UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY 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 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

On May 11, 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 HILLMAN COMPANIES, INC. AND SUBSIDIARIES

INDEX

				PAGE(S)
PART I.		FINANCIAL INFORMATION
Item 1.		Condensed Consolidated Financial Statements (Unaudited)
		Condensed Consolidated Balance Sheets			3-4
		Condensed Consolidated Statements of Operations			5-6
		Condensed Consolidated Statements of Cash Flows			7
		Condensed Consolidated Statements of Changes in Stockholders’ Equity			8
		Notes to Condensed Consolidated Financial Statements			9-25
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			26-37
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			38
Item 4.		Controls and Procedures			38-40
PART II.		OTHER INFORMATION
Item 1.		Legal Proceedings			41
Item 1A.		Risk Factors			41
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			41
Item 3.		Defaults upon Senior Securities			41
Item 4.		Submission of Matters to a Vote of Security Holders			41
Item 5.		Other Information			41
Item 6.		Exhibits			41-42
SIGNATURES					43

Item 1.		THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
		CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
		(dollars in thousands)

		June 30,				December 31,
		2005				2004
						(as restated,
						see Note 2)
ASSETS
Current assets:
Cash and cash equivalents		$	3,624			$	29,613
Restricted investments			138				75
Accounts receivable, net			52,426				37,370
Inventories, net			83,644				65,835
Deferred income taxes, net			6,310				6,712
Other current assets			3,782				2,820
Total current assets			149,924				142,425
Property and equipment, net			61,585				61,111
Goodwill			241,935				242,267
Other intangibles, net			164,122				167,842
Restricted investments			4,388				4,148
Deferred financing fees, net			6,249				6,786
Investment in trust common securities			3,261				3,261
Other assets			644				1,059
Total assets		$	632,108			$	628,899
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	24,034			$	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			3,311				4,299
Pricing allowances			6,552				9,681
Income and other taxes			2,032				1,520
Interest			3,767				3,362
Deferred compensation			138				75
Other accrued expenses			11,545				12,407
Total current liabilities			53,598				54,734
Long term senior term loans			212,606				213,694
Long term capitalized lease obligations			76				99
Long term unsecured subordinated notes			48,638				48,090
Junior subordinated debentures			117,492				117,690
Mandatorily redeemable preferred stock (Note 8)			65,832				62,232
Management purchased options (Note 9)			3,823				3,577
Deferred compensation			4,388				4,148
Deferred income taxes, net			34,435				33,221
Other non-current liabilities			14,773				9,770
Total liabilities			555,661				547,255

Item 1.		THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
		CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
		(dollars in thousands)

		June 30,				December 31,
		2005				2004
						(as restated,
						see Note 2)
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			407				407
Class B Common stock, $.01 par, 2,500 shares authorized, 1,000 issued and outstanding			1,232				1,000
Commitments and contingencies
Stockholders’ equity:
Preferred Stock:
Class A Preferred stock, $.01 par, 238,889 shares authorized, 82,104.8 issued and outstanding			1				1
Common Stock:
Class A Common stock, $.01 par, 23,141 shares authorized, 5,805.3 issued and outstanding			—				—
Class C Common stock, $.01 par, 30,109 shares authorized, 2,787.1 issued and outstanding			—				—
Additional paid-in capital			75,157				80,330
Accumulated deficit			(363	)			—
Accumulated other comprehensive income (loss)			13				(94	)
Total stockholders’ equity			74,808				80,237
Total liabilities and stockholders’ equity		$	632,108			$	628,899

SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
FOR THE THREE MONTHS ENDED

(dollars in thousands)

		June 30,				June 30,
		2005				2004
						(as restated,
						see Note 2)
Net sales		$	102,934			$	93,320
Cost of sales (exclusive of depreciation and amortization shown separately below)			46,578				41,867
Gross profit			56,356				51,453
Operating expenses:
Selling, general and administrative expenses			36,399				32,787
Depreciation			3,865				3,904
Amortization			1,808				2,679
Management and transaction fees to related party			278				256
Total operating expenses			42,350				39,626
Other expense, net			(38	)			(134	)
Income from operations			13,968				11,693
Interest expense, net			5,228				4,591
Interest expense on mandatorily redeemable preferred stock and management purchased options			1,959				1,757
Interest expense on junior subordinated debentures			3,153				3,153
Investment income on trust common securities			(95	)			(95	)
Income before income taxes			3,723				2,287
Income tax provision			3,762				3,413
Net loss		$	(39	)		$	(1,126	)

SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

		Successor									Predecessor
		Six months				Three months					Three months
		ended				ended					ended
		June 30,				June 30,					March 31,
		2005				2004					2004
						(as restated,					(as restated,
						see Note 2)					see Note 2)
Net sales		$	190,534			$	93,320				$	78,190
Cost of sales (exclusive of depreciation and amortization shown separately below)			85,679				41,867					35,383
Gross profit			104,855				51,453					42,807
Operating expenses:
Selling, general and administrative expenses			71,119				32,787					30,996
Non-recurring expense (Note 11)			—				—					30,707
Depreciation			7,887				3,904					3,799
Amortization			3,612				2,679					321
Management and transaction fees to related party			533				256					524
Total operating expenses			83,151				39,626					66,347
Other expense, net			(187	)			(134	)				(140	)
Income (loss) from operations			21,517				11,693					(23,680	)
Interest expense, net			9,904				4,591					3,841
Interest expense on mandatorily redeemable preferred stock and management purchased options			3,845				1,757					—
Interest expense on junior subordinated debentures			6,305				3,153					3,152
Investment income on trust common securities			(189	)			(95	)				(94	)
Income (loss) before income taxes			1,652				2,287					(30,579	)
Income tax provision (benefit)			2,015				3,413					(10,213	)
Net loss		$	(363	)		$	(1,126	)			$	(20,366	)

SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

		Successor									Predecessor
		Six months				Three months					Three months
		ended				ended					ended
		June 30,				June 30,					March 31,
		2005				2004					2004
						(As restated,					(As restated,
						see Note 2)					see Note 2)
Cash flows from operating activities:
Net loss		$	(363	)		$	(1,126	)			$	(20,366	)
Adjustments to reconcile net loss to net cash (used for) provided by operating activities:
Depreciation and amortization			11,499				6,583					4,120
Deferred income tax (benefit)			2,063				2,944					(11,608	)
PIK interest on unsecured subordinated notes			548				44					506
Interest on mandatorily redeemable preferred stock and management purchased options			3,845				—					—
Stock option grant			—				—					24,353
Prepayment penalty			—				(1,097	)				—
Changes in operating items, net of effects of acquisitions:
Increase in accounts receivable, net			(15,056	)			(6,474	)				(4,599	)
Increase in inventories, net			(17,809	)			(2,274	)				(1,121	)
(Increase) decrease in other assets			(547	)			(62	)				1,464
Increase (decrease) in accounts payable			2,862				(1,906	)				6,613
(Decrease) increase in other accrued liabilities			(4,060	)			(6,516	)				670
Other items, net			535				2,578					6
Net cash (used for) provided by operating activities			(16,483	)			(7,306	)				38
Cash flows from investing activities:
Capital expenditures			(8,305	)			(2,781	)				(2,586	)
Other, net			(92	)			6					(23	)
Net cash used for investing activities			(8,397	)			(2,775	)				(2,609	)
Cash flows from financing activities:
Borrowings of senior term loans			—				217,500					—
Repayments of senior term loans			(1,087	)			(61,102	)				—
Borrowings of revolving credit loans			—				2,198					2,680
Repayments of revolving credit loans			—				(50,402	)				—
Borrowings of unsecured subordinated notes			—				47,500					—
Repayments of unsecured subordinated notes			—				(44,569	)				—
Principal payments under capitalized lease obligations			(22	)			(18	)				(14	)
Financing fees, net			—				(7,592	)				—
Purchase of predecessor common stock			—				(239,077	)				—
Receipt of successor equity proceeds			—				147,980					—
Merger transaction costs			—				(2,171	)				—
Net cash (used for) provided by financing activities			(1,109	)			10,247					2,666
Net (decrease) increase in cash and cash equivalents			(25,989	)			166					95
Cash and cash equivalents at beginning of period			29,613				1,258					1,163
Cash and cash equivalents at end of period		$	3,624			$	1,424				$	1,258

SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

																										Accumulated
										Additional				Class A								Compre-				Other				Total
		Common Stock								Paid-in				Preferred				Accumulated				hensive				Comprehensive				Stockholders’
		Class A				Class C				Capital				Stock				Deficit				Income(Loss)				Income				Equity
Balance at December 31, 2004 (as previously reported)		$	—			$	—			$	81,452			$	1			$	(1,274	)						$	(128	)		$	80,051
Effect of restatement (see note 2)			—				—				(1,122	)			—				1,274								34				186
Balance at December 31, 2004 (as restated)			—				—				80,330				1				—								(94	)			80,237
Dividends to shareholders			—				—				(2,536	)			—				—								—				(2,536	)
Comprehensive income (loss):
Net loss (as restated) (2)			—				—				—				—				(324	)		$	(324	)			—				(324	)
Other comprehensive income (loss), net of tax:
Change in cumulative foreign translation adjustment (1)			—				—				—				—				—				10				10				10
Change in derivative security value, net of tax (1)			—				—				—				—				—				141				141				141
Other comprehensive income																							151
Comprehensive loss																						$	(173	)
Balance at March 31, 2005 (as restated)			—				—				77,794				1				(324	)							57				77,528
Dividends to shareholders			—				—				(2,637	)			—				—								—				(2,637	)
Comprehensive income (loss):
Net loss			—				—				—				—				(39	)		$	(39	)			—				(39	)
Other comprehensive income (loss), net of tax:
Change in cumulative foreign translation adjustment (1)			—				—				—				—				—				21				21				21
Change in derivative security value, net of tax (1)			—				—				—				—				—				(65	)			(65	)			(65	)
Other comprehensive loss																							(44	)
Comprehensive loss																						$	(83	)
Balance at June 30, 2005		$	—			$	—			$	75,157			$	1			$	(363	)						$	13			$	74,808

SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

1. Basis of Presentation:

The accompanying financial statements include the Condensed Consolidated accounts of The Hillman Companies, Inc. (“Hillman” or the “Company”) 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 the time of the 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 outstanding 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 outstanding common stock and 31.0% of the Company’s voting common stock and HarbourVest Partners VI owns 8.7% of the Company’s outstanding 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 outstanding common stock and 4.5% of the Company’s voting common stock.

CHS is a private equity firm that manages approximately $2.9 billion in capital in five funds. The acquisition of the Company by CHS adds to their existing portfolio of middle market manufacturing and distribution businesses.

The Company’s Condensed Consolidated Statements of Operations and Cash Flows 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 Condensed Consolidated Balance Sheets as of December 31, 2004 and June 30, 2005 and its related Condensed Consolidated Statements of Operations, Cash Flows and Changes in Stockholders’ Equity for the six month period ended June 30, 2005 and three month periods ended June 30, 2005 and 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 (“SFAS 141”), “Business Combinations”. The following table reconciles the fair value of the acquired assets and assumed liabilities to the total purchase price (as restated, see Note 2):

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

1. Basis of Presentation (continued):

Accounts receivable		$	37,750
Inventory			66,958
Property and equipment			63,230
Goodwill			241,935
Intangible assets			173,162
Deferred tax assets-gross			50,085
Other assets			8,924
Total assets acquired			642,044
Less:
Liabilities assumed			42,947
Deferred tax liabilities-gross			71,860
Junior subordinated debentures			117,986
Total assumed liabilities			232,793
Total purchase price		$	409,251

The purchase price includes transaction related costs aggregating $2,171 which were associated with CHS’s purchase of the Company.

The following table indicates the pro forma financial statements of the Company for the six months ended June 30, 2004 (including non-recurring charges of $30,707 as discussed in Note 11). The pro forma financial statements give effect to the Merger Transaction as if it had occurred on January 1, 2004.

		Six Months Ended
		June 30, 2004
		(as restated,
		see Note 2)
Net sales		$	171,510
Net loss			(24,182	)

The pro forma results are based on assumptions that the Company believes are reasonable under the circumstances. The pro forma results are not necessarily indicative of the operating results that would have occurred if the acquisition had been effective January 1, 2004, nor are they intended to be indicative of results that may occur in the future. The underlying pro forma information includes the historical financial results of the Company, the Company’s financing arrangements, and certain purchase accounting adjustments.

