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 Statement of Changes in Stockholders’ Equity			8
		Notes to Condensed Consolidated Financial Statements			9-26
Item 2.		Management’s Discussion and Analysis of Financial Conditions and Results of Operations			27-38
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			39
Item 4.		Controls and Procedures			39-41
PART II.		OTHER INFORMATION
Item 1.		Legal Proceedings			42
Item 1A.		Risk Factors			42
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			42
Item 3.		Defaults upon Senior Securities			42
Item 4.		Submission of Matters to a Vote of Security Holders			42
Item 5.		Other Information			42
Item 6.		Exhibits			43
SIGNATURES					44

Item 1.

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

		September 30,				December 31,
		2005				2004
						(as restated,
						see Note 2)
ASSETS
Current assets:
Cash and cash equivalents		$	12,244			$	29,613
Restricted investments			138				75
Accounts receivable, net			53,295				37,370
Inventories, net			81,059				65,835
Deferred income taxes, net			8,347				6,712
Other current assets			3,353				2,820
Total current assets			158,436				142,425
Property and equipment, net			60,930				61,111
Goodwill			241,934				242,267
Other intangibles, net			162,314				167,842
Restricted investments			4,546				4,148
Deferred financing fees, net			5,980				6,786
Investment in trust common securities			3,261				3,261
Other assets			660				1,059
Total assets		$	638,061			$	628,899
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	19,567			$	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			4,976				4,299
Pricing allowances			8,840				9,681
Income and other taxes			2,020				1,520
Interest			3,824				3,362
Deferred compensation			138				75
Other accrued expenses			11,235				12,407
Total current liabilities			52,819				54,734
Long term senior term loans			212,062				213,694
Long term capitalized lease obligations			66				99
Long term unsecured subordinated notes			48,911				48,090
Junior subordinated debentures			117,394				117,690
Mandatorily redeemable preferred stock (Note 8)			67,737				62,232
Management purchased options (Note 9)			3,953				3,577
Deferred compensation			4,546				4,148
Deferred income taxes, net			38,817				33,221
Other non-current liabilities			17,653				9,770
Total liabilities			563,958				547,255

Item 1.

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

		September 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			1,426				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			72,415				80,330
Accumulated deficit			(144	)			—
Accumulated other comprehensive loss			(2	)			(94	)
Total stockholders’ equity			72,270				80,237
Total liabilities and stockholders’ equity		$	638,061			$	628,899

SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

		September 30,
		2005				2004
						(as restated,
						see Note 2)
Net sales		$	102,593			$	97,032
Cost of sales (exclusive of depreciation and amortization shown separately below)			48,118				43,744
Gross profit			54,475				53,288
Operating expenses:
Selling, general and administrative expenses			35,282				33,836
Depreciation			3,912				3,706
Amortization			1,808				2,676
Management and transaction fees to related party			255				291
Total operating expenses			41,257				40,509
Other income, net			222				531
Income from operations			13,440				13,310
Interest expense, net			5,457				4,464
Interest expense on mandatorily redeemable preferred stock and management purchased options			2,035				1,826
Interest expense on junior subordinated debentures			3,153				3,152
Investment income on trust common securities			(95	)			(94	)
Income before income taxes			2,890				3,962
Income tax provision			2,671				5,134
Net income (loss)		$	219			$	(1,172	)

