately $382.5 million in 2005. The Hillman Group sells its product lines and provides its services to hardware stores, home centers, mass merchants, pet supply stores, and other retail outlets principally in the United States, Canada, Mexico and South America. Product lines include thousands of small parts such as fasteners and related hardware items; keys, key duplication systems and accessories; and identification items, such as, tags and letters, numbers, and signs. Services offered include design and installation of merchandising systems and maintenance of appropriate in-store inventory levels.

Merger Transaction

On March 31, 2004, The Hillman Companies, Inc. was acquired by an affiliate of Code Hennessy & Simmons LLC (“CHS”). Pursuant to the terms and conditions of an Agreement and Plan of Merger (“Merger Agreement”) dated as of February 14, 2004, the Company was merged with an affiliate of CHS with the Company surviving the merger (“Merger Transaction”). The total consideration paid in the Merger Transaction was $511.6 million including repayment of outstanding debt and including the value of the Company’s outstanding Trust Preferred Securities ($102.4 million at merger).

Prior to the merger, Allied Capital Corporation (“Allied Capital”) owned 96.8 % of the Company’s common stock. As a result of the change of control, an affiliate of CHS owns 49.1% of the Company’s common stock and 54.5% of the Company’s voting common stock, Ontario Teacher’s Pension Plan (“OTPP”) owns 27.9% of the Company’s common stock and 31.0% of the Company’s voting common stock and HarbourVest Partners VI owns 8.7% of the Company’s common stock and 9.7% of the Company’s voting common stock. OTPP’s voting rights with respect to the election of directors to the Board of Directors is limited to the lesser of 30.0% or the actual percentage of voting stock held. Certain members of management own 14.1% of the Company’s common stock and 4.5% of the Company’s voting common stock.

The Company’s operations for the periods presented prior to the March 31, 2004 Merger Transaction are referenced herein as the predecessor financial statements (the “Predecessor” or “Predecessor Financial Statements”). The Company’s Consolidated Balance Sheet as of December 31, 2005 and 2004 and its related Consolidated Statements of Operations for the year ended December 31, 2005 and the nine months ended December 31, 2004, and its Consolidated Statements of Cash Flows and Changes in Stockholders’ Equity for the year ended December 31, 2005 and the nine months ended December 31, 2004 are referenced herein as the successor financial statements (the “Successor” or “Successor Financial Statements”).

Financing Arrangements

On March 31, 2004, the Company, through its Hillman Group subsidiary, refinanced its revolving credit and senior term loans with a Senior Credit Agreement (the “Senior Credit Agreement”) consisting of a $40.0 million revolving credit (the “Revolver”) and a $217.5 million term loan (the “Term Loan”). The Senior Credit Agreement has a seven-year term and provides borrowings at interest rates based on the London Interbank Offered Rates (the

“LIBOR”) plus a margin of between 2.25% and 3.00% (the “LIBOR Margin”), or prime (the “Base Rate”) plus a margin of between 1.25% and 2.0% (the “Base Rate Margin”). The applicable LIBOR Margin and Base Rate Margin is based on the Company’s leverage as of the last day of the preceding fiscal quarter. In accordance with the Senior Credit Agreement, letter of credit commitment fees are based on the average daily face amount of each outstanding letter of credit multiplied by a letter of credit margin of between 2.25% and 3.00% per annum (the “Letter of Credit Margin”). The Letter of Credit Margin is also based on the Company’s leverage at the date of the preceding fiscal quarter. The Company also pays a commitment fee of 0.50% per annum on the average daily unused Revolver balance.

In addition, on March 31, 2004, the Company, through The Hillman Group, issued $47.5 million of unsecured subordinated notes to Allied Capital maturing on September 30, 2011 (“Subordinated Debt Issuance”). Interest on the Subordinated Debt Issuance is at a fixed rate of 13.5% per annum, with cash interest payments required on a quarterly basis at a fixed rate of 11.25% commencing April 15, 2004. The outstanding principal balance of the Subordinated Debt Issuance shall be increased on a quarterly basis at the remaining 2.25% fixed rate (the “PIK Amount”). All of the PIK Amounts are due on the maturity date of the Subordinated Debt Issuance.

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.

On April 28, 2004, the Company entered into an Interest Rate Swap Agreement (“Swap”) with a two-year term for a notional amount of $50.0 million. The Swap effectively fixes the interest rate on $50.0 million of the Term Loan at a rate of 1.17% plus the applicable interest rate margin for the first three months of the Swap with incremental increases ranging from 28 to 47 basis points in each successive quarter.

Acquisitions and Divestitures

On October 3, 2002, the Company, through The Hillman Group, purchased the net assets of the DIY division (“DIY”) of the Fastenal Company of Winona, MN (“Fastenal”). DIY, with annual sales of approximately $22 million, distributes fasteners, anchors, picture hanging wire, hooks, tacks, and brads to national hardware cooperatives and home centers. The Company paid $15.3 million in cash to Fastenal for the net assets of DIY. The transaction was financed from the Company’s existing credit lines.

On May 1, 2002, the Company’s Hillman Group purchased certain assets of the Lowe’s specialty fastener business from R&B, Inc. for cash consideration of $6.2 million. The purchase of the specialty fastener business has expanded the breadth of the Company’s product offering to Lowe’s. In connection with this transaction, the Company settled litigation filed by R&B, Inc. in February 1996 related to the Company’s sale of the Dorman Products division. The litigation settlement in the amount of $1.25 million was fully reserved on the Company’s balance sheet, and accordingly, there was no charge to income in 2002.

On March 2, 2000, the Company contributed the interests in its Kar Products, Inc. and A & H Bolt & Nut Company Limited operations (collectively, the “Kar business”), to a newly-formed partnership affiliated with Glencoe Capital, L.L.C. (“Glencoe”). Glencoe contributed cash equity to the new partnership, GC-Sun Holdings L.P. (“G-C”). The Company received $105 million in cash proceeds from the transaction through repayment of assumed debt by G-C and retained minority ownership in G-C. Affiliates of Glencoe held the controlling interest in G-C. The Company recorded a pre-tax gain on the transaction of approximately $49.1 million in the first quarter of 2000. On January 4, 2002, G-C provided the Company notice that it intended to exercise its call right to purchase the Company’s partnership interest as a result of the merger transaction with Allied Capital. On April 13, 2002, the Company entered into a Unit Repurchase Agreement with G-C, pursuant to which G-C exercised its call right. In exchange for its interest in G-C, the Company received a $10 million subordinated note from G-C.

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 and accrued interest thereon. Accordingly, the Company recorded an $11.3 million charge to income during the year ended December 31, 2003 to write-down the face value of the note and accrued interest thereon to zero.

The G-C note was distributed to the Company’s common stockholders on March 31, 2004.