The accompanying unaudited condensed consolidated financial statements present information in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and applicable rules of Regulation S-X. Accordingly, they do not include all information or footnotes required by generally accepted accounting principles for complete financial statements. Management believes the financial statements include all normal recurring accrual adjustments necessary for a fair presentation. Operating results for the six months ended June 30, 2005 do not necessarily indicate the results that may be expected for the full year. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s annual report filed on Form 10-K/A for the year ended December 31, 2004.

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

1. Basis of Presentation (continued):

Nature of Operations:

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 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. 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.

2. Restatement of Financial Statements:

Subsequent to the issuance of the Company’s March 31, 2005 unaudited condensed consolidated financial statements, the Company concluded that certain of its accounting practices with respect to revenue recognition, income taxes, capitalized interest cost, stock options, outstanding checks, customer pricing allowances, insurance demutualization and trust preferred securities were not in accordance with generally accepted accounting principles.

The following table reconciles the net income (loss) as originally reported to amounts as restated for applicable periods:

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

2. Restatement of Financial Statements (continued):

		Successor					Predecessor
		Three months					Three months
		ended					ended
		June 30,					March 31,
		2004					2004
Net income (loss) as originally reported		$	211				$	(19,316	)
Revenue recognition, before tax (1)			368					(461	)
Other matters, before tax:
Outstanding checks (2)			—					—
Volume rebates (3)			55					51
Trust de-consolidation (4)			—					—
Stock option grant (5)			—					—
Insurance demutualization (6)			—					—
Income tax effects on the above			(174	)				168
Other adjustments relating to income tax matters:
Interim tax provisions (7)			(1,327	)				—
Tax rate (8)			—					(340	)
Axxess intangible amortization and transaction fees (9)			—					104
1998 Stock Option exercises (10)			—					(2,001	)
2001 Stock Option exercises (11)			—					—
Indefinite lived intangibles (12)			—					—
Valuation allowance adjustments (13)			—					982
Uncertain tax position adjustments (14)			(259	)				406
G-C Note (15)			—					—
State income and franchise tax (16)			—					41
Provision to return adjustments (17)			—					—
Other tax corrections (18)			—					—
Total adjustments			(1,337	)				(1,050	)
Net loss as restated		$	(1,126	)			$	(20,366	)

(1) The Company’s standard freight terms are FOB shipping point and historically revenue was recognized upon shipment. However, the Company arranges for the shipment of product, selects the carrier and maintains responsibility for lost or damaged product. Accordingly, management has determined that the risk of loss is not fully transferred to the customer until shipments are received by the customer which is generally within two days of product shipment. Therefore, the Company concluded that revenue was not recognized in accordance with Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements.”

(2) At the end of each fiscal period the Company has historically reclassified all checks issued but still outstanding between accounts payable and cash or, for outstanding payroll checks, between accrued salaries and cash. Generally accepted accounting principles allow only the portion of the outstanding checks in excess of available deposits to be classified as a liability. In the accompanying condensed consolidated balance sheet as of December 31, 2004 an adjustment has been made to reclassify the outstanding checks to accounts payable or accrued salaries and wages.

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

2. Restatement of Financial Statements (continued):

(3) For the year ended December 31, 2004, the Company’s estimate of the accrued volume rebate for a certain customer was overstated by $228. As a result, net sales were understated and accrued pricing allowances were overstated by $51 and $55 for the three months ended March 31, 2004 and June 30, 2004, respectively.

(4) On March 31, 2004 the Company de-consolidated The Hillman Group Capital Trust in accordance with FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46R”) (see Note 10). Following the deconsolidation, the Company presented junior subordinated debentures net of the investment in the trust common securities in the consolidated balance sheet as of December 31, 2004. Investment income from the trust common securities was improperly netted against interest expense on the junior subordinated debentures in the statement of operations. The investment in trust common securities and junior subordinated debentures should have been recorded gross on the balance sheet, as no right of offset exists. The related investment income and interest expense should have been recorded gross in the statement of operations.

(5) For the three months ended March 31, 2004, the Company recorded a $24,353 charge in connection with the grant of stock options (see Note 9, Stock Based Compensation). The charge should have been recorded to additional paid-in capital in the Predecessor balance sheet but was incorrectly recorded as an accrued liability. The adjustment increases the amount reported as paid-in capital of the Predecessor in the consolidated statement of changes in stockholders’ equity. Additional paid-in capital of the Predecessor was then eliminated in connection with the Merger Transaction. The consolidated statements of cash flows for the three month period ended March 31, 2004 was also adjusted to reflect the stock option grant as a non cash adjustment to net income in the Predecessor statements and a financing activity in the Successor statement.

(6) A former subsidiary of the Company was a policyholder of The Principal Mutual Holding Company which demutualized in October 2001. The Company was entitled to receive 10,550 shares of The Principal Group common stock in connection with the demutualization. The Company was not notified of the ownership in the common shares until January 2006 and, therefore, had not recorded the investment. Adjustments have been recorded in the three months ended December 31, 2001 to record the original investment of $222, less an income tax provision of $87. Changes in the fair value of the common stock for the periods subsequent to December 31, 2001 have been recorded, net of the related tax effect, in accumulated other comprehensive income.

(7) The Company also reviewed its accounting for income taxes and determined that the income tax accounts were not properly recorded in accordance with Statement of Financial Accounting Standard No. 109, “Accounting for Income Taxes” (“SFAS 109”), APB Opinion 28, “Interim Financial Reporting,” and FASB Interpretation No. 18, “Accounting for Income Taxes in Interim Periods.” Historically, the Company calculated income taxes in the interim periods on a discrete period basis by multiplying the statutory income tax rate by pretax earnings adjusted for permanent book tax basis differences. APB Opinion 28, however, generally requires that an estimated annual effective tax rate be used to determine interim period income tax provisions.

(8) The Company applied a combined 41% state and federal statutory tax rate to taxable income in determining the income tax provision for all interim and annual periods from 2002 through 2004. The combined state and federal statutory rate applied to taxable income should have been 39.4% for the three month periods ended March 31, 2004 and June 30, 2004.

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

2. Restatement of Financial Statements (continued):

(9) In April 2000, the Company acquired Axxess Technologies, Inc. (Axxess). In connection with the acquisition, the Company recorded intangible assets of $14.4 million. The Company did not record a deferred tax liability on the intangible assets in accordance with SFAS 109. As a result, deferred tax liabilities and goodwill were understated at the date of the acquisition by $5,853. In subsequent periods through the March 31, 2004 Merger Transaction, the Axxess intangible amortization was treated as a permanent difference and, accordingly, income tax expense was overstated. In addition, the Company did not record a deferred tax asset of $356 on transaction fees capitalized for tax purposes as part of the Axxess acquisition. The Company’s income tax expense was understated in subsequent periods to the extent that a tax benefit was recognized on the amortization of the transaction fees.