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
		Nine months				Six months					Three months
		ended				ended					ended
		September 30,				September 30,					March 31,
		2005				2004					2004
						(As restated,					(As restated,
						see Note 2)					see Note 2)
Net sales		$	293,127			$	190,352				$	78,190
Cost of sales (exclusive of depreciation and amortization shown separately below)			133,797				85,611					35,383
Gross profit			159,330				104,741					42,807
Operating expenses:
Selling, general and administrative expenses			106,401				66,623					30,996
Non-recurring expense (Note 11)			—				—					30,707
Depreciation			11,799				7,610					3,799
Amortization			5,420				5,355					321
Management and transaction fees to related party			788				547					524
Total operating expenses			124,408				80,135					66,347
Other income (expense), net			35				397					(140	)
Income (loss) from operations			34,957				25,003					(23,680	)
Interest expense, net			15,361				9,055					3,841
Interest expense on mandatorily redeemable preferred stock and management purchased options			5,880				3,583					—
Interest expense on junior subordinated debentures			9,458				6,305					3,152
Investment income on trust common securities			(284	)			(189	)				(94	)
Income (loss) before income taxes			4,542				6,249					(30,579	)
Income tax provision (benefit)			4,686				8,547					(10,213	)
Net loss		$	(144	)		$	(2,298	)			$	(20,366	)

SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

		Successor									Predecessor
		Nine months				Six months					Three months
		ended				ended					ended
		September 30,				September 30,					March 31,
		2005				2004					2004
						(As restated,					(As restated,
						see Note 2)					see Note 2)
Cash flows from operating activities:
Net loss		$	(144	)		$	(2,298	)			$	(20,366	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization			17,219				12,965					4,120
Deferred income tax (benefit)			3,807				8,078					(11,608	)
Stock option grant			—				—					24,353
PIK interest on unsecured subordinated notes			821				315					506
Interest on mandatorily redeemable preferred stock and management purchased options			5,880				—					—
Prepayment penalty			—				(1,097	)				—
Changes in operating items, net of effects of acquisitions:
Increase in accounts receivable, net			(15,925	)			(8,550	)				(4,599	)
(Increase) decrease in inventories, net			(15,224	)			800					(1,121	)
(Increase) decrease in other assets			(134	)			1,665					1,464
(Decrease) increase in accounts payable			(1,605	)			(2,802	)				6,613
Increase (decrease) in other accrued liabilities			305				(4,148	)				670
Other items, net			945				4,644					6
Net cash (used in) provided by operating activities			(4,055	)			9,572					38
Cash flows from investing activities:
Capital expenditures			(11,541	)			(5,510	)				(2,586	)
Other, net			(109	)			47					(23	)
Net cash used in investing activities			(11,650	)			(5,463	)				(2,609	)
Cash flows from financing activities:
Borrowings of senior term loans			—				217,500					—
Repayments of senior term loans			(1,632	)			(61,646	)				—
Borrowings of revolving credit loans			—				4,728					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			(32	)			(28	)				(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 in) provided by financing activities			(1,664	)			12,223					2,666
Net (decrease) increase in cash and cash equivalents			(17,369	)			16,332					95
Cash and cash equivalents at beginning of period			29,613				1,258					1,163
Cash and cash equivalents at end of period		$	12,244			$	17,590				$	1,258

SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

																										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
Dividends to shareholders			—				—				(2,742	)			—												—				(2,742	)
Comprehensive income (loss):
Net income			—				—				—				—				219			$	219				—				219
Other comprehensive income (loss), net of tax:
Change in cumulative foreign translation adjustment (1)							—				—				—				—				(56	)			(56	)			(56	)
Change in derivative security value, net of tax (1)							—				—				—				—				41				41				41
Other comprehensive loss																							(15	)
Comprehensive income																						$	204
Balance at September 30, 2005		$	—			$	—			$	72,415			$	1			$	(144	)						$	(2	)		$	72,270

SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

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 September 30, 2005 and its related Condensed Consolidated Statements of Operations, Cash Flows and Changes in Stockholders’ Equity for the nine month period ended September 30, 2005 and three month periods ended September 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			241,934
Intangible assets			173,162
Other assets			8,924
Total assets acquired			591,958
Less:
Liabilities assumed			42,948
Deferred taxes, net			21,773
Junior subordinated debentures			117,986
Total assumed liabilities			182,707
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 nine months ended September 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.

		Nine Months Ended
		September 30, 2004
		(as restated,
		see Note 2)
Net sales		$	268,542
Net loss			(25,354	)

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 nine months ended September 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 and trust preferred securities were not in accordance with generally accepted accounting principles.