Subsequent Event

On January 5, 2006, the Company’s Hillman Group, Inc. subsidiary purchased certain assets of The SteelWorks Corporation (“SteelWorks”), a Denver, Colorado based manufacturer and distributor of metal shapes, threaded rod and metal sheet to the Retail Hardware and Home Improvement Industry. Annual revenues of the SteelWorks customer base acquired are approximately $31 million. The aggregate purchase price was $34.2 million paid in cash at closing.

Results of Operations

Sales and Profitability for each of the Three Years Ended December 31

		(dollars in thousands)
		2005								2004 (a)								2003
						% of								% of								% of
		Amount				Total				Amount				Total				Amount				Total
Net sales		$	382,512				100.0	%		$	351,564				100.0	%		$	317,671				100.0	%
Cost of sales (exclusive of depreciation and amortization shown below)			176,222				46.1	%			158,355				45.0	%			143,355				45.1	%
Gross profit			206,290				53.9	%			193,209				55.0	%			174,316				54.9	%
Operating expenses:
Selling			72,282				18.9	%			67,796				19.3	%			57,939				18.2	%
Warehouse & delivery			47,705				12.5	%			44,245				12.6	%			40,590				12.8	%
General & Administrative			19,078				5.0	%			18,221				5.2	%			22,229				7.0	%
Stock compensation expense			1,601				0.4	%			272				0.1	%			—				0.0	%
Total SG&A			140,666				36.8	%			130,534				37.1	%			120,758				38.0	%
Non-recurring expense (b)			—				0.0	%			30,707				8.7	%			—				0.0	%
Depreciation			15,605				4.1	%			15,187				4.3	%			14,399				4.5	%
Amortization			7,228				1.9	%			5,748				1.6	%			1,437				0.5	%
Management fees			1,045				0.3	%			1,329				0.4	%			1,800				0.6	%
Total operating expenses			164,544				43.0	%			183,505				52.2	%			138,394				43.6	%
Other income (expense)			(87	)			0.0	%			277				0.1	%			681				0.2	%
Income from operations			41,659				10.9	%			9,981				2.8	%			36,603				11.5	%
Interest expense			20,974				5.5	%			17,539				5.0	%			15,405				4.8	%
Interest expense on mandatorily redeemable preferred stock & management purchased preferred options			7,972				2.1	%			5,458				1.6	%			—				0.0	%
Interest expense on junior subordinated notes			12,609				3.3	%			12,609				3.6	%			—				0.0	%
Investment income on trust common securities			(378	)			-0.1	%			(378	)			-0.1	%			—				0.0	%
Distributions on guaranteed preferred beneficial interests			—				0.0	%			—				0.0	%			12,231				3.9	%
Write-down of note receivable			—				0.0	%			—				0.0	%			11,258				3.5	%
Income (loss) before taxes			482				0.1	%			(25,247	)			-7.2	%			(2,291	)			-0.7	%

(a)		For the purpose of comparing the Company’s results of operations for each of the three years ended December 31, 2005, the results of the Predecessor Operations for the three months ended March 31, 2004 have been combined with the results of the Successor Operations for the nine months ended December 31, 2004.
(b)		Represents one-time charges for stock options, management bonuses, investment banking, and legal fees incurred in connection with the March 31, 2004 Merger Transaction.

Years Ended December 31, 2005 and 2004

Net sales of $382.5 million in 2005 increased $30.9 million or 8.8 % from 2004. Most of the increase was due to sales to national accounts, including Lowe’s, Home Depot and Wal*Mart, which were up $12.4 million or 8.2% in 2005. Lowe’s, on the strength of new store openings and new product introductions, accounted for $8.1 million of the National Account sales increase. The Home Depot sales increase in 2005 of $5.3 million can also be attributed primarily to new store openings. Wal*Mart’s 2005 sales in the United States actually declined by 5% or $1.3 million as a result of a concerted effort by Wal*Mart corporate to reduce inventory levels in their fiscal fourth quarter.

Sales to Franchise and Independent (“F&I”) hardware stores improved by $9.6 million or 7.8% compared to 2004. The F&I accounts are typically individual hardware dealers who are members of a larger cooperative such as Ace, True Value and Do-it Best. After several years of slow growth, the F&I business had a second year of solid growth. New account activity, including 115 new stores and over 160 competitor conversions were the primary drivers of the 2005 sales growth. Also, Hillman introduced several new products to the F&I accounts in 2005 such as chrome plated fasteners and a new picture hanging line.

Regional accounts including 84 Lumber, Sutherlands and Westlake Hardware, increased sales by $3.6 million or 18.6%. Engraving sales also posted strong sales growth of 9.7% or $2.9 million in 2005. The growth can be attributed to new store openings at PetSmart and PETCO combined with improvement in Wal*mart same store sales. International sales including Canada, Mexico, the Caribbean and Latin America increased $2.5 million or 34.0% in 2005. Other accounts including the coop wholesalers, direct marketing and commercial accounts, declined by $0.1 million in 2005.

The Company’s sales backlog, based upon cancelable purchase orders, was $5.8 million as of December 31, 2005 compared to $5.7 million as of December 31, 2004.

Gross profit declined from 54.9% in 2004 to 53.9% in 2005 and was negatively affected in 2005 by cost increases in several commodities essential to both our key and LNS product lines. The material cost of a key blank is largely dictated by the price of copper which experienced significant increases in 2005. Also, styrene, which is used in the manufacture of LNS, is a resin based product affected by surging oil prices in 2005.

Selling, general and administrative (“S,G&A”) expense of $140.6 million in 2005 increased $10.1 million or 7.8% over 2004. The increase in selling expenses of $4.5 million can be attributed primarily to the cost of displays for new national account locations and retrofits of existing stores which increased $2.1 million in 2005 compared with the prior year. The additional increase in selling cost is the result of costs to provide service and merchandising to the expanded store base. Warehouse and delivery costs, which are almost wholly variable with sales volume increases, were up $3.5 million in 2005. Productivity gains from the 2005 implementation of new technology in the Dallas and Bakersfield distributions centers kept the overall cost to pick and ship orders relatively flat compared to 2004 despite the 8.9% increase in sales volume. Freight costs of $21.6 million, on the other hand, increased $2.6 million or 14% over the prior year. Freight costs were negatively impacted by fuel surcharges imposed by most of the Company’s transit suppliers. General and administrative expenses were up $0.9 million in 2005 primarily as a result of additional accounting fees associated with the restatement of the 2004 10-K.

Depreciation expense increased $0.4 million from $15.2 million in 2004 to $15.6 million in 2005. The increased depreciation was a result of additional capital spending in 2005 for the automation and expansion of distribution facilities, an ERP implementation in the Company’s Mexico facility and expanded placement of Quick-Tag machines.