(10) In the three months ended March 31, 2004, the Company did not properly record the tax effect of stock option exercises in accordance with SFAS 109. The tax benefit of stock option exercises was improperly recorded as an income tax benefit in the statement of operations for the three months ended March 31, 2004. The tax benefit of the stock option exercises should have been recorded as a reduction to goodwill.

(11) The Company recorded a deferred tax asset at March 31, 2004 to reflect the future tax benefit of unexercised stock options. Under SFAS 109, the benefit of the options should not be recognized in a purchase business combination until they are exercised. As a result, the December 31, 2004 deferred tax assets were overstated and goodwill was understated by $53.

(12) At the Merger Transaction date the Company did not properly record deferred taxes associated with indefinite-lived intangible assets and tax deductible goodwill as required by SFAS 109 which resulted in an understatement of goodwill and deferred tax liabilities of $22,964.

(13) In connection with the purchase of the Company by Allied Capital in September 2001 and the Merger Transaction in March 2004, the Company established valuation allowances for state net operating loss carryforwards and capital loss carryforwards. SFAS 109 requires subsequent recognition of a tax benefit for valuation allowances established at the date of acquisition to be recorded as a reduction of goodwill. The Company had initially recorded the benefit of the change as a reduction in the provision and, accordingly, an adjustment is required to reverse the benefit for the three months ended March 31, 2004 and to adjust goodwill as of December 31, 2004.

       Also, at December 31, 2002 and 2003, valuation allowances were established for 100% of the deferred tax asset for state net operating loss carryforwards. Similarly, at March 31, 2004 the deferred tax asset for state net operating loss carryforwards was almost entirely offset by valuation allowances. Based on the length of the carryforward period for the underlying state net operating loss carryforwards and estimates of future taxable income available at the time the valuation allowances were established, the Company has determined a portion of the deferred tax asset for state net operating loss carryforwards at December 31, 2002 and 2003 and March 31, 2004 was realizable. Accordingly, adjustments have been recorded to reduce the valuation allowance for state net operating loss carryforwards.

       In connection with the insurance demutualization described above, valuation allowances for capital loss carryforwards have been reduced to the extent of the fair value of the common shares and the subsequent increases in the fair value. As the valuation allowances for capital loss carryforwards were established in purchase accounting the initial recognition of the benefit has been recorded as a reduction of goodwill.

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

2. Restatement of Financial Statements (continued):

(14) The Company established reserves for uncertain tax positions in connection with both the September 2001 Allied Capital acquisition and the Merger Transaction. EITF 93-7, “Uncertainties Related to Income Taxes in a Purchase Business Combination,” requires subsequent changes to reserves for uncertain tax positions established in purchase business combinations to be charged to goodwill. The Company has recorded an adjustment for the three months ended March 31, 2004 and the three months ended June 30, 2004 to properly record changes in estimates for uncertain tax positions to goodwill. Additionally, contingencies for certain non-income tax liabilities including payroll and sales taxes were included in the reserve for uncertain tax positions. Adjustments have been made in the three months ended March 31, 2004 and June 30, 2004 to record the non-income tax contingencies as selling, general, and administrative expense.

(15) At the time of the Allied Capital acquisition, the Company had an investment in a partnership, GC Sun Holdings L.P. (“G-C”). For the years ended December 31, 2002 and 2003 the Company incorrectly recorded the book versus tax difference in the basis of the investment in the partnership and the related note as permanent items whereas under SFAS 109 the differences should have been treated as temporary. A deferred tax asset has been recorded with an offsetting valuation allowance as it has been determined that it is not likely that the deferred tax asset for the capital loss on the GC-note will be realized.

(16) A review of the Company’s state income and franchise tax expense and liabilities resulted in adjustments to the state tax provision and related state and franchise tax payable accounts as of and for the three months ended March 31, 2004 and the nine months ended December 31, 2004. The adjustments to the state income tax and franchise liabilities reduced the reported goodwill balance $551 as of December 31, 2004.

       Also, the Company has historically included state franchise tax expense in the income tax provision in the consolidated statements of operations. SFAS 109 requires state franchise taxes to be reported as a component of selling, general and administrative expense. Accordingly, an adjustment to reclassify state franchise taxes from the income tax provision to selling, general and administrative expense has been recorded for the three months ended March 31, 2004.

(17) For the nine months ended December 31, 2004, the Company estimated the amount of certain book versus tax permanent and temporary differences when preparing the income tax provision. During the subsequent preparation of the state and federal income tax returns, several of the book versus tax adjustments were adjusted based on better information. The Company has determined that some of the income tax provision versus tax return differences were based on information available at the time the provision was prepared. Therefore, adjustments have been made to record income tax provision versus return adjustments in the proper period.

(18) Adjustments have been made to the deferred tax balances for the period ended March 31, 2004 as a result of mathematical errors and corrections to certain deferred tax balances.

       In connection with the Merger Transaction, the Company incurred $4,035 of transaction fees which were treated as a permanent difference in the computation of the March 31, 2004 tax provision. The transaction fees should have been treated as a timing item, and accordingly, an adjustment has been made to increase deferred tax assets by $1,654 as of December 31, 2004. An offsetting valuation allowance was established for the entire amount of the deferred asset for transaction fees as management has concluded it is not more likely than not a deduction for the transaction fees will be utilized.

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

2. Restatement of Financial Statements (continued):

As a result of the items noted above, the Company has restated its consolidated balance sheet at December 31, 2004 and its consolidated statements of operations and cash flows for the three months ended March 31, 2004 and the three months ended June 30, 2004. In connection with the restatement, the changes in earnings for the nine months ended December 31, 2004 caused adjustments to dividends allocable to additional paid-in capital.

The following is a summary of the effects of these changes on the Company’s condensed consolidated balance sheet as of December 31, 2004, as well as the effect on the condensed consolidated statements of operations and cash flows for the three months ended March 31, 2004 and June 30, 2004.

