10-K: Annual report pursuant to Section 13 and 15(d)
Published on March 28, 2019
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 29, 2018
Commission file number 1-13293
The Hillman Companies, Inc.
(Exact name of registrant as specified in its charter)
Delaware |
23-2874736 |
(State or other jurisdiction of
incorporation or organization)
|
(I.R.S. Employer
Identification No.)
|
10590 Hamilton Avenue
Cincinnati, Ohio
|
45231 |
(Address of principal executive offices) |
(Zip Code) |
Registrant's telephone number, including area code: (513) 851-4900
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class |
Name of Each Exchange on Which Registered |
11.6% Junior Subordinated Debentures |
None |
Preferred Securities Guaranty |
None |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ¨ NO ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES ¨ NO ý
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 ý NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ý NO ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b‑2 of the Exchange Act. (Check one):
Large accelerated filer |
¨ |
Accelerated filer |
¨ |
Non-accelerated filer |
x (Do not check if a smaller reporting company)
|
Smaller reporting company |
¨ |
Emerging growth company |
¨ |
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). YES ¨ NO ý
On March 28, 2019, 5,000 shares of the Registrant's common stock were issued and outstanding and 4,217,724 Trust Preferred Securities were issued and outstanding by the Hillman Group Capital Trust. The Trust Preferred Securities trade on the NYSE Amex under the symbol "HLM.Pr." The aggregate market value of the Trust Preferred Securities held by non-affiliates at June 30, 2018 was $128,514,050.
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PART I
Forward-Looking Statements
Certain disclosures related to acquisitions, refinancing, capital expenditures, resolution of pending litigation, and realization of deferred tax assets contained in this annual report involve substantial risks and uncertainties and may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. Forward-looking statements include statements regarding our future financial position, business strategy, budgets, projected costs, plans and objectives of management for future operations. In some cases, forward-looking statements can be identified by terminology such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” “project,” or the negative of such terms or other similar expressions.
These forward-looking statements are not historical facts, but rather are based on our current expectations, assumptions, and projections about future events. Although we believe that the expectations, assumptions, and projections on which these forward-looking statements are based are reasonable, they nonetheless could prove to be inaccurate, and as a result, the forward-looking statements based on those expectations, assumptions, and projections also could be inaccurate. Forward-looking statements are not guarantees of future performance. Instead, forward-looking statements are subject to known and unknown risks, uncertainties, and assumptions that may cause our strategy, planning, actual results, levels of activity, performance, or achievements to be materially different from any strategy, planning, future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. Actual results could differ materially from those currently anticipated as a result of a number of factors, including the risks and uncertainties discussed under the caption “Risk Factors” set forth in Item 1A of this annual report. Given these uncertainties, current or prospective investors are cautioned not to place undue reliance on any such forward-looking statements.
All forward-looking statements attributable to the Company, as defined herein, or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements included in this annual report; they should not be regarded as a representation by the Company or any other individual. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this annual report might not occur or might be materially different from those discussed.
Item 1 – Business.
General
The Hillman Companies, Inc. and its wholly-owned subsidiaries (collectively, “Hillman” or “Company”) are one of the largest providers of hardware-related products and related merchandising services to retail markets in North America. Our principal business is operated through our wholly-owned subsidiary, The Hillman Group, Inc. and its wholly-owned subsidiaries (collectively, “Hillman Group”), which had net sales of approximately $974.2 million in 2018. Hillman Group sells its products to hardware stores, home centers, mass merchants, pet supply stores, and other retail outlets principally in the United States, Canada, Mexico, Latin America, and the Caribbean. Product lines include thousands of small parts such as fasteners and related hardware items; threaded rod and metal shapes; keys, key duplication systems, and accessories; builder's hardware; personal protective equipment, such as gloves and eye-wear; and identification items, such as tags and letters, numbers, and signs. We support product sales with services that include design and installation of merchandising systems and maintenance of appropriate in-store inventory levels.
Our headquarters are located at 10590 Hamilton Avenue, Cincinnati, Ohio. We maintain a website at www.hillmangroup.com. Information contained or linked on our website is not incorporated by reference into this annual report and should not be considered a part of this annual report.
On October 1, 2018, we completed the acquisition of NB Parent Company, Inc. and its affiliated companies including Big Time Products, LLC and Rooster Products International, Inc. (collectively, "Big Time"), a leading provider of personal protection and work gear products for a purchase price of approximately $348.8 million. With the addition of Big Time, Hillman’s product portfolio now spans the hardware, automotive, garden, and cleaning categories and includes Big Time’s industry-leading brands such as Firm Grip, AWP, McGuire-Nicholas, Grease Monkey, and Gorilla Grip, which are sold throughout retailers in North America. Big Time has operations in the United States, Canada, and Mexico and will be included in each of our reportable segments.
On August 10, 2018, we completed the acquisition of Minute Key Holdings, Inc. (“MinuteKey”), an innovative leader in self-service key duplicating kiosks for a total consideration reflecting an enterprise value of $156.3 million. We believe that the
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combination of MinuteKey's self service kiosk business with Hillman's existing key duplication platform will create additional growth opportunities. MinuteKey has operations in the United States and Canada and will be included in our United States and Canada reportable segments.
On November 8, 2017, we entered into an Asset Purchase Agreement with Hargis Industries, LP doing business as ST Fastening Systems and other related parties pursuant to which Hillman acquired substantially all of the assets, and assumed certain liabilities, of ST Fastening Systems. ST Fastening Systems, which is located in Tyler, Texas, specializes in manufacturing and distributing threaded self-drilling fasteners, foam closure strips, and other accessories to the steel-frame, post-frame, and residential building markets. Pursuant to the terms of the Agreement, we paid a cash purchase price of approximately $47.3 million. The ST Fastening Systems business is included in our United States reportable segment.
Hillman Group
We are organized as three separate business segments aligned with the customers that we serve in the respective markets located in the United States, Canada, and Mexico
We provide products such as fasteners and related hardware items; threaded rod and metal shapes; keys, key duplication systems, and accessories; builder's hardware; personal protective equipment, such as gloves and eye-wear; and identification items, such as tags and letters, numbers, and signs, to retail outlets, primarily hardware stores, home centers and mass merchants, pet supply stores, grocery stores, and drug stores. We complement our extensive product selection with regular retailer visits by our field sales and service organization.
We market and distribute a wide variety of stock keeping units (“SKUs”) of small, hard-to-find and hard-to-manage hardware items. We function as a category manager for retailers and support these products with in-store service, high order fill rates, and rapid delivery of products sold. Sales and service representatives regularly visit retail outlets to review stock levels, reorder items in need of replacement, and interact with the store management to offer new product and merchandising ideas. Thousands of items can be actively managed with the retailer experiencing a substantial reduction of in-store labor costs and replenishment paperwork. Service representatives also assist in organizing the products in a consumer-friendly manner. We complement our broad range of products with merchandising services such as displays, product identification stickers, retail price labels, store rack and drawer systems, assistance in rack positioning and store layout, and inventory restocking services. We regularly refresh retailers' displays with new products and package designs utilizing color-coding to simplify the shopping experience for consumers and improve the attractiveness of individual store displays.