Following the March 31, 2004 Merger Transaction, the value of intangible assets was determined by an independent appraisal. In 2005, amortization expense increased $1.5 million as a result of a full year amortization of the newly valued intangible assets.

The Company has recorded a management and transaction fee charge of $1.0 million for 2005 and $1.3 million for 2004. As of the closing of the Merger Transaction in March 2004, the Company is obligated to pay management fees to a subsidiary of CHS for management

services rendered in the amount of fifty-eight thousand dollars per month, plus out of pocket expenses, and to pay transaction fees to a subsidiary of OTPP in the amount of twenty-six thousand dollars per month, plus out of pocket expenses, for each month. The Company was obligated to pay management fees to a subsidiary of Allied Capital for management services rendered in the amount of $1.8 million, plus out of pocket expenses, for calendar years subsequent to 2001. The payment of management fees was due annually after delivery of the Company’s annual audited financial statements to the Board of Directors of the Company. The obligation to pay management fees to Allied Capital was terminated upon the payment of outstanding fees in the amount of $2.3 million on March 31, 2004 in connection with the closing of the Merger Transaction.

Interest expense, net, increased $3.5 million to $21.0 million in 2005 from $17.5 million in 2004. The increase in interest expense, net, was primarily the result of increased Company debt related to the Merger Transaction, the amortization of additional deferred financing costs and increased borrowing costs on the variable rate Term Loan.

Interest expense on the mandatorily redeemable preferred stock and management purchased preferred options related to the Merger Transaction increased from $5.5 million in 2004 to $8.0 million in 2005. The increase can be attributed to an additional quarter of interest in 2005 and additional vesting on the management purchased preferred options.

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 $12.6 million per annum in the aggregate. The Company receives investment income on the trust common securities in the amount of $0.4 million per annum. The Trust distributes the equivalent net amount to the holders of the trust preferred securities. For the years ended December 31, 2005 and 2004, the Company paid interest net of investment income of $12.2 million on the junior subordinated debentures, which is equivalent to the amounts distributed by the Trust on the trust preferred securities.

The Company also pays interest to the Trust on the junior subordinated debentures underlying the trust common securities at the rate of 11.6% per annum on their face amount of $3.3 million, or $0.4 million per annum in the aggregate. The Trust distributes an equivalent amount to the Company as a distribution on the underlying trust common securities. For the years ended December 31, 2005 and 2004, the Company paid $0.4 million interest on the Junior Subordinated Debentures, which is equivalent to the amounts received by the Company as investment income.

The effective tax rates in 2005 and 2004 were 858.1% and 22.4%, respectively. The change in effective rate is attributable to lower levels of book income and the existence of large permanent differences. See Note 5, Income Taxes, of Notes to Consolidated Financial Statements of the Company for the three years ended December 31, 2005, for income taxes and disclosures related to 2005 and 2004 income tax events.

Years Ended December 31, 2004 and 2003

Net sales increased $33.9 million or 10.7% in 2004 to $351.6 million from $317.7 million in 2003. Sales to national accounts represented $19.4 million of the $33.9 million total sales increase. The new store growth of our national accounts customers was primarily responsible for the increased fastener, keys, and LNS sales to Lowe’s, increased keys and LNS sales to Home Depot, and increased keys sales to Wal-Mart. Sales to Franchise and Independent (“F&I”) accounts increased $9.4 million from 2003 primarily due to improved economic activity at the retail level and increased sales of galvanized fasteners used in the newly formulated treated lumber. The F&I accounts are typically individual hardware dealers who are members of larger cooperatives, such as True Value, Ace, and Do-It-Best. In addition, the regional and engraving accounts increased $3.3 million over the comparable period in 2003. The regional accounts represent mid-sized hardware and lumber chains. Sales by our Canadian division increased $1.3 million, export sales increased $0.7 million, and other sales were $0.2 million less than the prior year.

The Company’s sales backlog, based upon cancelable purchase orders, was $5.7 million as of December 31, 2004 and $4.8 million as of December 31, 2003.

The Hillman Group’s gross margin of 55.0% in 2004 increased slightly from 54.9% in 2003. Price increases together with production efficiencies following the December 2003 consolidation of the Rockford packaging and distribution facility into the Company’s Cincinnati facility offset the rising cost of the Company’s products.

The Company’s consolidated selling, general and administrative (“S,G&A”) expenses increased $9.7 million or 8.1% from $120.8 million in 2003 to $130.5 million in 2004. Selling expenses increased $9.8 million or 17.1% primarily as a result of increased servicing and display costs at new national account stores. Warehouse and delivery expenses increased $3.6 million or 8.9% as a result of increased freight and labor costs of $2.8 million to process and ship the additional sales volume. General and administrative expenses decreased by $4.0 million or 18.0% as a result of a substantial decrease in medical claims experienced in 2004 compared to 2003 which included $1.5 million in claims by an employee for medical services. In addition, 2004 expense declined further from 2003 as a result of the elimination of several positions from our corporate office and Tempe facility together with the December 2003 shutdown of the Rockford facility. Stock compensation expenses from stock options related to the Merger Transaction were $0.3 million in 2004. There was no stock compensation expense in 2003.

Depreciation expense increased $0.8 million to $15.2 million in 2004 from $14.4 million in 2003 primarily as a result of an increase in the depreciable fixed asset base in connection with the placement of key duplication machines used in new national accounts.

Amortization expense increased $4.3 million to $5.7 million in 2004 from $1.4 million in 2003. The increase in amortization was the result of an increase in the valuation of certain intangible assets in connection with the Merger Transaction.

The Company has recorded a management and transaction fee charge of $1.3 million for 2004 and $1.8 million for 2003. As of the closing of the Merger Transaction in March 2004, the Company is obligated to pay management fees to a subsidiary of CHS for management services rendered in the amount of fifty-eight thousand dollars per month, plus out of pocket expenses, and to pay transaction fees to a subsidiary of OTPP in the amount of twenty-six thousand dollars per month, plus out of pocket expenses. The Company was obligated to pay management fees to a subsidiary of Allied Capital for management services rendered in the amount of $1.8 million, plus out of pocket expenses, for calendar years subsequent to 2001. The payment of management fees was due annually after delivery of the Company’s annual audited financial statements to the Board of Directors of the Company.

Income from operations for the year ended December 31, 2004 was $10.0 million and includes $30.7 million in non-recurring costs recorded in connection with the Merger Transaction. This compares to $36.6 million for the year ended December 31, 2003.

The Company’s consolidated operating profit margin from operations (income from operations as a percentage of net sales) was 11.5% in 2003 and 2.8% in 2004. However, 2004 includes the non-recurring costs of $30.7 million recorded in connection with the Merger Transaction. The operating profit margin was impacted by a reduction of S,G&A expenses and management fees as a percentage of sales, but these benefits were offset by the increase in amortization costs as a percentage of sales which resulted from the Merger Transaction.