		Condensed Consolidated Balance Sheet
		As				Adjustments
		Previously				Revenue				Income												As
As of December 31, 2004:		Reported				Recognition				Taxes				Other (1)				Dividends				Restated
Cash and cash equivalents		$	33,032			$	—			$	—			$	(3,419	)		$	—			$	29,613
Accounts receivable, net			39,903				(2,533	)			—				—				—				37,370
Inventories, net			64,627				1,208				—				—				—				65,835
Deferred tax assets — current			6,520				613				(328	)			(93	)			—				6,712
Goodwill			219,051				974				22,499				(257	)			—				242,267
Investment in trust common securities			—				—				—				3,261				—				3,261
Other assets			627				—				—				432				—				1,059
Accounts payable			24,367				—				—				(3,195	)			—				21,172
Accrued salaries and wages			4,523				—				—				(224	)			—				4,299
Accrued pricing allowances			9,909				—				—				(228	)			—				9,681
Accrued income and other taxes			2,137				—				(617	)			—				—				1,520
Other accrued expenses			11,724				27				656				—				—				12,407
Junior subordinated debentures			114,429				—				—				3,261				—				117,690
Deferred tax liabilities — non current			10,730				56				22,264				171				—				33,221
Additional paid-in capital			81,452				—				—				—				(1,122	)			80,330
Accumulated deficit			(1,274	)			179				(132	)			105				1,122				—
Accumulated other comprehensive loss			(128	)			—				—				34				—				(94	)

		Condensed Consolidated Statement of Operations
						Adjustments
For the three months		As Previously				Revenue				Income
ended March 31, 2004:		Reported				Recognition				Taxes				Other (1)				As Restated
Net sales		$	78,997			$	(858	)		$	—			$	51			$	78,190
Cost of sales			35,780				(397	)			—				—				35,383
Gross profit			43,217				(461	)			—				51				42,807
Selling, general and administrative			30,999				—				(3	)			—				30,996
Loss from operations			(23,273	)			(461	)			3				51				(23,680	)
Interest expense on junior subordinated debentures			3,058				—				—				94				3,152
Investment income on trust common securities			—				—				—				(94	)			(94	)
Loss before income taxes			(30,172	)			(461	)			3				51				(30,579	)
Income tax benefit			(10,856	)			(189	)			811				21				(10,213	)
Net loss			(19,316	)			(272	)			(808	)			30				(20,366	)

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

2. Restatement of Financial Statements (continued):

		Condensed Consolidated Statement of Operations
		As				Adjustments
For the three months		Previously				Revenue				Income								As
ended June 30, 2004:		Reported				Recognition				Taxes				Other (1)				Restated
Net sales		$	92,636			$	629			$	—			$	55			$	93,320
Cost of sales			41,606				261				—				—				41,867
Gross profit			51,030				368				—				55				51,453
Sellling, general and administrative			32,687				—				100				—				32,787
Income from operations			11,370				368				(100	)			55				11,693
Interest expense on junior subordinated debentures			3,058				—				—				95				3,153
Investment income on trust common securities			—				—				—				(95	)			(95	)
Income before income taxes			1,964				368				(100	)			55				2,287
Income tax provision			1,753				151				1,486				23				3,413
Net income (loss)			211				217				(1,586	)			32				(1,126	)

		Condensed Consolidated Statement of Cash Flows
For the three months ended		As Previously				As
March 31, 2004:		Reported				Restated
Net cash (used for) provided by operating activities		$	(699	)		$	38
Net cash used for investing activities			(2,609	)			(2,609	)
Net cash provided by financing activities			4,695				2,666
Net increase in cash and equivalents			1,387				95
Cash and cash equivalents at beginning of period			1,528				1,163
Cash and cash equivalents at end of period		$	2,915			$	1,258

		Condensed Consolidated Statement of Cash Flows
For the three months ended		As Previously				As
June 30, 2004:		Reported				Restated
Net cash used for operating activities		$	(28,425	)		$	(6,209	)
Net cash used for investing activities			(2,775	)			(2,775	)
Net cash provided by financing activities			33,503				9,150
Net increase in cash and equivalents			2,303				166
Cash and cash equivalents at beginning of period			2,915				1,258
Cash and cash equivalents at end of period		$	5,218			$	1,424

3. Summary of Significant Accounting Policies:

Shipping and Handling:

The costs incurred to ship product to customers, including freight and handling expenses are included in selling, general and administrative (“SG&A”) expenses on the Company’s statements of operations. For the six months ended June 30, 2005 and for the three months ended June 30, 2005 and 2004, shipping and handling costs included in SG&A

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

3. Summary of Significant Accounting Policies (continued):

were $9,063, $4,971 and $4,257 for the Successor Company, respectively. The Predecessor Company’s shipping and handling costs were $3,629 for the quarter ended March 31, 2004.

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.

Reclassifications:

Certain amounts in the 2004 consolidated financial statements have been reclassified to conform to the 2005 presentation.

4. Goodwill and Other Intangible Assets:

The Company follows Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 provides for the non-amortization of goodwill. Goodwill is subject to at least an annual assessment for impairment by applying a fair value-based test. Goodwill recorded in connection with the Merger Transaction was adjusted by $332 in the six months ended June 30, 2005 for purchase accounting adjustments and totaled $241,935 (as restated). Other intangible assets are amortized over their useful lives and are subject to impairment testing.

The values assigned to intangible assets in connection with the March 31, 2004 Merger Transaction were determined by an independent appraisal. Intangible assets as of June 30, 2005 and December 31, 2004 consist of the following:

		Estimated
		Useful Life				June 30,				December 31,
		(Years)				2005				2004
Customer Relationships		23				$	114,790			$	114,897
Trademarks		Indefinite					44,670				44,670
Patents		9					7,960				7,960
Non Compete Agreements		4					5,742				5,742
Intangible assets, gross							173,162				173,269
Less: Accumulated amortization							9,040				5,427
Other Intangibles, net						$	164,122			$	167,842

The Company’s amortization expense for amortizable assets for the six months ended June 30, 2005 was $3,612. The Company’s amortization expense for amortizable assets for the year ended December 31, 2005 is estimated to be $7,228 and for the years ending December 31, 2006, 2007, 2008, 2009, and 2010 are estimated to be $7,232, $6,758, $6,521, $6,359, and $5,875, respectively.