We operate from 25 strategically located distribution centers in the United States, Canada, and Mexico. Our main distribution centers utilize state-of-the-art warehouse management systems (“WMS”) to ship customer orders within 48 hours while achieving a very high order fill rate. We also supplement our operations with third-party logistics providers to warehouse and ship customer orders in the U.S., Canada, and Mexico.
Products and Suppliers
Our product strategy concentrates on providing total project solutions using the latest technology for common and unique home improvement projects. Our portfolio provides retailers the assurance that their shoppers can find the right product at the right price within an 'easy to shop' environment.
We currently manage a worldwide supply chain comprised of a large number of vendors, the largest of which accounted for approximately 5.6% of the Company's annual purchases and the top five of which accounted for approximately 14.8% of its annual purchases. Our vendor quality control procedures include on-site evaluations and frequent product testing. Vendors are also evaluated based on delivery performance and the accuracy of their shipments.
Fastening Solutions
Fastening solutions remains the core of our business. The product line encompasses one of the largest selections among suppliers servicing the retail hardware industry. Fastening solutions consist of three categories: core fasteners, construction fasteners, and anchors. Core fasteners include nuts, bolts, screws, washers, and specialty items. Construction fasteners include deck, drywall, metal screws, and both hand driven and collated nails. Anchors include hollow wall and solid wall items such as plastic anchors, toggle bolts, concrete screws, and wedge anchors.
There are several brands within the Fastening product category. The core fastener line is marketed under the Hillman name for its brand. Construction fasteners have several brands including: PowerPro™, Deckplus™, and Fas-n-Tite™. Our premium line of PowerPro™ products are specifically engineered for ultimate performance with the most advanced materials, coatings, and
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designs and have earned the reputation and trust of both professionals and homeowners through its availability in retailers nationwide.
Our products within the category are recognized in the industry for their packaging and merchandising. The label art consists of large product images with impactful content so shoppers can easily navigate the display and locate items quickly. We keep the fastener category vibrant and refreshed for retailers by providing a continuous stream of new products. We recently launched the PowerPro™ ONE screw category. The screw was engineered to work with various materials such as wood, metal, drywall, plastic, and concrete. The PowerPro™ ONE screw satisfies a unique market position as “The One Screw You’ll Ever Need”. Due to the success of this new program, Hillman was recently awarded an innovation award from one of our top customers.
On November 8, 2017, we acquired ST Fastening Systems. ST Fastening Systems, which is located in Tyler, Texas, specializes in manufacturing and distributing threaded self-drilling fasteners, foam closure strips, and other accessories to the steel-frame, post-frame, and residential building markets. ST Fastening Systems added $47.2 million and $5.9 million in revenue for the years ended December 29, 2018 and December 30, 2017, respectively.
Fastening solutions generated approximately $553.6 million of revenues in 2018, as compared to $492.9 million in 2017 and $482.6 million in 2016.
Home and Access Solutions
Home and access solutions include products for the home such as builders’ hardware, threaded rod and metal shapes, picture hanging, home décor, and letters, numbers, and signs (“LNS”). It also includes our associate-assisted key duplication systems and key accessories. Our programs include product and category management, merchandising services, and access to our proprietary key duplicating equipment.
We design and manufacture proprietary equipment which forms the cornerstone for our key duplication business. Our key duplication system is offered in various retail channels including mass merchants, home centers, automotive parts retailers, franchise and independent (“F&I”) hardware stores, and grocery/drug chains.
This proprietary equipment for key duplication varies by retail channel to fit that channel’s specific needs. The Hillman key program targets the F&I hardware retailers with a traditional machine that works well in businesses with lower turnover and highly skilled employees. The Axxess Precision Key Duplication System™ continues to be the most prevalent system with over 8,000 programs placed and marketed to national retailers requiring a high volume key duplication program easily mastered by novice associates. Our Precision Laser Key System™ system uses a digital optical camera, lasers, and proprietary software to scan a customer's key. The system identifies the key and retrieves the key's specifications, including the appropriate blank and cutting pattern, from a comprehensive database. This technology automates nearly every aspect of key duplication and provides the ability for every store associate to cut a key accurately. Approximately 2,700 of these key duplicating systems are in service throughout North American retailers. The Hillman KeyKrafter™ is our most innovative and effective key duplication equipment. It provides significant reduction in duplication time while increasing accuracy and ease of use. Additionally, with the KeyKrafter™ solution, the capability exists for consumers to securely store and retrieve digital back-ups of their key without the original though the revolutionary Hillman KeyHero™ smart phone application. There are over 5,000 KeyKrafter™ programs placed in North American retailers.
We also market keys and key accessories in conjunction with our duplication systems. Our proprietary key offering features the universal blank which uses a "universal" keyway to replace up to five original equipment keys. This innovative system allows a retailer to duplicate 99% of the key market while stocking less than 100 SKUs. We continually refresh the retailer's key offering by introducing decorated and licensed keys and accessories. Our Wackey™ and Fanatix™ lines feature decorative themes of art and popular licenses such as NFL, Disney, Breast Cancer Awareness, and M&M's to increase personalization, purchase frequency and average transaction value per key. We also market a successful line of decorative and licensed lanyards.
The builder's hardware category includes a variety of common household items such as coat hooks, door stops, hinges, gate latches, and decorative hardware. We market the builder's hardware products under the Hardware Essentials™ brand and provide the retailer with an innovation in both product and merchandising solutions. The Hardware Essentials™ program utilizes modular packaging, color coding, and integrated merchandising to simplify the shopping experience for consumers. Colorful signs, packaging, and installation instructions guide the consumer quickly and easily to the correct product location in store while digital content including pictures, vides, copy and diagrams assist the on line journey. Hardware Essentials™ provides retailers and consumers decorative upgrade opportunities through contemporary finishes and designs.
The wall hanging category includes traditional picture hanging hardware and the High & Mighty™ series of tool-free wall hangers, decorative hooks, key and hook rails and floating shelves that was launched in 2017. High & Mighty™ was designed
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to eliminate “hangxiety” and revolutionize the way consumers express their personal style through hanging home décor. High & Mighty™ was innovated with DIYers and décor enthusiasts in mind, creating simple solutions to empower them to decorate and personalize their homes in minutes. Eliminating the barrier between inspiration and installation, the new series makes wall décor design accessible, easy and fun in three simple steps: Place. Push. Hang. There is no longer a need for hammers, screws, anchors or nails when consumers are looking for a quick and secure decorating or organizing solution.
We are the leading supplier of metal shapes and threaded rod in the retail market. The SteelWorks™ threaded rod product includes hot and cold rolled rod, both weld-able and plated, as well as a complete offering of All-Thread rod in galvanized steel, stainless steel, and brass. The SteelWorks™ program is carried by many top retailers, including Lowe's and Menards, and through cooperatives such as Ace Hardware. In addition, we are the primary supplier of metal shapes to many wholesalers throughout the country.
Letters, numbers, and signs (“LNS”) includes product lines that target both the homeowner and commercial user. Product lines within this category include individual and/or packaged letters, numbers, signs, safety related products (e.g., 911 signs), driveway markers, and a diversity of sign accessories, such as sign frames.
Home and Access solutions generated approximately $284.2 million of revenues in 2018, as compared to $279.3 million in 2017 and $268.9 million in 2016.