Interest expense, net, increased $2.1 million to $17.5 million in 2004 from $15.4 million in 2003. The increase in interest expense, net, was primarily the result of increased Company debt related to the Merger Transaction and the amortization of additional deferred financing costs.

Interest expense was $5.5 million in 2004 on the mandatorily redeemable preferred stock and management purchased preferred options related to the Merger Transaction. No such interest expense was recorded in 2003.

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 $12.6 million per annum in the aggregate. The Company receives investment income on the trust common securities in the amount of $0.4 million per annum. The Trust distributes the equivalent net amount to the holders of the trust preferred securities. For the years ended December 31, 2004 and 2003, the Company paid interest net of investment income of $12.2 million on the junior subordinated debentures, which is equivalent to the amounts distributed by the Trust on the trust preferred securities.

The Company also pays interest to the Trust on the junior subordinated debentures underlying the trust common securities at the rate of 11.6% per annum on their face amount of $3.3 million, or $0.4 million per annum in the aggregate. The Trust distributes an equivalent amount to the Company as a distribution on the underlying trust common securities. For the year ended December 31, 2004, the Company paid $0.4 million interest on the Junior Subordinated Debentures, which is equivalent to the amounts received by the Company as investment income.

The effective tax rates in 2004 and 2003 were 22.4% and (149.2)%, respectively. The 2004 rate was impacted by the existence of large permanent items. The 2003 rate included a $3.9 million increase in the deferred tax valuation allowance. See Note 5, Income Taxes, of Notes to Consolidated Financial Statements of the Company for the three years ended December 31, 2005, for income taxes and disclosures related to 2004 and 2003 income tax events.

Liquidity and Capital Resources

Net cash provided by operating activities for the year ended December 31, 2005 was $13.9 million, primarily due to the net loss adjusted for non-cash charges of $32.5 million for depreciation, amortization, dispositions of equipment, deferred taxes, PIK interest, and interest on mandatorily redeemable preferred stock which were partially offset by cash related adjustments of $18.6 million for routine operating activities represented by changes in inventories, accounts receivable, accounts payable, accrued liabilities and other assets. The 2005 increase in accounts receivable of $4.1 million is primarily the result of sales growth. The inventory increase of $11.3 million in 2005 can be attributed to the growth in sales as well as inventory builds at the end of the year for anticipated roll outs of new customer programs scheduled for the first quarter of 2006. Accounts payable was $3.5 million lower at the end of 2005 as the Company elected to take advantage of cash discounts from vendors.

Net cash used for investing activities was $15.4 million for the year ended December 31, 2005. Capital expenditures for the year totaled $15.2 million, consisting of $7.2 million for key duplicating machines, $2.3 million for engraving machines, $1.5 million for Cincinnati office expansion and $4.2 million for equipment purchases.

Net cash used for financing activities for the year ended December 31, 2005 was $1.7 million, primarily related to principal payments on the senior term loan.

Management believes projected cash flows from operations and revolver availability will be sufficient to fund working capital and capital expenditure needs for the next 12 months.

The Company’s working capital (current assets minus current liabilities) position of $104.4 million as of December 31, 2005, represents an increase of $16.7 million from the December 31, 2004 level of $87.7 million as follows:

(dollars in thousands)

		Amount
Decrease in cash and cash equivalents		$	(3,122	)
Increase in accounts receivable, net			4,113
Increase in inventories, net			11,343
Increase in other current assets			28
Decrease in deferred taxes			(1,053	)
Decrease in accounts payable			3,547
Decrease in accrued salaries and wages			921
Increase in accrued interest			(841	)
Decrease in other accrued liabilities			1,943
Other items, net			(142	)
Net increase in working capital for the year ended December 31, 2005		$	16,737

The Company’s contractual obligations in thousands of dollars as of December 31, 2005 are summarized below:

						Payments Due
						Less Than				1 to 3				3 to 5				More Than
Contractual Obligations		Total				One Year				Years				Years				Five Years
Junior Subordinated Debentures (1)		$	117,295			$	—			$	—			$	—			$	117,295
Long Term Senior Term Loans			214,237				2,175				4,350				4,350				203,362
Bank Revolving Credit Facility			—				—				—				—				—
Long Term Unsecured Subordinated Notes			49,172				—				—				—				49,172
Interest Payments (2)			100,387				21,955				40,897				32,846				4,689
Operating Leases			51,503				8,991				10,608				7,857				24,047
Mandatorily Redeemable Preferred Stock			69,695				—				—				—				69,695
Management Purchased Preferred Options			4,087				—				—				—				4,087
Deferred Compensation Obligations			4,809				167				334				334				3,974
Capital Lease Obligations			109				51				58				—				—
Other Long Term Obligations			4,844				1,232				800				521				2,291
Total Contractual Cash Obligations		$	616,138			$	34,571			$	57,047			$	45,908			$	478,612

All of the obligations noted above are reflected on the Company’s Consolidated Balance Sheet as of December 31, 2005, except for the Interest Payments and Operating Leases. See Notes to Consolidated Financial Statements as of and for the three years ended December 31, 2005 for additional information.

The Company has a purchase agreement with its supplier of key blanks which requires minimum purchases of 100 million key blanks per year. To the extent minimum purchases of key blanks are below 100 million the Company must pay the suppliers $.0035 per key multiplied by the shortfall. Since the inception of the contract in 1998, the Company purchases of key blanks from the supplier have exceeded 100 million. The purchase agreement expires on December 31, 2006.

The Company does not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K under the Securities Exchange Act of 1934, as amended.

As of December 31, 2005, the Company had $34.8 million available under its secured credit facilities. The Company had approximately $214.3 million of outstanding debt under its secured credit facilities at December 31, 2005, consisting of $214.2 million in a term loan and $0.1 million in capitalized lease obligations. The term loan consisted of a $213.1 million Term B Loan currently at a six (6) month LIBOR rate plus margin of 7.6875%, a $0.6 million Term B Loan currently at a three (3) month LIBOR rate plus margin of 7.812% and a $0.5 million Term B loan at the prime rate plus margin of 9.5%. The capitalized lease obligations were at various interest rates.

Interest on the Subordinated Debt Issuance of $47.5 million which matures September 30, 2011 is at a fixed rate of 13.5% per annum, with cash interest payments being required on a quarterly basis at a fixed rate of 11.25% commencing April 15, 2004. The outstanding principal balance of the Subordinated Debt Issuance shall be increased on a quarterly basis by the remaining 2.25% PIK Amount. All of the PIK Amounts are due on the maturity date of the Subordinated Debt Issuance. As of December 31, 2005, the outstanding Subordinated Debt Issuance including the PIK Amounts was $49.2 million.