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

5. Contingencies:

Under the Company’s insurance programs, commercial umbrella coverage is obtained for catastrophic exposure and aggregate losses in excess of normal claims. Beginning in 1991, the Company has retained risk on certain expected losses from both asserted and unasserted claims related to worker’s compensation, general liability and automobile as well as the health benefits of certain employees. Provisions for losses expected under these programs are recorded based on an analysis of historical insurance claim data and certain actuarial assumptions. As of June 30, 2005, the Company has provided insurers letters of credit aggregating $5,906 related to certain insurance programs.

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

6. Related Party Transactions:

On September 26, 2001, the Company was acquired by Allied Capital pursuant to the terms and conditions of an Agreement and Plan of Merger dated as of June 18, 2001. In connection with the Allied acquisition, the Company was obligated to pay management fees to a subsidiary of Allied Capital for management services rendered in the amount of $1,800 per year, plus out of pocket expenses, for calendar years subsequent to 2001.

The Predecessor Company has recorded a management fee charge of $524 for the three months ended March 31, 2004. 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 $2,324 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 Code Hennessy & Simmons LLC. In connection with the CHS acquisition, the Company is obligated to pay management fees to a subsidiary of CHS in the amount of $58 per month and to pay transaction fees to a subsidiary of OTPP in the amount of $26 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 fee charges and expenses from CHS and OTPP of $533 for the six month period ended June 30, 2005 and $278 and $256 for the three month periods ended June 30, 2005 and 2004, respectively.

The Predecessor Company incurred interest expense to Allied Capital on the subordinated debt 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 $45,571 were paid in full at March 31, 2004 in connection with the Merger Transaction.

7. Income Taxes:

The effective income tax rate was 122.0% for the first six months of 2005, 149.2% for the three month Successor period ended June 30, 2004 and 33.4% for the three month Predecessor period ended March 31, 2004. In addition to the effect of state taxes, the effective income tax rate differed from the federal statutory rate due to the effect of nondeductible interest on mandatorily redeemable preferred stock and stock compensation expenses that were incurred in the Successor periods. There was also a $136 reduction of the deferred tax benefit recorded for the carryforward of net operating losses in Ohio due to a change in the Ohio income/franchise tax law that went into effect in the second quarter of 2005.

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

8. Common and Preferred Stock:

Common Stock issued in connection with the Merger Transaction:

There are 23,141 authorized shares of Class A Common Stock, 6,212.9 of which are issued and outstanding. Each share of Class A Common Stock entitles its holder to one vote. Each holder of Class A Common Stock is entitled at any time to convert any or all of the shares into an equal number of shares of Class C Common Stock.

There are 2,500 authorized shares of Class B Common Stock, 1,000 of which are issued and outstanding. Holders of Class B Common Stock have no voting rights. The Class B Common Stock was purchased by and issued to certain members of the Company’s management and is subject to vesting over five years with 20% vesting on each anniversary of the Merger Transaction.

In connection with the Merger Transaction, certain members of management entered into an Executive Securities Agreement (“ESA”). The ESA provides for the method and terms under which management proceeds were invested in the Company. Under the terms of the ESA, management shareholders have the right to put their Class A Common Stock and Class B Common Stock back to the Company at fair market value if employment is terminated for other than cause. If terminated for cause, the management shareholders can generally put the Class A Common Stock and Class B Common Stock back to the Company for the lower of the fair market value or cost. The SEC’s Accounting Series Release No. 268, “Presentation in Financial Statements of Redeemable Preferred Stock,” requires certain securities whose redemption is not in the control of the issuer to be classified outside of permanent equity. The put feature embedded in management’s Class A Common Stock and Class B Common Stock allows redemption at the holder’s option under certain circumstances. Accordingly, management’s 407.6 Class A Common Stock shares and 1,000 Class B Common Stock shares have been classified between liabilities and stockholder’s equity in the accompanying condensed consolidated balance sheet.

The repurchase feature of the Class B Common Stock triggers variable accounting treatment under FASB Interpretation No. 44, Accounting For Certain Transactions involving Stock Compensation – an interpretation of APB Opinion No. 25 (“FIN 44”). For the six and three month periods ended June 30, 2005 compensation expense of $232 and $117 were recorded in the accompanying condensed consolidated statements of operations.

There are 30,109 authorized shares of Class C Common Stock, 2,787.1 of which are issued and outstanding. Each share of Class C Common Stock entitles its holder to one vote, provided that the aggregate voting power of Class C Common Stock (with respect to the election of directors) never exceeds 30%. Each holder of Class C Common Stock is entitled at any time to convert any or all of the shares into an equal number of shares of Class A Common Stock.

Preferred Stock issued in connection with the Merger Transaction:

The Company has 238,889 authorized shares of Class A Preferred Stock, 82,104.8 of which are issued and outstanding and 13,450.7 of which are reserved for issuance upon the exercise of options to purchase shares of Class A Preferred Stock. Holders of Class A Preferred Stock are not entitled to any voting rights. Holders of Class A Preferred Stock are entitled to preferential dividends that shall accrue on a daily basis at the rate of 11.5% per annum of the sum of the Liquidation Value (as defined in the Certificate of Incorporation) thereof plus all accumulated and unpaid dividends thereon.

Hillman Investment Company, a subsidiary of the Company, has 166,667 authorized shares of Class A Preferred Stock, 57,282.4 of which are issued and outstanding and 9,384.2 of which are reserved for issuance upon the exercise of options to purchase shares of Class A Preferred Stock. Holders of Class A Preferred Stock are not entitled to any voting rights. Holders of Class A Preferred Stock are entitled to preferential dividends that shall accrue on a daily basis at the rate of 11.0% per annum of the sum of the Liquidation Value (as defined in the Certificate of Incorporation) thereof plus all accumulated and unpaid dividends thereon.

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

8. Common and Preferred Stock (continued):

The Hillman Investment Company Class A Preferred Stock is mandatorily redeemable on March 31, 2028 and in accordance with Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“SFAS 150”) has been classified as debt in the accompanying condensed consolidated balance sheets. Dividends on the mandatorily redeemable Class A Preferred Stock are included in interest expense on the accompanying condensed consolidated statements of operations.

9. Stock Based Compensation:

Stock Options:

On March 30, 2004, the Company granted 1,085,116 common stock options under the SunSource Inc. 2001 Stock Incentive Plan (the “2001 Incentive Plan”). The options were issued with an exercise price below the fair market value of the common stock on the grant date. The fair value of the stock on March 30, 2004 was $29.20 per share and the weighted average exercise price was $6.76 per share. Compensation expense of $24,353 was recorded in the first quarter of 2004 for the excess of the fair market value over the exercise price. See Note 11, Non-Recurring Expense, for additional details.