Consumer Connected Solutions
Consumer connected solutions consist of key duplication and engraving kiosks that can be operated directly by the consumer. Our kiosks operate in retail and other high-traffic locations offering customized licensed and unlicensed products targeted to consumers in the respective locations.
In 2018, we completed the acquisition of MinuteKey, the world's first self-service key duplication machine. The accuracy of robotics technology put to work in an innovative way makes MinuteKey machines easy to use, convenient and fast. The kiosk is completely self-service and has a 100% customer satisfaction guarantee. We have over 4,500 MinuteKey machines located in high-traffic locations of some of the largest retailers throughout North America. We also have over 1,000 FastKey machines, a similar key duplicating kiosk, in service in retail outlets throughout North America. Our key duplicating kiosks have demonstrated the ability to increase the overall key sales at the retail store level for customers that also have the associate-assisted key duplicating program.
In addition, we supply a variety of innovative options of consumer-operated vending systems such as Quick-Tag™, TagWorks™, and FIDO™ for engraving specialty items such as pet identification tags, luggage tags, and other engraved identification tags. We have developed unique engraving systems leveraging state-of-the-art technologies to provide a customized solution for mass merchant, pet supply retailers, and other high traffic areas such as theme parks. As of December 29, 2018, over 7,000 of our engraving systems are in service in retail locations which are also supported by our sales and service representatives.
Our engraving business focuses on the growing consumer spending trends surrounding personalized and pet identification. Innovation has played a major role in the development of our engraving business unit. From the original Quick-Tag™ consumer-operated vending system to the proprietary laser system of TagWorks™, we continue to lead the industry with consumer-friendly engraving solutions.
We design, manufacture, and assemble the key duplication and engraving kiosks in our Tempe, Arizona facility. Consumer connected solutions generated approximately $80.9 million of revenues in 2018, as compared to $66.1 million in 2017 and $63.4 million in 2016.
Personal Protective Solutions
In October 2018, we completed the acquisition of NB Parent Company, Inc. and its affiliated companies including Big Time Products, LLC and Rooster Products International, Inc. (collectively, "Big Time"), a leading provider of personal protection and work gear products. With the addition of Big Time, our product portfolio now spans the hardware, automotive, garden, and cleaning categories and includes Big Time’s industry-leading brands such as Firm Grip, AWP, McGuire-Nicholas, Grease Monkey, and Gorilla Grip, which are sold throughout retailers in North America. Big Time’s high-quality products like gloves, wearable tool storage, jobsite storage and kneepads, as well as outstanding customer service and award-winning packaging have had a dramatic impact on the industry.
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Personal protective solutions generated approximately $55.4 million of revenues in 2018. There were no sales of personal protective solutions prior to the Big Time acquisition.
Markets and Customers
We sell our products to national accounts such as Lowe's, Home Depot, Walmart, Tractor Supply, Menards, PetSmart, and PETCO. Our status as a national supplier of proprietary products to big box retailers allows us to develop a strong market position and high barriers to entry within our product categories.
We service a wide variety of F&I retail outlets. These individual dealers are typically members of the larger cooperatives, such as True Value, Ace Hardware, and Do-It-Best. We ship directly to the cooperative's retail locations and also supply many items to the cooperative's central warehouses. These central warehouses distribute to their members that do not have a requirement for Hillman's in-store service. These arrangements reduce credit risk and logistic expenses for us while also reducing central warehouse inventory and delivery costs for the cooperatives.
A typical hardware store maintains thousands of different items in inventory, many of which generate small dollar sales but large profits. It is difficult for a retailer to economically monitor all stock levels and to reorder the products from multiple vendors. This problem is compounded by the necessity of receiving small shipments of inventory at different times and stocking the goods. The failure to have these small items available will have an adverse effect on store traffic, thereby possibly denying the retailer the opportunity to sell items that generate higher dollar sales.
We sell our products to a large volume of customers, the top three of which accounted for approximately $493.6 million, or approximately 51%, of our total revenue in 2018. For the year ended December 29, 2018, Home Depot was the single largest customer, representing approximately $212.6 million of our total revenues, Lowe's was the second largest at approximately $202.6 million, and Walmart was the third largest at approximately $78.5 million of our total revenue. No other customer accounted for more than 5.0% of total revenue in 2018. In each of the years ended December 29, 2018, December 30, 2017 and December 31, 2016, we derived over 10% of our total revenues from Lowe's and Home Depot which operated in the following segments: United States, Canada, and Mexico.
In 2018, Hillman expanded its B2B eCommerce platform allowing certain customers to order online through the Company’s website, www.hillmangroup.com. The B2B eCommerce platform features over 34,000 items available for sale online. In 2018, the Company had 1,500 customers enroll with the online ordering platform. Hillman also supports over 30,000 items available for sale on retailers' websites. We supported direct-to-store and direct-to-consumer fulfillment for consumers who choose to order fasteners directly from retailers' websites. Consumers can visit the retailer's website, select their desired fasteners, pay by credit card, and pick up their order at the retailer's store or choose to have the order shipped to the address of the consumer's choice. We continued to support retailers' requests to expand their on-line offerings in 2018.
Sales and Marketing
We provide product support and customer service for our retail distribution partners. We believe that our competitive advantage is in our ability to provide a greater level of customer service than our competitors.
Service is the hallmark of Hillman company-wide. The national accounts field service organization consists of approximately 690 employees and 50 field managers focusing on big box retailers, pet super stores, large national discount chains, and grocery stores. This organization reorders products, details store shelves, and sets up in-store promotions. Many of our largest customers use electronic data interchange (“EDI”) for processing of orders and invoices.
We employ what we believe to be the largest direct sales force in the industry. The sales force, which consists of approximately 230 employees and is managed by 25 field managers, focuses on the F&I customers. The depth of the sales and service team enables us to maintain consistent call cycles ensuring that all customers experience proper stock levels and inventory turns. This team also prepares custom plan-o-grams of displays to fit the needs of any store and establishes programs that meet customers' requirements for pricing, invoicing, and other needs. This group also benefits from daily internal support from our inside sales and customer service teams. On average, each sales representative is responsible for approximately 60 full service accounts that the sales representative calls on approximately every two weeks.
These efforts, coupled with those of the marketing department, allow the sales force to sell and support our product lines. Our marketing department provides support through the development of new products and categories, sales collateral material, promotional items, merchandising aids, and custom signage. Marketing services such as advertising, graphic design, and trade show management are also provided to the sales force. The department is organized along our three marketing competencies: product management, channel marketing, and marketing communications.
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Competition
Our primary competitors in the national accounts marketplace for fasteners are Illinois Tool Works Inc., Dorman Products Inc., Midwest Fastener Corporation, Primesource Building Products, Inc, and competition from direct import by our customers. Our national competitors for gloves and personal protective equipment include West Chester Protective Gear, PIP, Iron Clad and MidWest Quality Gloves, Inc. Competition is based primarily on in-store service and price. Other competitors are local and regional distributors. Competitors in the pet tag market are specialty retailers, direct mail order, and retailers with in-store mail order capability. The Quick-Tag™, FIDO™, and TagWorks™ systems have patent protected technology that is a major barrier to entry and helps to preserve this market segment.