In accordance with the Company’s Senior Credit Agreement, Hillman must maintain its fixed charge coverage at all times in excess of 1.05x from January 1, 2005 through December 31, 2005 and 1.15x thereafter to continue monthly distributions on its Trust Preferred Securities ($1.0 million per month). Hillman’s fixed charge coverage was 1.38x for the twelve-month period ended December 31, 2005 as calculated in accordance with the Senior Credit Agreement.

The Company had deferred tax assets aggregating $39.2 million, net of valuation allowance of $15.6 million, and deferred tax liabilities of $69.6 million as of December 31, 2005, as determined in accordance with SFAS 109. Management believes that the Company’s net 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.

Inflation

The Company is sensitive to inflation present in the economies of the United States and our foreign suppliers located primarily in Taiwan and China. Inflation in recent years has produced only a modest impact on the Company’s operations, however, the recent growth in China’s economic activity produced a spike in the cost of certain imported fastener products in the latter part of 2003 and 2004 increasing the cost of certain fasteners as much as 45%. Additionally, recent increases in the cost of diesel fuel have contributed to transportation rate increases. Continued inflation and resulting cost increases over a period of years would result in significant increases in inventory costs and operating expenses. 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. The Company was able to recover most of the 2003 and 2004 fastener cost increases by raising prices to its customers.

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 this Agreement and Plan of Merger, the Company was obligated to pay management fees to a subsidiary of Allied Capital for management services rendered in the amount of $1.8 million per year, plus out of pocket expenses, for calendar years subsequent to 2001. The Company has recorded a management fee charge of $0.5 million, and $1.8 million on the Predecessor’s Statement of Operations for the three months ended March 31, 2004 and the year ended December 31, 2003. Payment of management fees was due annually after delivery of the Company’s annual audited financial statements to the Board of Directors of the Company. The obligation to pay management fees to Allied Capital was terminated upon the payment of outstanding fees in the amount of $2.3 million on March 31, 2004 in connection with the close of the Merger Transaction.

On March 31, 2004, the Company was acquired by an affiliate of CHS. In connection with the CHS acquisition, the Company is obligated to pay management fees to a subsidiary of CHS in the amount of $58 thousand per month and to pay transaction fees to a subsidiary of OTPP in the amount of $26 thousand per month, plus out of pocket expenses, for each month commencing with the closing date of the Merger Transaction. The Company has recorded management and transaction charges and expenses from CHS and OTPP of $1.0 million and $0.8 million for the year ended December 31, 2005 and the nine month period ended December 31, 2004.

The Predecessor Company incurred interest expense to Allied Capital on the unsecured subordinated note at a fixed rate of 18.0% per annum. Cash interest payments were 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. The subordinated debt and accrued interest thereon of $45.6 million were paid in full at March 31, 2004 in connection with the Merger Transaction. See discussion above and in Note 8, Long-Term Debt, of Notes to Consolidated Financial Statements.

Critical Accounting Policies and Estimates

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 Company’s consolidated financial statements and results of operations.

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. The Company’s purchase price allocation methodology requires estimates of the fair value of assets acquired and liabilities assumed. 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 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; purchase price allocation adjustments are based on changes in settlements of liabilities and assets realized; litigation is based on projections provided by legal counsel; deferred taxes 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. The dollar amounts below are presented in thousands.

Revenue Recognition:

Revenue is recognized when products are shipped or delivered to customers depending upon when title and risks of ownership have passed.

The Company offers a variety of sales incentives to its customers primarily in the form of discounts, rebates and slotting fees. 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. Slotting fees are used on an infrequent basis and are not considered to be significant. Discounts, rebates and slotting fees 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. Returns and allowances are included in the determination of net sales.

Accounts Receivable and Allowance for Doubtful Accounts:

The Company establishes the allowance for doubtful accounts using the specific identification method and also provides a reserve in the aggregate. The estimates for calculating the aggregate reserve are based on historical information. The allowance for doubtful accounts was $434 and $526 as of December 31, 2005 and 2004, respectively.

Inventory Realization:

Inventories consisting predominantly of finished goods are valued at the lower of cost or market, cost being determined principally on the weighted average cost 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 twenty-four month period or with on hand quantities in excess of twenty-four months average usage. The inventory reserve amounts were $3,948 and $3,558 at December 31, 2005 and 2004, respectively.

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 income from 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 over the terms of the related leases.

Goodwill and Other Intangible Assets:

The Company accounts for goodwill and other intangible assets in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” which requires that goodwill and intangibles with indefinite lives no longer be amortized, but instead be tested for impairment at least annually. If impairment is indicated a write-down to fair value is recorded. Other intangible assets arising principally from the Merger Transaction are amortized on a straight-line basis over periods ranging from four to twenty-three years. Trademarks are not amortized due to their indefinite useful lives.

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.

Investments:

All of the Company’s investments are in marketable equity securities classified as available-for-sale securities which are carried at fair value with the unrealized gains and losses, net of tax, reported in other comprehensive income.

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 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 self insures its product liability, worker’s compensation and general liability losses up to $250 thousand per occurrence. Catastrophic coverage is maintained for occurrences in excess of $250 thousand up to $35 million.

The Company self insures its group health claims up to an annual stop loss limit of $150 thousand per participant. Aggregate coverage is maintained for annual group health insurance claims in excess of 125% of expected claims.

Provisions for losses expected under these programs are recorded based on an analysis of historical insurance claim data and certain actuarial assumptions.

Retirement Benefits:

Certain employees of the Company are covered under a profit-sharing and retirement savings plan (“defined contribution plan”). See Note 14, Retirement Benefits, of Notes to Consolidated Financial Statements for additional information.

Shipping and Handling:

The costs incurred to ship product to customers, including freight and handling expenses, are included in selling, general and administrative expenses on the Company’s Statements of Operations. The Predecessor Company’s shipping and handling costs were $3,629 and $15,916 for the three months ended March 31, 2004 and the year ended December 31, 2003, respectively. The Successor Company’s shipping and handling costs were $18,615 and $12,790 for the year ended December 31, 2005 and the nine months ended December 31, 2004, respectively.

Research and Development:

The Company incurs research and development costs consisting primarily of internal wages and benefits in connection with improvements to the key duplicating and engraving machines. The Predecessor Company’s research and development costs were $277 and $1,381, for the three months ended March 31, 2004 and the year ended December 31, 2003, respectively. The Successor Company’s research and development costs were $1,058 and $796 for the year ended December 31, 2005 and the nine months ended December 31, 2004, respectively.

Stock Based Compensation:

For options granted under the 2004 stock option plan, the Company applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations in accounting for its stock based employee compensation plans. The Company is also subject to disclosure requirements of SFAS No. 123, “Accounting for Stock Based Compensation” (“SFAS 123”). Had compensation cost for the plans been determined based on the fair value at the grant dates consistent with the fair value method of SFAS 123, the effect on the Company’s net loss for the year ended December 31, 2005 would have been approximately $6. There would have been no compensation charge for the periods ended December 31, 2004, March 31, 2004 or December 31, 2003.