Prior to the Merger Transaction, the Company had 369,641 options issued in connection with the 1998 SunSource Equity Compensation Plan (“1998 Incentive Plan”). The options were 100% vested and had a weighted average strike price of $4.19 per share. In connection with the Merger Agreement, 154,641 of the 1998 Incentive Plan options and 75,714 of the 2001 Incentive Plan options were cancelled and converted into rights to receive options to purchase 3,895.16 shares of Hillman Companies, Inc. Class A Preferred Stock and 2,717.55 shares of Hillman Investment Company Class A Preferred Stock (collectively the “Purchased Options”). The Purchased Options have a weighted average strike price of $170.69 per share. The fair value of the Hillman Investment Company Class A Preferred Stock options has been included with the underlying security in the accompanying condensed consolidated balance sheets. SFAS 150 requires security instruments with a redemption date that is certain to occur to be classified as liabilities. The Hillman Companies, Inc. Class A Preferred Stock options, which have a March 31, 2028 expiration date, have been classified at their fair market value in the liability section of the accompanying Condensed Consolidated Balance Sheets. To the extent the Company pays a dividend to holders of the Class A Preferred Stock and the Hillman Investment Company Class A Preferred Stock, the Purchased Option holder will be entitled to receive an amount equal to the dividend which would have been paid if the Purchased Options had been exercised on the date immediately prior to the record date for the dividend. Dividends on the Purchased Options are recorded as interest expense in the accompanying condensed consolidated statement of operations. Additionally, under the terms of the ESA, the Purchased Options can be put back to the Company at fair market value if employment is terminated.

SFAS 150 requires the initial and subsequent valuations of the Purchased Options be measured at fair value with the change in fair value recognized as interest expense. For the six months ended June 30, 2005 and the three month periods ended June 30, 2005 and 2004, interest expense of $408, $208, and $186, respectively, was recorded in the accompanying statement of operations to recognize the increase in fair market value of the Purchased Options.

The remaining 1998 Incentive Plan Options and 2001 Incentive Plan Options were cancelled and converted into rights to receive a pro rata share of the merger consideration. The 1998 Incentive Plan and the 2001 Incentive Plan were then terminated.

On March 31, 2004, the Company adopted the 2004 Stock Option Plan (“Common Option Plan”) following Board and shareholder approval. Grants under the Common Option Plan

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

9. Stock Based Compensation (continued):

will consist of non-qualified stock options for the purchase of Class B Common Shares. The number of Class B Common Shares authorized for issuance under the Common Option Plan is not to exceed 356.41 shares. Unless otherwise consented to by the Board, the aggregate number of Class B Common Shares for which options may be granted under the Common Option Plan cannot exceed 71.28 in any one calendar year.

The Common Option Plan is administered by a Committee of the Board. The Committee determines the term of each option, provided that the exercise period may not exceed ten years from date of grant. On December 14, 2004, options to purchase 10 shares of Class B Common Shares were granted at a strike price of $1,000 per share to certain members of the Company’s Board of Directors. Options to purchase 51.28 shares of Class B Common Shares at a strike price of $1,625 per share were granted to certain members of management on May 25, 2005.

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 123, Accounting for Stock Based Compensation (“SFAS 123”). Stock compensation expense as recorded under the APB 25 intrinsic value method approximates the fair value model prescribed by SFAS 123; accordingly, no pro forma disclosures are necessary under SFAS 123.

On March 31, 2004, certain members of the Company’s management were granted options to purchase 9,555.5 shares of Class A Preferred Stock and 6,666.7 shares of Hillman Investment Company Class A Preferred Stock (collectively the “Preferred Options”). The Preferred Options were granted with an exercise price of $1,000 per share which was equal to the value of the underlying Preferred Stock. The Preferred Options vest over five years with 20% vesting on each anniversary of the Merger Transaction. Holders of the Preferred Options are entitled to accrued dividends as if the underlying Preferred Stock were issued and outstanding as of the grant date.

Upon resignation from the Company after the third anniversary of grant, termination by the Company without Cause, death or disability, or retirement at age 61 the holder of the Preferred Options has a put right on the vested securities at a price equal to fair market value less any option exercise price payable. FIN 44 requires variable accounting treatment for stock awards with employee repurchase rights. Under APB Opinion 25, compensation expense is recognized to the extent the market value of the underlying security on the measurement date exceeds the cost to the employee. The market value on the Preferred Options increases by the amount of dividends accrued on the underlying Preferred Stock. Compensation expense will be recognized over the five-year vesting period in accordance with FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans – an interpretation of APB Opinions No. 15 and 25 (“FIN 28”). Accordingly, the Company has recorded a compensation charge of $500 and $284 in the accompanying condensed consolidated statements of operations for the six and three month periods ended June 30, 2005.

10. Guaranteed Preferred Beneficial Interest in the Company’s Junior Subordinated Debentures:

In September 1997, The Hillman Group Capital Trust (“Trust”), a Grantor trust, completed a $105,446 underwritten public offering of 4,217,724 11.6% Trust Preferred Securities (“TOPrS”). The Trust invested the proceeds from the sale of the preferred securities in an equal principal amount of 11.6% Junior Subordinated Debentures of Hillman due September 2027. The Trust distributes monthly cash payments it receives from the Company as interest on the debentures to preferred security holders at an annual rate of 11.6% on the liquidation amount of $25 per preferred security.

In connection with the public offering of TOPrS, the Trust issued $3,261 of trust common securities to the Company. The Trust invested the proceeds from the sale of the trust

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

10. Guaranteed Preferred Beneficial Interest in the Company’s Junior Subordinated Debentures (continued):

common securities in an equal principal amount of 11.6% Junior Subordinated Debentures of Hillman due September 2027. The Trust distributes monthly cash payments it receives from the Company as interest on the debentures to the Company at an annual rate of 11.6% on the liquidation amount of the common security.

The Company may defer interest payments on the debentures at any time, for up to 60 consecutive months. If this occurs, the Trust will also defer distribution payments on the preferred securities. The deferred distributions, however, will accumulate distributions at a rate of 11.6% per annum. The Trust will redeem the preferred securities when the debentures are repaid, or at maturity on September 30, 2027. The Company may redeem the debentures before their maturity at a price equal to 100% of the principal amount of the debentures redeemed, plus accrued interest. When the Company redeems any debentures before their maturity, the Trust will use the cash it receives to redeem preferred securities and common securities as provided in the trust agreement. The Company guarantees the obligations of the Trust on the Trust Preferred Securities.