The principal competitors for our F&I business are Midwest Fastener and Hy-Ko Products Company (“Hy-Ko”) in the hardware store marketplace. Midwest Fastener primarily focuses on fasteners, while Hy-Ko is the major competitor in LNS products and keys/key accessories. The hardware outlets that purchase our products without regularly scheduled sales representative visits may also purchase products from local and regional distributors and cooperatives. We compete primarily on field service, merchandising, as well as product availability, price, and depth of product line.
Insurance Arrangements
Under our current insurance programs, commercial umbrella coverage is obtained for catastrophic exposure and aggregate losses in excess of expected claims. We retain the exposure on certain expected losses related to workers' compensation, general liability, and automobile claims. We also retain the exposure on expected losses related to health benefits of certain employees. We believe that our present insurance is adequate for our businesses. See Note 15 - Commitments and Contingencies, of Notes to Consolidated Financial Statements.
Employees
As of December 29, 2018, we had 3,772 full time and part time employees, none of which were covered by a collective bargaining agreement. In our opinion, employee relations are good.
Backlog
We do not consider the sales backlog to be a significant indicator of future performance due to the short order cycle of our business. Our sales backlog from ongoing operations was approximately $14.9 million as of December 29, 2018 and approximately $10.4 million as of December 30, 2017. We expect to realize the entire December 29, 2018 backlog during fiscal 2019.
Where You Can Find More Information
We file quarterly reports on Form 10-Q and annual reports on Form 10-K and furnish current reports on Form 8-K and other information with the Securities and Exchange Commission (the “Commission”). The Commission also maintains an Internet site at www.sec.gov that contains quarterly, annual, and current reports, proxy and information statements, and other information regarding issuers, like Hillman, that file electronically with the Commission.
In addition, our quarterly reports on Form 10-Q, annual reports on Form 10-K, current reports on Form 8-K, and all amendments to those reports, are available free of charge on our website at www.hillmangroup.com as soon as reasonably practicable after such reports are electronically filed with the Commission. We are providing the address to our website solely for the information of investors. We do not intend the address to be an active link or to incorporate the contents of the website into this report.
Item 1A - Risk Factors.
You should carefully consider the following risks. However, the risks set forth below are not the only risks that we face, and we face other risks which have not yet been identified or which are not yet otherwise predictable. If any of the following risks occur or are otherwise realized, our business, financial condition, and results of operations could be materially adversely affected. You should carefully consider the risks described below and all other information in this Annual Report on Form 10-K, including our consolidated financial statements and the related notes and schedules thereto.
Risks Relating to Our Business
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Unfavorable economic conditions may adversely affect our business, results of operations, financial condition, and cash flows.
Our business is impacted by general economic conditions in North American and other international markets, particularly the U.S. retail markets including hardware stores, home centers, mass merchants, and other retailers. The current and future economic conditions in the U.S. and internationally, including, without limitation, the level of consumer debt, higher interest rates, and the ability of our customers to obtain credit, may cause a continued or further decline in business and consumer spending.
Adverse changes in economic conditions, including inflation, recession, or instability in the financial markets or credit markets may either lower demand for our products or increase our operational costs, or both. Such conditions may also materially impact our customers, suppliers, and other parties with whom we do business and may result in financial difficulties leading to restructurings, bankruptcies, liquidations, and other unfavorable events for our customers, suppliers, and other service providers. Our revenue will be adversely affected if demand for our products declines. The impact of unfavorable economic conditions may also impair the ability of our customers to pay for products they have purchased and could have a material adverse effect on our results of operations, financial condition, and results of operations.
We operate in a highly competitive industry, which may have a material adverse effect on our business, financial condition, and results of operations.
The retail industry is highly competitive, with the principal methods of competition being product innovation, price, quality of service, quality of products, product availability and timeliness, credit terms, and the provision of value-added services, such as merchandising design, in-store service, and inventory management. We encounter competition from a large number of regional and national distributors, some of which have greater financial resources than us and may offer a greater variety of products. If these competitors are successful, our business, financial condition, and results of operations may be materially adversely affected.
To compete successfully, we must develop and commercialize a continuing stream of innovative new products that create consumer demand.
Our long-term success in the current competitive environment depends on our ability to develop and commercialize a continuing stream of innovative new products, including those in our new mass merchant fastener program, which create and maintain consumer demand. We also face the risk that our competitors will introduce innovative new products that compete with our products. Our strategy includes increased investment in new product development and continued focus on innovation. There are, nevertheless, numerous uncertainties inherent in successfully developing and commercializing innovative new products on a continuing basis, and new product launches may not provide expected growth results.
Our business may be adversely affected by seasonality.
In general, we have experienced seasonal fluctuations in sales and operating results from quarter to quarter. Typically, the first calendar quarter is the weakest due to the effect of weather on home projects and the construction industry. If adverse weather conditions persist on a regional or national basis into the second or other calendar quarters, our business, financial condition, and results of operations may be materially adversely affected.
Large customer concentration and the inability to penetrate new channels of distribution could adversely affect our business.
Our three largest customers constituted approximately $493.6 million of net sales and $54.1 million of the year-end accounts receivable balance for 2018. Each of these customers is a big box chain store. Our results of operations depend greatly on our ability to maintain existing relationships and arrangements with these big box chain stores. To the extent that the big box chain stores are materially adversely impacted by the changing retail landscape, this could have a negative effect on our results of operations. The loss of one of these customers or a material adverse change in the relationship with these customers could have a negative impact on our business. Our inability to penetrate new channels of distribution, including ecommerce, may also have a negative impact on our future sales and business.
Successful sales and marketing efforts depend on our ability to recruit and retain qualified employees.
The success of our efforts to grow our business depends on the contributions and abilities of key executives, our sales force, and other personnel, including the ability of our sales force to achieve adequate customer coverage. We must therefore continue to
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recruit, retain, and motivate management, sales, and other personnel to maintain our current business and to support our projected growth. A shortage of these key employees might jeopardize our ability to implement our growth strategy.
We are exposed to adverse changes in currency exchange rates.
Exposure to foreign currency risk exists because we, through our global operations, enter into transactions and make investments denominated in multiple currencies. Our predominant exposures are in Canadian, Mexican, and Asian currencies, including the Chinese Yuan (“CNY”). In preparing our consolidated financial statements for foreign operations with functional currencies other than the U.S. dollar, asset and liability accounts are translated at current exchange rates and income and expenses are translated using weighted-average exchange rates. With respect to the effects on translated earnings, if the U.S. dollar strengthens relative to local currencies, our earnings could be negatively impacted. We do not make a practice of hedging our non-U.S. dollar earnings.
We source many products from China and other Asian countries for resale in other regions. To the extent that the CNY or other currencies appreciate with respect to the U.S. dollar, we may experience cost increases on such purchases. The U.S. dollar increased in value relative to the CNY by 5.7% in 2018, decreased by 6.3% in 2017 and increased by 7.2% in 2016. Significant appreciation of the CNY or other currencies in countries where we source our products could adversely impact our profitability. In addition, our foreign subsidiaries in Canada and Mexico may purchase certain products from their vendors denominated in U.S. dollars. If the U.S. dollar strengthens compared to the local currencies, it may result in margin erosion. We have a practice of hedging some of our Canadian subsidiary's purchases denominated in U.S. dollars. We may not be successful at implementing customer pricing or other actions in an effort to mitigate the related cost increases and thus our results of operations may be adversely impacted.