Using fair value method of SFAS 123, the fair value of the options granted in fiscal 2005 was $33. The fair value of the option grants is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: dividend yield equaling 0%, risk-free interest rate of 3.8%, expected volatility assumed to be 34%, and expected life of 6 years. See Note 13, Stock Based Compensation, of the Notes to the Consolidated Financial Statements.

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 and Mexican 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. The exchange rates represent the noon buying rates reported by the Federal Reserve Bank of New York.

Comprehensive Income (Loss):

The components of comprehensive income (loss) were as follows:

		Successor				Successor				Predecessor				Predecessor
		Year				Nine months				Three months				Year
		ended				ended				ended				ended
		December 31,				December 31,				March 31,				December 31,
		2005				2004				2004				2003
Net (loss) income		$	(3,654	)		$	779			$	(20,366	)		$	(5,709	)
Unrealized gains on investments, net			41			$	34			$	16			$	19
Change in derivative security value, net			(24	)			(18	)			—				—
Foreign currency translation adjustment, net			109				(110	)			10				(135	)
Comprehensive (loss) income		$	(3,528	)		$	685			$	(20,340	)		$	(5,825	)

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 information.

Recent Accounting Pronouncements:

In May 2005, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 requires that retrospective application of a change in accounting principle be limited to the direct effects of the change, and that indirect effects of a change in accounting principle, such as a change in non-discretionary profit-sharing payments resulting from an accounting change, be recognized in the period of the accounting change. SFAS No. 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and error corrections made in fiscal years beginning after the date the statement was issued. The Company is required to adopt the provisions of SFAS 154 beginning January 1, 2006.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary Assets- an amendment of APB Opinion No. 29.” The statement amends Opinion 29 to eliminate the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The statement is effective for fiscal periods beginning after June 15, 2005 and adoption is not expected to have a material impact on the Company’s results of operations or financial position.

In November 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 151, “Inventory Costs” (“SFAS 151”). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and spoilage. This statement requires that these items be expensed as incurred and not included in overhead.

In addition, SFAS 151 requires that allocation of fixed production overhead to conversion costs should be based on normal capacity of the production facilities. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005 and adoption is not expected to have a material impact on the Company’s results of operations or financial position.

In December 2004, the Financial Accounting Standards Board issued Statement No. 123(R), “Share-Based Payment” (“SFAS 123(R)”). This statement revises Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123(R) will require compensation costs related to share-based payment transactions to be recognized in the financial statements (with limited exceptions). The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. On March 29, 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB No. 107”), which provides supplemental guidance in adopting SFAS 123(R). Pursuant to the SEC guidance in SAB No. 107, the Company will adopt the provisions of this statement in the first quarter of fiscal 2006.

The Company will adopt SFAS 123(R) using the modified prospective application without restating prior periods, which requires the recognition of compensation expense for all stock options and other equity based awards that vest or become exercisable on and after January 1, 2006. The adoption of SFAS 123(R) is not expected to have a material effect on the Company’s result of operations or financial position.

Forward Looking Statements

Certain disclosures related to acquisitions and divestitures, refinancing, capital expenditures, resolution of pending litigation and realization of deferred tax assets contained in this annual report involve substantial risks and uncertainties and may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 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.

These forward-looking statements are not historical facts, but rather are based on management’s current expectations, assumptions and projections about future events. Although management believes that the expectations, assumptions and projections on which these forward-looking statements are based are reasonable, they nonetheless could prove to be inaccurate, and as a result, the forward-looking statements based on those expectations, assumptions and projections also could be inaccurate. Forward-looking statements are not guarantees of future performance. Instead, forward-looking statements are subject to known and unknown risks, uncertainties and assumptions that may cause the Company’s strategy, planning, actual results, levels of activity, performance, or achievements to be materially different from any strategy, planning, 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 this annual report. Given these uncertainties, current or prospective investors are cautioned not to place undue reliance on any such forward-looking statements.

All forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the cautionary statements included in this annual report; they should not be regarded as a representation by the Company or any other individual. 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 annual report might not occur or be materially different from those discussed.

Item 7A – Quantitative and Qualitative Disclosures About Market Risk.

The Company is exposed to the impact of interest rate changes as borrowings under the Senior Credit Agreement bear interest at variable interest rates. It is the Company’s policy to enter into interest rate transactions only to the extent considered necessary to meet objectives. On April 28, 2004, the Company entered into an Interest Rate Swap Agreement (“Swap”) with a two-year term for a notional amount of $50 million. The Swap fixes the interest rate on $50 million of the Term Loan at a rate of 1.17% plus the applicable interest rate margin for the first three months of the Swap with incremental increases ranging from 28 to 47 basis points in each successive quarter. Based on Hillman’s exposure to variable rate borrowings at December 31, 2005, a one percent (1%) change in the weighted average interest rate for a period of one year would change the annual interest expense by approximately $1.6 million.

The Company is exposed to foreign exchange rate changes of the Canadian and Mexican currencies as it impacts the $2.7 million net asset value of its Canadian and Mexican subsidiaries as of December 31, 2005. Management considers the Company’s exposure to foreign currency translation gains or losses to be minimal.

Item 8 – Financial Statements and Supplementary Data.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULES

		Page(s)
Reports of Independent Registered Public Accounting Firm			30-31
Consolidated Financial Statements:
Consolidated Balance Sheets			32-33
Consolidated Statements of Operations			34
Consolidated Statements of Cash Flows			35
Consolidated Statements of Changes in Stockholders’ Equity			36
Notes to Consolidated Financial Statements			37-58
Financial Statement Schedule:
Valuation Accounts			59

Report of Independent Registered Public Accounting Firm

To The Board of Directors and Stockholders of
The Hillman Companies, Inc.

In our opinion, the accompanying consolidated balance sheets and related consolidated statements of operations, cash flows and changes in stockholders’ equity present fairly, in all material respects, the financial position of The Hillman Companies, Inc. and its subsidiaries (successor company) at December 31, 2005 and 2004 and the results of their operations and their cash flows for the year ended December 31, 2005 and the nine months ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the accompanying financial statement schedule for the year ended December 31, 2005 and the nine months ended December 31, 2004 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits 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 presentation. We believe that our audits provide a reasonable basis for our opinion.

PricewaterhouseCoopers LLP
Indianapolis, Indiana
March 30, 2006

Report of Independent Registered Public Accounting Firm

To The Board of Directors and Stockholders of
The Hillman Companies, Inc.