The Company has determined that the Trust is a variable interest entity and the Company is not the primary beneficiary of the Trust pursuant to the provisions of FIN 46R. Accordingly, pursuant to the requirements of FIN 46R, the Company has de-consolidated the Trust at March 31, 2004. Summarized below is the condensed financial information of the Trust as of June 30, 2005.

Non-current assets — junior subordinated debentures — preferred		$	114,231
Non-current assets — junior subordinated debentures — common			3,261
Total assets			117,492
Non-current liabilities — Trust Preferred Securities		$	114,231
Stockholder’s equity — Trust Common Securities			3,261
Total liabilities and stockholder’s equity			117,492

The non-current assets for the Trust relate to its investment in the 11.6% junior subordinated deferrable interest debentures of Hillman due September 30, 2027.

On March 31, 2004, the Junior Subordinated Debentures were recorded at the fair value of $117,986 based on the price underlying the Trust Preferred Securities of $27.20 per share upon close of trading on the American Stock Exchange on that date plus the liquidation value of the trust common securities. The Company is amortizing the premium on the Junior Subordinated Debentures of $9,279 over their remaining life in the amount of $99 per quarter. At June 30, 2005, the recorded value of the Junior Subordinated Debentures, net of premium amortization, was $117,492. The fair value of the Junior Subordinated Debentures on June 30, 2005 was $125,153 based on the $28.90 per share closing price of the underlying Trust Preferred Securities as quoted on the American Stock Exchange plus the liquidation value of the trust common securities.

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

11. Non-Recurring Expense:

In the quarter ended March 31, 2004, the Company incurred $30,707 of non-recurring, one-time charges. The charges included a $24,353 expense for stock options granted in connection with the Merger Transaction at an exercise price below fair market value. See Note 9, Stock Based Compensation for additional details. Payroll taxes on the stock option grant of $397 were also recorded in the first quarter of 2004. In addition, the Company recorded Merger Transaction costs incurred by the selling shareholders which consisted primarily of investment banking and legal fees of $4,035. Finally, in connection with the Merger Transaction the Company awarded bonuses to certain members of management totaling $1,922.

12. Derivatives and Hedging:

The Company uses derivative financial instruments to manage its exposures to interest rate fluctuations on its floating rate senior debt. The derivative instruments are accounted for pursuant to SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities.” As amended, SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet, measure those instruments at fair value and recognize changes in the fair value of derivatives in earnings in the period of change, unless the derivative qualifies as an effective hedge that offsets certain exposures.

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 Senior 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.

The Swap has been designated as a cash flow hedge and the fair value at June 30, 2005 was $58, net of $39 in tax expense. The Swap is reported on the condensed consolidated balance sheet in other current assets. The related deferred gain on the Swap agreements of $58 has been deferred in shareholders’ equity as a component of other comprehensive loss. This deferred gain is then recognized as an adjustment to interest expense over the same period in which the related interest payments being hedged are recorded in interest expense.

13. 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 affected 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

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

13. Recent Accounting Pronouncements (continued):

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 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 results of operations or financial position.

14. 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. In connection with the acquisition, the Hillman Group, Inc. entered into a supply agreement whereby SteelWorks will be their exclusive provider of metal shapes for a period of 8 years.

Item 2.

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 condensed consolidated financial statements and notes thereto appearing elsewhere herein.

Restatement of Financial Statements

As discussed more fully in Note 2, Restatement of Financial Statements, of notes to condensed consolidated financial statements, the Company has restated the previously issued condensed consolidated financial statements for the three months ended March 31, 2004 and June 30, 2004 and as of December 31, 2004.

Management’s discussion and analysis should be read in conjunction with the restated condensed consolidated financial statements and notes thereon in Part 1, Item 1 of this Form 10-Q.

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 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 (“LNS”). 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.

Merger Transaction

On March 31, 2004, Hillman 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 outstanding 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 outstanding common stock and 31.0% of the Company’s voting common stock and HarbourVest Partners VI owns 8.7% of the Company’s outstanding common stock and 9.7% of the Company’s voting common stock. Certain members of management own 14.1% of the Company’s outstanding common stock and 4.5% of the Company’s voting common stock.

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 are 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.

On March 31, 2004, the Company, through its Hillman Group subsidiary, 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 fixes the interest rate on $50.0 million of the Senior 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.

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. In connection with the acquisition, the Hillman Group, Inc. entered into a supply agreement whereby SteelWorks will be their exclusive provider of metal shapes for a period of 8 years.

Results of Operations

Sales and Profitability for each of the Three Month Periods Ended June 30,

		(dollars in thousands)
		2005								2004
						% of								% of
		Amount				Total				Amount				Total
										(As restated)
Net sales		$	102,934				100.0	%		$	93,320				100.0	%
Cost of sales (exclusive of depreciation and amortization shown separately below)			46,578				45.3	%			41,867				44.9	%
Gross profit			56,356				54.7	%			51,453				55.1	%
Operating expenses:
Selling			18,411				17.9	%			16,881				18.1	%
Warehouse & delivery			12,661				12.3	%			11,493				12.3	%
General & Administrative			4,926				4.8	%			4,413				4.7	%
Stock compensation expense			401				0.4	%			—				0.0	%
Total SG&A			36,399				35.4	%			32,787				35.1	%
Depreciation			3,865				3.8	%			3,904				4.2	%
Amortization			1,808				1.8	%			2,679				2.9	%
Management and transaction fees			278				0.3	%			256				0.3	%
Total operating expenses			42,350				41.1	%			39,626				42.5	%
Other expense			(38	)			0.0	%			(134	)			-0.1	%
Income from operations			13,968				13.6	%			11,693				12.5	%
Interest expense, net			5,228				5.1	%			4,591				4.9	%
Interest expense on mandatorily redeemable preferred stock & management purchased options			1,959				1.9	%			1,757				1.9	%
Interest expense on junior subordinated notes			3,153				3.1	%			3,153				3.4	%
Investment income on trust common securities			(95	)			-0.1	%			(95	)			-0.1	%
Income before income taxes			3,723				3.6	%			2,287				2.5	%