Our results of operations could be negatively impacted by inflation or deflation in the cost of raw materials, freight, and energy.
Our products are manufactured of metals, including but not limited to steel, aluminum, zinc, and copper. Additionally, we use other commodity-based materials in the manufacture of LNS that are resin-based and subject to fluctuations in the price of oil. We are also exposed to fluctuations in the price of diesel fuel in the form of freight surcharges on customer shipments and the cost of gasoline used by the field sales and service force. Continued inflation over a period of years would result in significant increases in inventory costs and operating expenses. If we are unable to mitigate these inflation increases through various customer pricing actions and cost reduction initiatives, our financial condition may be adversely affected. Conversely, in the event that there is deflation, we may experience pressure from our customers to reduce prices. There can be no assurance that we would be able to reduce our cost base (through negotiations with suppliers or other measures) to offset any such price concessions which could adversely impact our results of operations and cash flows.
We are subject to the risks of doing business internationally.
A portion of our revenue is generated outside the United States, primarily from customers located in Canada, Mexico, Latin America, and the Caribbean. Because we sell our products and services outside the United States, our business is subject to risks associated with doing business internationally, which include:
• |
changes in a specific country's or region's political and cultural climate or economic condition; |
• |
unexpected or unfavorable changes in foreign laws and regulatory requirements; |
• |
difficulty of effective enforcement of contractual provisions in local jurisdictions; |
• |
inadequate intellectual property protection in foreign countries; |
• |
the imposition of duties and tariffs and other trade barriers; |
• |
trade-protection measures, import or export licensing requirements such as Export Administration Regulations promulgated by the U.S. Department of Commerce, Economic Sanctions Laws and Regulations administered by the Office of Foreign Assets Control, and fines, penalties, or suspension or revocation of export privileges; |
• |
violations of the United States Foreign Corrupt Practices Act; |
• |
the effects of applicable and potentially adverse foreign tax law changes; |
• |
significant adverse changes in foreign currency exchange rates; |
• |
longer accounts receivable cycles; |
• |
managing a geographically dispersed workforce; and |
9
• |
difficulties associated with repatriating cash in a tax-efficient manner. |
Any failure to adapt to these or other changing conditions in foreign countries in which we do business could have an adverse effect on our business and financial results.
Our business is subject to risks associated with sourcing product from overseas.
We import a significant amount of our products and rely on foreign sources to meet our supply demands at prices that support our current operating margins. Substantially all of our import operations are subject to customs requirements and to tariffs and quotas set by governments through mutual agreements or unilateral actions. The recently implemented U.S. tariffs on steel and aluminum and other imported goods have materially increased the costs of many of our foreign sourced products, and any escalation in the tariffs will increase the impact. In order to sustain current operating margins while the tariffs are in effect, we must be able to increases prices with our customers and find alternative, similarly priced sources that are not subject to the tariffs. If we are unable to effectively implement these countermeasures, our operating margins will be impacted.
In addition, the countries from which our products and materials are manufactured or imported may, from time to time, impose additional quotas, duties, tariffs, or other restrictions on their imports or adversely modify existing restrictions. Adverse changes in these import costs and restrictions, or our suppliers' failure to comply with customs regulations or similar laws, could harm our business.
If any of our existing vendors fail to meet our needs, we believe that sufficient capacity exists in the open market to supply any shortfall that may result. However, it is not always possible to replace a vendor on short notice without disruption in our operations which may require more costly expedited transportation expense and replacement of a major vendor is often at higher prices.
Our ability to import products in a timely and cost-effective manner may also be affected by conditions at ports or issues that otherwise affect transportation and warehousing providers, such as port and shipping capacity, labor disputes, severe weather, or increased homeland security requirements in the U.S. and other countries. These issues could delay importation of products or require us to locate alternative ports or warehousing providers to avoid disruption to customers. These alternatives may not be available on short notice or could result in higher transit costs, which could have an adverse impact on our business and financial condition.
Acquisitions have formed a significant part of our growth strategy in the past and may continue to do so. If we are unable to identify suitable acquisition candidates, successfully integrate an acquired business, or obtain financing needed to complete an acquisition, our growth strategy may not succeed.
Historically, our growth strategy has relied on acquisitions that either expand or complement our businesses in new or existing markets. However, there can be no assurance that we will be able to identify or acquire acceptable acquisition candidates on terms favorable to us and in a timely manner, if at all, to the extent necessary to fulfill our growth strategy.
The process of integrating acquired businesses into our operations may result in unforeseen difficulties and may require a disproportionate amount of resources and management attention, and there can be no assurance that we will be able to successfully integrate acquired businesses into our operations. Additionally, we may not achieve the anticipated benefits from any acquisition.
Unfavorable changes in the current economic environment may make it difficult to acquire businesses in order to further our growth strategy. We will continue to seek acquisition opportunities both to expand into new markets and to enhance our position in our existing markets. However, our ability to do so will depend on a number of factors, including our ability to obtain financing that we may need to complete a proposed acquisition opportunity which may be unavailable or available on terms that are not advantageous to us. If financing is unavailable, we may be forced to forego otherwise attractive acquisition opportunities which may have a negative effect on our ability to grow.
If we were required to write down all or part of our goodwill or indefinite-lived trade names, our results of operations could be materially adversely affected.
We have $803.8 million of goodwill and $85.2 million of indefinite-lived trade names recorded on our Consolidated Balance Sheet at December 29, 2018. We are required to periodically determine if our goodwill or indefinite-lived trade names have become impaired, in which case we would write down the impaired portion. If we were required to write down all or part of our goodwill or indefinite-lived trade names, our net income could be materially adversely affected.
10
Our success is highly dependent on information and technology systems.
We believe that our proprietary computer software programs are an integral part of our business and growth strategies. We depend on our information systems to process orders, to manage inventory and accounts receivable collections, to purchase, sell, and ship products efficiently and on a timely basis, to maintain cost-effective operations, and to provide superior service to our customers. If these systems are damaged, intruded upon, shutdown, or cease to function properly (whether by planned upgrades, force majeure, telecommunications failures, hardware or software break-ins or viruses, other cyber-security incidents, or otherwise), we may suffer disruption in our ability to manage and operate our business.
There can be no assurance that the precautions which we have taken against certain events that could disrupt the operations of our information systems will prevent the occurrence of such a disruption. Any such disruption could have a material adverse effect on our business and results of operations.
In addition, we are in the process of expanding our enterprise resource planning (“ERP”) system to improve our business capabilities. Although it is not anticipated, any disruptions, delays, or deficiencies in the design and/or implementation of the ERP system, or our inability to accurately predict the costs of such initiatives or our failure to generate revenue and corresponding profits from such activities and investments, could impact our ability to perform necessary business operations, which could adversely affect our reputation, competitive position, business, results of operations, and financial condition.
Unauthorized disclosure of sensitive or confidential customer, employee, supplier, or Company information, whether through a breach of our computer systems, including cyber-attacks or otherwise, could severely harm our business.