In our opinion, the accompanying consolidated statements of operations, cash flows and changes in stockholders’ equity present fairly, in all material respects, the results of operations, changes in cash flows and stockholders’ equity of The Hillman Companies, Inc. and its subsidiaries (predecessor company) for the three months ended March 31, 2004 and the year ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the accompanying financial statement schedule for the three months ended March 31, 2004 and the year ended December 31, 2003 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits 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 presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 11, effective January 1, 2004, the Company adopted the provisions of Statement of Financial Accounting Standards No. 150, “Accounting For Certain Financial Instruments with Characteristics of both Liabilities and Equity” and FASB Interpretation No. 46(R), “Consolidation of Variable interest Entities – an interpretation of ARB No. 51 (revised December 2003).”

PricewaterhouseCoopers LLP
Cincinnati, Ohio
March 30, 2006

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)

		December 31,				December 31,
		2005				2004
ASSETS
Current assets:
Cash and cash equivalents		$	26,491			$	29,613
Restricted investments			167				75
Accounts receivable, net			41,483				37,370
Inventories, net			77,178				65,835
Deferred income taxes, net			5,659				6,712
Other current assets			2,848				2,820
Total current assets			153,826				142,425
Property and equipment, net			60,717				61,111
Goodwill			241,461				242,267
Other intangibles, net			160,507				167,842
Restricted investments			4,642				4,148
Deferred financing fees, net			5,712				6,786
Investment in trust common securities			3,261				3,261
Other assets			1,210				1,059
Total assets		$	631,336			$	628,899
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	17,625			$	21,172
Current portion of senior term loans			2,175				2,175
Current portion of capitalized lease obligations			44				43
Accrued expenses:
Salaries and wages			3,378				4,299
Pricing allowances			9,603				9,681
Income and other taxes			1,739				1,520
Interest			4,203				3,362
Deferred compensation			167				75
Other accrued expenses			10,464				12,407
Total current liabilities			49,398				54,734
Long term senior term loans			212,062				213,694
Long term capitalized lease obligations			55				99
Long term unsecured subordinated notes			49,172				48,090
Junior subordinated debentures			117,295				117,690
Mandatorily redeemable preferred stock			69,695				62,232
Management purchased preferred options			4,087				3,577
Deferred compensation			4,642				4,148
Deferred income taxes, net			36,026				33,221
Accrued dividends on preferred stock			18,057				7,321
Other non-current liabilities			3,156				2,449
Total liabilities			563,645				547,255

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)

		December 31,				December 31,
		2005				2004
LIABILITIES AND STOCKHOLDERS’ EQUITY (CONTINUED)
Common stock with put options:
Class A Common stock, $.01 par, 23,141 shares authorized, 407.6 issued and outstanding at December 31, 2005 and 2004			407				407
Class B Common stock, $.01 par, 2,500 shares authorized, 1,000 issued and outstanding at December 31, 2005 and 2004			1,311				1,000
Commitments and contingencies (Note 17)
Stockholders’ equity:
Preferred Stock:
Class A Preferred stock, $.01 par, 238,889 shares authorized, 82,104.8 issued and outstanding at December 31, 2005 and 2004			1				1
Common Stock:
Class A Common stock, $.01 par, 23,141 shares authorized, 5,805.3 issued and outstanding at December 31, 2005 and 2004			—				—
Class C Common stock, $.01 par, 30,109 shares authorized, 2,787.1 issued and outstanding at December 31, 2005 and 2004			—				—
Additional paid-in capital			69,594				80,330
Accumulated deficit			(3,654	)			—
Accumulated other comprehensive income (loss)			32				(94	)
Total stockholders’ equity			65,973				80,237
Total liabilities and stockholders’ equity		$	631,336			$	628,899

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands)

		Successor									Predecessor
		Year				Nine months					Three months				Year
		ended				ended					ended				ended
		December 31,				December 31,					March 31,				December 31,
		2005				2004					2004				2003
Net sales		$	382,512			$	273,374				$	78,190			$	317,671
Cost of sales (exclusive of depreciation and amortization shown separately below)			176,222				122,972					35,383				143,355
Gross profit			206,290				150,402					42,807				174,316
Operating expenses:
Selling, general and administrative expenses			140,666				99,538					30,996				120,758
Non-recurring expense (Note 15)			—				—					30,707				—
Depreciation			15,605				11,388					3,799				14,399
Amortization			7,228				5,427					321				1,437
Management fee to related party			1,045				805					524				1,800
Total operating expenses			164,544				117,158					66,347				138,394
Other (expense) income, net			(87	)			417					(140	)			681
Income (loss) from operations			41,659				33,661					(23,680	)			36,603
Interest expense, net			20,974				13,698					3,841				15,405
Interest expense on mandatorily redeemable preferred stock and management purchased preferred options			7,972				5,458					—				—
Interest expense on junior subordinated notes			12,609				9,457					3,152				—
Investment income on trust common securities			(378	)			(284	)				(94	)
Distributions on guaranteed preferred beneficial interests			—				—					—				12,231
Write-down of note receivable			—				—					—				11,258
Income (loss) before income taxes			482				5,332					(30,579	)			(2,291	)
Income tax provision (benefit)			4,136				4,553					(10,213	)			3,418
Net (loss) income		$	(3,654	)		$	779				$	(20,366	)		$	(5,709	)

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)

		Successor									Predecessor
		Year				Nine months					Three months				Year
		ended				ended					ended				ended
		December 31,				December 31,					March 31,				December 31,
		2005				2004					2004				2003
Cash flows from operating activities:
Net (loss) income		$	(3,654	)		$	779				$	(20,366	)		$	(5,709	)
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization			22,833				16,815					4,120				15,836
Dispositions of property and equipment			151				75					—				—
Deferred income tax (benefit)			4,176				4,040					(11,608	)			1,971
PIK interest on unsecured subordinated notes			1,082				590					506				1,954
Interest on mandatorily redeemable preferred stock			7,972				5,458					—				—
Stock option grant			—				—					24,353				—
Write-down of note receivable			—				—					—				11,258
Prepayment penalty			—				(1,097	)				—				—
Changes in operating items, net of effects of acquisitions:
(Increase) decrease in accounts receivable, net			(4,113	)			380					(4,599	)			(2,758	)
(Increase) decrease in inventories, net			(11,343	)			1,123					(1,121	)			(5,404	)
(Increase) decrease in other assets			(111	)			1,786					1,464				(1,236	)
(Decrease) increase in accounts payable			(3,547	)			95					6,613				(3,494	)
(Decrease) increase in other accrued liabilities			(1,253	)			(2,380	)				670				(2,129	)
Other items, net			1,756				955					6				1,925
Net cash provided by operating activities			13,949				28,619					38				12,214
Cash flows from investing activities:
Proceeds from sale of property and equipment			—				—					—				20
Capital expenditures			(15,158	)			(9,404	)				(2,586	)			(11,479	)
Other, net			(238	)			—					(23	)			(143	)
Net cash used for investing activities			(15,396	)			(9,404	)				(2,609	)			(11,602	)
Cash flows from financing activities:
Borrowings of senior term loans			—				217,500					—				—
Repayments of senior term loans			(1,632	)			(62,189	)				—				(9,269	)
Borrowings of revolving credit loans			—				4,728					2,680				10,533
Repayments of revolving credit loans			—				(52,932	)				—
Borrowings of unsecured subordinated notes			—				47,500					—				—
Repayments of unsecured subordinated notes			—				(44,569	)				—				—
Principal payments under capitalized lease obligations			(43	)			(38	)				(14	)			(55	)
Financing fees, net			—				(7,592	)				—				(1,447	)
Purchase of predecessor common stock			—				(239,077	)				—				—
Receipt of successor equity proceeds			—				147,980					—				—
Merger transaction expenses			—				(2,171	)				—				—
Net cash (used for) provided by financing activities			(1,675	)			9,140					2,666				(238	)
Net (decrease) increase in cash and cash equivalents			(3,122	)			28,355					95				374
Cash and cash equivalents at beginning of period			29,613				1,258					1,163				789
Cash and cash equivalents at end of period		$	26,491			$	29,613				$	1,258			$	1,163