The following table reconciles the net income 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
		Six months				Three months					Three months
		ended				ended					ended
		Sept. 30,				Sept. 30,					March 31,
		2004				2004					2004
Net income (loss) as originally reported		$	1,901			$	1,690				$	(19,316	)
Revenue recognition, before tax (1)			86				(282	)				(461	)
Other matters, before tax:
Outstanding checks (2)			—				—					—
Volume rebates (3)			120				65					51
Trust de-consolidation (4)			—				—					—
Stock option grant (5)			—				—					—
Insurance demutualization (6)			—				—					—
Income tax effects on the above			(84	)			90					168
Other adjustments relating to income tax matters			:
Interim tax provisions (7)			(4,062	)			(2,735	)				—
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			(4,199	)			(2,862	)				(1,050	)
Net loss as restated		$	(2,298	)		$	(1,172	)			$	(20,366	)

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, $55 and $65 for the three months ended March 31, 2004, June 30, 2004 and September 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 commons 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 both the three month period ended March 31, 2004 and the six month period ended September 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 initial recognition 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 six months ended September 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 $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 and six month periods ended September 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 the three and six months ended September 30, 2004.

		Condensed Consolidated Balance Sheet
		As				Adjustments
		Previously				Revenue				Income																As
As of December 31, 2004:		Reported				Recognition				Taxes				Other (1)				Dividends				Other				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
Investments			—				—				—				432				—				—				432
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	)

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 September 30, 2004:		Reported				Recognition				Taxes				Other (1)				Restated
Net sales		$	97,463			$	(496	)		$	—			$	65			$	97,032
Cost of sales			43,958				(214	)			—				—				43,744
Gross profit			53,505				(282	)			—				65				53,288
Income from operations			13,527				(282	)			—				65				13,310
Interest expense on junior subordinated debentures			3,058				—				—				94				3,152
Investment income on trust common securities			—				—				—				(94	)			(94	)
Income before income taxes			4,179				(282	)			—				65				3,962
Income tax provision			2,489				(116	)			2,735				26				5,134
Net income (loss)			1,690				(166	)			(2,735	)			39				(1,172	)

		Condensed Consolidated Statement of Operations
		As				Adjustments
For the six months		Previously				Revenue				Income								As
ended September 30, 2004:		Reported				Recognition				Taxes				Other (1)				Restated
Net sales		$	190,099			$	133			$	—			$	120			$	190,352
Cost of sales			85,564				47				—				—				85,611
Gross profit			104,535				86				—				120				104,741
Selling, general and administrative expenses			66,523				—				100				—				66,623
Income from operations			24,897				86				(100	)			120				25,003
Interest expense on junior subordinated debentures			6,116				—				—				189				6,305
Investment income on trust common securities			—				—				—				(189	)			(189	)
Income before income taxes			6,143				86				(100	)			120				6,249
Income tax provision			4,242				35				4,221				49				8,547
Net income (loss)			1,901				51				(4,321	)			71				(2,298	)

		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):

(1)

Other adjustments include the cash overdraft, gross up of the junior subordinated debentures, and volume rebates. See discussion above for details.

		Condensed Consolidated Statement of Cash Flows
For the six months ended		As Previously				As
September 30, 2004:		Reported				Restated
Net cash (used for) provided by operating activities		$	(13,147	)		$	9,572
Net cash used for investing activities			(5,463	)			(5,463	)
Net cash provided by financing activities			35,479				12,223
Net increase in cash and equivalents			16,869				16,332
Cash and cash equivalents at beginning of period			2,915				1,258
Cash and cash equivalents at end of period		$	19,784			$	17,590

		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

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 nine months ended September 30, 2005, for the six months ended September 30, 2004, and for the three months ended September 30, 2005 and 2004, shipping and handling costs included in SG&A were $13,922, $8,587, $4,859, and $4,330 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.