As part of our business, we collect, process, and retain sensitive and confidential personal information about our customers, employees, and suppliers. Despite the security measures we have in place, our facilities and systems, and those of the retailers and other third party distributors with which we do business, may be vulnerable to security breaches, cyber-attacks, acts of vandalism, computer viruses, misplaced or lost data, programming and/or human errors, or other similar events. Any security breach involving the misappropriation, loss, or other unauthorized disclosure of confidential customer, employee, supplier, or Company information, whether by us or by the retailers and other third party distributors with which we do business, could result in losses, severely damage our reputation, expose us to the risks of litigation and liability, disrupt our operations, and have a material adverse effect on our business, results of operations, and financial condition. The regulatory environment related to information security, data collection, and privacy is increasingly rigorous, with new and constantly changing requirements applicable to our business, and compliance with those requirements could result in additional costs.
Failure to adequately protect intellectual property could adversely affect our business.
Intellectual property rights are an important and integral component of our business. We attempt to protect our intellectual property rights through a combination of patent, trademark, copyright, and trade secret laws, as well as licensing agreements and third-party nondisclosure and assignment agreements. Failure to obtain or maintain adequate protection of our intellectual property rights for any reason could have a material adverse effect on our business.
Regulations related to conflict minerals could adversely impact our business.
The Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions to improve transparency and accountability concerning the supply of certain minerals, known as “conflict minerals”, originating from the Democratic Republic of Congo (“DRC”) and adjoining countries. These rules could adversely affect the sourcing, supply, and pricing of materials used in our products, as the number of suppliers who provide conflict-free minerals may be limited. We may also suffer harm to our image if we determine that certain of our products contain minerals not determined to be conflict-free or if we are unable to modify our products to avoid the use of such materials. We may also face challenges in satisfying customers who may require that our products be certified as containing conflict-free minerals.
We are subject to legal proceedings and legal compliance risks.
We are involved in various legal proceedings, which from time to time may involve lawsuits, state and federal governmental inquiries, audits and investigations, environmental matters, employment, tort, state false claims act, consumer litigation, and intellectual property litigation. At times, such matters may involve executive officers and other management. Certain of these legal proceedings may be a significant distraction to management and could expose us to significant liability, including settlement expenses, damages, fines, penalties, attorneys' fees and costs, and non-monetary sanctions, any of which could have a material adverse effect on our business and results of operations.
11
Increases in the cost of employee health benefits could impact our financial results and cash flows.
Our expenses relating to employee health benefits are significant. Healthcare costs have risen significantly in recent years, and recent legislative and private sector initiatives regarding healthcare reform have resulted and could continue to result in significant changes to the U.S. healthcare system. Unfavorable changes in the cost of such benefits could have a material adverse effect on our financial results and cash flows.
Risks Relating to Our Indebtedness
We have significant indebtedness that could affect operations and financial condition and prevent us from fulfilling our obligations under our indebtedness.
We have a significant amount of indebtedness. On December 29, 2018, total indebtedness was $1,606.4 million, consisting of $108.7 million of indebtedness of Hillman and $1,497.7 million of indebtedness of Hillman Group.
Our substantial indebtedness could have important consequences. For example, it could:
• |
make it more difficult for us to satisfy obligations to holders of our indebtedness; |
• |
increase our vulnerability to general adverse economic and industry conditions; |
• |
require the dedication of a substantial portion of cash flow from operations to payments on indebtedness, thereby reducing the availability of cash flow to fund working capital, capital expenditures, research and development efforts, and other general corporate purposes; |
• |
limit flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; |
• |
place us at a competitive disadvantage compared to competitors that have less debt; and |
• |
limit our ability to borrow additional funds. |
In addition, the indenture governing Hillman Group's notes and senior secured credit facilities contain financial and other restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. The failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all outstanding debts.
Despite current indebtedness levels, we may still be able to incur substantially more debt. This could further exacerbate the risks associated with our substantial leverage.
We may be able to incur substantial additional indebtedness in the future. The terms of the indenture do not fully prohibit us from doing so. The senior secured credit facilities permit additional borrowing of $30.1 million on the revolving credit facility. If new debt is added to our current debt levels, the related risks that we now face could intensify.
The failure to meet certain financial covenants required by our credit agreements may materially and adversely affect assets, financial position, and cash flows.
Certain aspects of our credit agreements require the maintenance of a leverage ratio and limit our ability to incur debt, make investments, make dividend payments to holders of the Trust Preferred Securities, or undertake certain other business activities. In particular, our minimum allowed fixed charge coverage ratio requirement is 1.0x as of December 29, 2018. A breach of the covenant, or any other covenants, could result in an event of default under the credit agreements. Upon the occurrence of an event of default under the credit agreements, all amounts outstanding, together with accrued interest, could be declared immediately due and payable by our lenders. If this happens, our assets may not be sufficient to repay in full the payments due under the credit agreements. The current credit market environment and other macro-economic challenges affecting the global economy may adversely impact our ability to borrow sufficient funds or sell assets or equity in order to pay existing debt.
We are subject to fluctuations in interest rates.
On May 31, 2018 we entered into a new credit agreement that includes a funded term loan for $530.0 million and a unfunded delayed draw term loan facility ("DDTL") for $165.0 million (collectively, "2018 Term Loan"). Concurrently, we also entered into a new asset-based revolving credit agreement ("ABL Revolver") for $150.0 million. We utilized the full $165.0 million DDTL to finance the MinuteKey acquisition on August 10, 2018. On October 1, 2018, we entered into an amendment (the
12
"Amendment") to the aforementioned 2018 Term Loan agreement which provided an additional $365.0 million of incremental term loan proceeds.
All of our indebtedness incurred in connection with the 2018 Term Loan and ABL Revolver has variable interest rates. Increases in borrowing rates will increase our cost of borrowing, which may adversely affect our results of operations and financial condition.
Restrictions imposed by the indenture governing the 6.375% Senior Notes, and by our Senior Facilities and our other outstanding indebtedness, may limit our ability to operate our business and to finance our future operations or capital needs or to engage in other business activities.
The terms of our Senior Facilities and the indenture governing the notes restrict us from engaging in specified types of transactions. These covenants restrict our ability and the ability of our restricted subsidiaries, among other things, to:
• |
incur or guarantee additional indebtedness; |
• |
pay dividends on our capital stock or redeem, repurchase, or retire our capital stock or indebtedness; |
• |
make investments, loans, advances, and acquisitions; |
• |
pay dividends or other amounts to us from our restricted subsidiaries; |
• |
engage in transactions with our affiliates; |
• |
sell assets, including capital stock of our subsidiaries; |
• |
consolidate or merge; and |
• |
create liens. |
In addition, the Revolver requires us to maintain inventory and accounts receivable balances to collateralize the underlying loan with a maximum allowable borrowing limit of $150.0 million. Our ability to comply with this covenant can be affected by events beyond our control, and we may not be able to satisfy them. A breach of this covenant would be an event of default. In the event of a default under the Revolver, those lenders could elect to declare all amounts outstanding under the Revolver to be immediately due and payable or terminate their commitments to lend additional money, which would also lead to a cross-default and cross-acceleration of amounts owing under the Senior Facilities. If the indebtedness under our Senior Facilities or the notes were to be accelerated, our assets may not be sufficient to repay such indebtedness in full. In particular, note holders will be paid only if we have assets remaining after we pay amounts due on our secured indebtedness, including our Senior Facilities. We have pledged a significant portion of our assets as collateral under our Senior Facilities.