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(dollars in thousands)

Accumulated

Predecessor

Successor

Additional

Class A

Other

Total

Common

Common Stock

Paid-in

Preferred

Accumulated

Comprehensive

Stockholders’

Stock

Class A

Class C

Capital

Stock

Deficit

Income

Equity

Balance at December 31, 2002- Predecessor

$

71

$

—

$

—

$

52,231

$

—

$

—

$

63

$

52,365

Net loss

—

—

—

—

—

(5,709

)

—

(5,709

)

Net unrealized gains on investments (1)

—

—

—

—

—

—

19

19

Change in cumulative foreign translation adjustment (1)

—

—

—

—

—

—

(135

)

(135

)

Balance at December 31, 2003- Predecessor

71

—

—

52,231

—

(5,709

)

(53

)

46,540

Net loss

—

—

—

—

—

(20,366

)

—

(20,366

)

Stock option grant

—

—

—

24,353

—

—

—

24,353

Net unrealized gains on investments (1)

—

—

—

—

—

—

16

16

Change in cumulative foreign translation adjustment (1)

—

—

—

—

—

—

10

10

Balance at March 31, 2004 - Predecessor

71

—

—

76,584

—

(26,075

)

(27

)

50,553

Close Predecessor’s stockholder’s equity at merger date

(71

)

—

—

(76,584

)

—

26,075

27

(50,553

)

Issuance of 5,805.3 shares of Class A Common Stock

—

—

—

5,443

—

—

—

5,443

Issuance of 2,787.1 shares of Class C Common Stock

—

—

—

2,787

—

—

—

2,787

Issuance of 82,104.8 shares of The Hillman Companies, Inc.

Class A Preferred Stock

—

—

—

78,642

1

—

—

78,643

Balance at March 31, 2004 - Successor

—

—

—

86,872

1

—

—

86,873

Net income

—

—

—

—

—

779

—

779

Dividends to shareholders

—

—

—

(6,542

)

—

(779

)

—

(7,321

)

Net unrealized gains on investments (1)

—

—

—

—

—

—

34

34

Change in cumulative foreign translation adjustment (1)

—

—

—

—

—

—

(110

)

(110

)

Change in derivative security value (1)

—

—

—

—

—

—

(18

)

(18

)

Balance at December 31, 2004 - Successor

—

—

—

80,330

1

—

(94

)

80,237

Net loss

—

—

—

—

—

(3,654

)

—

(3,654

)

Dividends to shareholders

—

—

—

(10,736

)

—

—

(10,736

)

Net unrealized gains on investments (1)

—

—

—

—

—

—

41

41

Change in cumulative foreign translation adjustment (1)

—

—

—

—

—

—

(24

)

(24

)

Change in derivative security value (1)

—

—

—

—

—

—

109

109

Balance at December 31, 2005 - Successor

$

—

$

—

$

—

$

69,594

$

1

$

(3,654

)

$

32

$

65,973

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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. (the “Company” or “Hillman”) and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

On March 31, 2004, The Hillman Companies, Inc. was acquired by an affiliate of Code Hennessy & Simmons LLC (“CHS”). Pursuant to the terms and conditions of an Agreement and Plan of Merger (“Merger Agreement”) dated as of February 14, 2004, the Company was merged with an affiliate of CHS with the Company surviving the merger (“Merger Transaction”). The total consideration paid in the Merger Transaction was $511,646 including repayment of outstanding debt and including the value of the Company’s outstanding Trust Preferred Securities ($102,395 at merger).

Prior to the merger, Allied Capital Corporation (“Allied Capital”) owned 96.8 % of the Company’s common stock. As a result of the change of control, an affiliate of CHS owns 49.1% of the Company’s common stock and 54.5% of the Company’s voting common stock, Ontario Teacher’s Pension Plan (“OTPP”) owns 27.9% of the Company’s common stock and 31.0% of the Company’s voting common stock and HarbourVest Partners VI owns 8.7% of the Company’s common stock and 9.7% of the Company’s voting common stock. OTPP’s voting rights with respect to the election of directors to the Board of Directors is limited to the lesser of 30.0% or the actual percentage of voting common stock held. Certain members of management own 14.1% of the Company’s common stock and 4.5% of the Company’s voting common stock.

The Company’s Consolidated Balance Sheet and its related Consolidated Statements of Operations, Cash Flows and Changes in Stockholders’ Equity for the periods presented prior to the March 31, 2004 Merger Transaction are referenced herein as the predecessor financial statements (the “Predecessor” or “Predecessor Financial Statements”). The Company’s Consolidated Balance Sheets as of December 31, 2005 and 2004 and its related Consolidated Statements of Operations, Cash Flows and Changes in Stockholders’ Equity for the year ended December 31, 2005 and the nine months ended December 31, 2004 are referenced herein as the successor financial statements (the “Successor” or “Successor Financial Statements”). The accompanying Successor Financial Statements reflect the allocation of the aggregate purchase price of $511,646, including the value of the Company’s Trust Preferred Securities, to the assets and liabilities of Hillman based on fair values at the date of the merger in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” The following table reconciles the fair value of the acquired assets and assumed liabilities to the total purchase price:

Accounts receivable		$	37,750
Inventory			66,958
Property and equipment			63,230
Goodwill			241,461
Intangible assets			173,162
Other assets			8,924
Total assets acquired			591,485
Less:
Liabilities assumed			42,948
Deferred taxes, net			21,300
Junior subordinated debentures			117,986
Total assumed liabilities			182,234
Total purchase price		$	409,251