We may not be able to generate sufficient cash to service all of our indebtedness, including the notes, and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.
Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business, and other factors beyond our control. We may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness, including the notes. If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital, or restructure or refinance our indebtedness. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. The terms of existing or future debt instruments may restrict us from adopting some of these alternatives. In addition, any failure to make payments of interest and principal on our outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. Our Senior Facilities and the indenture governing the notes restrict our ability to dispose of assets and use the proceeds from the disposition. We may not be able to consummate those dispositions or to obtain the proceeds that we could realize from them and these proceeds may not be adequate to meet any debt service obligations then due. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations.
Our ability to repay our debt is affected by the cash flow generated by our subsidiaries.
13
Our subsidiaries own substantially all of our assets and conduct substantially all of our operations. Accordingly, repayment of our indebtedness will be dependent on the generation of cash flow by our subsidiaries and their ability to make such cash available to us, by dividend, debt repayment, or otherwise. Unless they are guarantors of the notes, our subsidiaries will not have any obligation to pay amounts due on the notes or to make funds available for that purpose. Our subsidiaries may not be able to, or may not be permitted to, make distributions to enable us to make payments in respect of our indebtedness. Each subsidiary is a distinct legal entity and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from our subsidiaries. While the indenture governing the notes limits the ability of our subsidiaries to incur consensual restrictions on their ability to pay dividends or make other intercompany payments to us, these limitations are subject to certain qualifications and exceptions. In the event that we do not receive distributions from our subsidiaries, we may be unable to make required principal and interest payments on our indebtedness.
Volatility and weakness in bank and capital markets may adversely affect credit availability and related financing costs for us.
Bank and capital markets can experience periods of volatility and disruption. If the disruption in these markets is prolonged, our ability to refinance, and the related cost of refinancing, some or all of our debt could be adversely affected. Additionally, during periods of volatile credit markets, there is a risk that lenders, even those with strong balance sheets and sound lending practices, could fail or refuse to honor their legal commitments and obligations under existing credit commitments. Although we currently can access the bank and capital markets, there is no assurance that such markets will continue to be a reliable source of financing for us. These factors, including the tightening of credit markets, could adversely affect our ability to obtain cost-effective financing. Increased volatility and disruptions in the financial markets also could make it more difficult and more expensive for us to refinance outstanding indebtedness and obtain financing. In addition, the adoption of new statutes and regulations, the implementation of recently enacted laws or new interpretations or the enforcement of older laws and regulations applicable to the financial markets or the financial services industry could result in a reduction in the amount of available credit or an increase in the cost of credit. Disruptions in the financial markets can also adversely affect our lenders, insurers, customers, and other counterparties. Any of these results could cause a material adverse effect to our business, financial condition, and results of operations.
Item 1B - Unresolved Staff Comments.
None.
Item 2 – Properties.
As of December 29, 2018, our principal office, manufacturing, and distribution properties were as follows:
14
Business Segment |
Approximate
Square
Footage
|
Description |
||
United States |
||||
Atlanta, Georgia |
12,000 |
Office |
||
Boulder, Colorado |
20,000 |
Office, Distribution |
||
Cincinnati, Ohio |
270,000 |
Office, Distribution |
||
Dallas, Texas |
166,000 |
Distribution |
||
Fairfield, Ohio |
52,000 |
Distribution |
||
Forest Park, Ohio |
385,000 |
Office, Distribution |
||
Jacksonville, Florida |
97,000 |
Distribution |
||
Parma, Ohio |
16,000 |
Office, Distribution |
||
Pompano Beach, Florida |
39,000 |
Office, Distribution |
||
Rialto, California |
402,000 |
Distribution |
||
Rome, Georgia |
14,000 |
Office |
||
San Antonio, Texas |
150,000 |
Office, Distribution |
||
Shafter, California |
134,000 |
Distribution |
||
Shannon, Georgia |
300,000 |
Distribution |
||
Springdale, Ohio |
28,000 |
Mfg., Distribution |
||
Tempe, Arizona |
184,000 |
Office, Mfg., Distribution |
||
Tyler, Texas (1)
|
202,000 |
Office, Mfg., Distribution |
||
Canada |
||||
Burnaby, British Columbia |
29,000 |
Distribution |
||
Edmonton, Alberta |
100,000 |
Distribution |
||
Laval, Quebec |
34,000 |
Distribution |
||
Milton, Ontario |
26,000 |
Manufacturing |
||
Mississauga, Ontario |
25,000 |
Distribution |
||
Moncton, New Brunswick |
16,000 |
Distribution |
||
Pickering, Ontario |
301,000 |
Distribution |
||
Scarborough, Ontario |
372,000 |
Office, Mfg., Distribution |
||
Toronto, Ontario |
385,000 |
Office, Distribution |
||
Winnipeg, Manitoba |
42,000 |
Distribution |
||
Mexico |
||||
Monterrey |
13,000 |
Distribution |
(1) |
The Company leases two facilities in Tyler, Texas. The first is a 139,000 square foot facility located at 2329 E. Commerce Street used for manufacturing and distribution. The second is a 63,000 square foot facility located at 6357 Reynolds Road used for offices, manufacturing, and distribution. |
All of the Company's facilities are leased, with the exception of one building in Rome, Georgia. In the opinion of the Company's management, the Company's existing facilities are in good condition.
Item 3 – Legal Proceedings.
We are subject to various claims and litigation that arise in the normal course of business. For a description of our material legal proceedings, see Note 15 - Commitments and Contingencies, to the accompanying consolidated financial statements included in this Annual Report on Form 10-K.
Item 4 – Mine Safety Disclosures.
Not Applicable.
15
PART II
Item 5 – Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Stock Exchange Listing
Our common stock does not trade and is not listed on or quoted in an exchange or other market. The Trust Preferred Securities trade under the ticker symbol "HLM.Pr." on the NYSE Amex. The following table sets forth the high and low sales prices as reported on the NYSE Amex for the Trust Preferred Securities.
2018 |
High |
Low |
|||||
First Quarter |
$ |
36.78 |
$ |
29.63 |
|||
Second Quarter |
34.40 |
26.41 |
|||||
Third Quarter |
32.00 |
29.86 |
|||||
Fourth Quarter |
30.94 |
26.00 |
|||||
2017 |
High |
Low |
|||||
First Quarter |
$ |
34.00 |
$ |
32.00 |
|||
Second Quarter |
34.75 |
33.17 |
|||||
Third Quarter |
36.95 |
32.26 |
|||||
Fourth Quarter |
34.90 |
33.55 |
The Trust Preferred Securities have a liquidation value of $25.00 per security. As of March 28, 2019, the total number of Trust Preferred Securities outstanding was 4,217,724. As of March 28, 2019, our total number of shares of common stock outstanding was 5,000, held by one stockholder.
Distributions
We pay interest to the Hillman Group Capital Trust (the “Trust”) on the junior subordinated debentures underlying the Trust Preferred Securities at the rate of 11.6% per annum on their face amount of $105.4 million, or $12.2 million per annum in the aggregate. The Trust distributes an equivalent amount to the holders of the Trust Preferred Securities. For the years ended December 29, 2018 and December 30, 2017, we paid $12.2 million per year in interest on the junior subordinated debentures, which was equivalent to the amounts distributed by the Trust for the same periods.
Pursuant to the indenture that governs the Trust Preferred Securities, the Trust is able to defer distribution payments to holders of the Trust Preferred Securities for a period that cannot exceed 60 months (the “Deferral Period”). During the Deferral Period, we are required to accrue the full amount of all interest payable, and such deferred interest payments are immediately payable at the end of the Deferral Period. There were no deferrals of distribution payments to holders of the Trust Preferred Securities in 2018 or 2017.
The interest payments on the junior subordinated debentures underlying the Trust Preferred Securities are subject to the interest expense limitations arising from the Tax Cuts and Jobs Act (the “2017 Tax Act”) (see Note 6 - Income Taxes for further information) and will remain our obligation until the Trust Preferred Securities are redeemed or upon their maturity in 2027.
For more information on the Trust and junior subordinated debentures, see “Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations.”
Unregistered Sales of Equity Securities
We made no sales of our equity securities during the year ended December 29, 2018.
Issuer Purchases of Equity Securities
We made no repurchases of our equity securities during the year ended December 29, 2018.
16
Item 6 – Selected Financial Data.
On June 30, 2014, affiliates of CCMP Capital Advisors, LLC (“CCMP”) and Oak Hill Capital Partners III, L.P., Oak Hill Capital Management Partners III, L.P. and OHCP III HC RO, L.P. (collectively, “Oak Hill Funds”), together with certain current and former members of Hillman's management, consummated a merger transaction (the “Merger Transaction”) pursuant to the terms and conditions of an Agreement and Plan of Merger dated as of May 16, 2014. As a result of the Merger Transaction, The Hillman Companies, Inc. remained a wholly-owned subsidiary of OHCP HM Acquisition Corp., which changed its name to HMAN Intermediate II Holdings Corp. (“Predecessor Holdco”), and became a wholly-owned subsidiary of HMAN Group Holdings Inc. (“Successor Holdco” or “Holdco”).
Our operations for the periods presented prior to June 30, 2014 are referenced herein as the Predecessor or Predecessor Operations. Our operations for the periods presented since the Merger Transaction are referenced herein as the Successor or Successor Operations and include the effects of our debt refinancing.
The following table sets forth selected consolidated financial data of the Predecessor for the six months ended June 29, 2014; and consolidated financial data of the Successor as of and for the six months ended December 31, 2014, and for the years ended December 31, 2015 and 2016, December 30, 2017, and December 29, 2018.
Successor |
Predecessor |
|||||||||||||||||
(dollars in thousands) |
Year Ended 12/29/2018 |
Year Ended 12/30/17 |
Year Ended 12/31/16 |
Year Ended 12/31/15 |
Period from 6/30/2014 Through 12/31/14 |
Six Months Ended 6/29/14 |
||||||||||||
Income Statement Data: |
||||||||||||||||||
Net sales |
$ |
974,175 |
$ |
838,368 |
$ |
814,908 |
$ |
786,911 |
$ |
377,292 |
$ |
357,377 |
||||||
Cost of Sales (exclusive of depreciation and amortization) |
537,885 |
455,717 |
438,418 |
436,004 |
193,221 |
183,342 |
||||||||||||
Acquisition and integration expense (1)
|
— |
— |
— |
257 |
22,719 |
31,681 |
||||||||||||
Income (loss) from operations |
26,836 |
36,985 |
41,515 |
27,398 |
8,241 |
(39,388 |
) |
|||||||||||
Net income (loss) |
(69,641 |
) |
58,648 |
(14,206 |
) |
(23,083 |
) |
(18,937 |
) |
(44,526 |
) |
|||||||
Balance Sheet Data: |
||||||||||||||||||
Total assets |
$ |
2,431,470 |
$ |
1,799,217 |
$ |
1,781,636 |
$ |
1,844,999 |
$ |
1,880,230 |
N/A |
|||||||
Long-term debt & capital lease obligations (2) (3)
|
1,167,676 |
550,685 |
536,572 |
570,277 |
547,857 |
N/A |
||||||||||||
11.6% Junior Subordinated Debentures |
108,704 |
108,704 |
108,704 |
108,704 |
108,704 |
N/A |
||||||||||||
6.375% Senior Notes (3)
|
330,000 |
330,000 |
330,000 |
330,000 |
330,000 |
N/A |
(1) |
Acquisition and integration expenses for investment banking, legal, and other professional fees incurred in connection with the Merger Transaction. |
(2) |
Includes current portion of long-term debt (at face value) and capitalized lease obligations. |
(3) |
In 2018 we refinanced our term loan, see Note 7 - Long-Term Debt of the Notes to Consolidated Financial Statements for additional information on our current debt.
|
Item 7 – Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion provides information which our management believes is relevant to an assessment and understanding of our operations and financial condition. This discussion should be read in conjunction with the consolidated financial statements and related notes and schedules thereto appearing elsewhere herein. In addition, see “Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 Regarding Forward-Looking Information”, as well as “Risk Factors” in Item 1A of this Annual Report.
General
Hillman is one of the largest providers of hardware-related products and related merchandising services to retail markets in North America. Our principal business is operated through our wholly-owned subsidiary, The Hillman Group, Inc. and its
17
wholly-owned subsidiaries (collectively, “Hillman Group”), which had net sales of approximately $974.2 million in 2018. We sell our products to hardware stores, home centers, mass merchants, pet supply stores, and other retail outlets principally in the United States, Canada, Mexico, Latin America, and the Caribbean. Product lines include thousands of small parts such as fasteners and related hardware items; threaded rod and metal shapes; keys, key duplication systems, and accessories; builder's hardware; and identification items, such as tags and letters, numbers, and signs. We support our product sales with services that include the design and installation of merchandising systems and maintenance of appropriate in-store inventory levels.
On October 1, 2018, we completed the acquisition of NB Parent Company, Inc. and its affiliated companies including Big Time Products, LLC and Rooster Products International, Inc. (collectively, "Big Time"), a leading provider of personal protection and work gear products for a purchase price of approximately $348.8 million. With the addition of Big Time, Hillman’s product portfolio now spans the hardware, automotive, garden, and cleaning categories and includes Big Time’s industry-leading brands such as Firm Grip, AWP, McGuire-Nicholas, Grease Monkey, and Gorilla Grip, which are sold throughout retailers in North America. Big Time has operations in the United States, Canada and Mexico and will be included in each of our reportable segments.
On August 10, 2018, we completed the acquisition of Minute Key Holdings, Inc. (“MinuteKey”), an innovative leader in self-service key duplicating kiosks for a total consideration reflecting an enterprise value of $156.3 million. We believe that the combination of MinuteKey's self-service kiosk business with Hillman's existing key duplication platform will create additional growth opportunities. MinuteKey has operations in the United States and Canada and will be included in our United States and Canada reportable segments.
On May 31, 2018, we entered into a new term credit agreement consisting of a new funded term loan of $530 million and $165 million delayed draw term loan facility. Concurrently, we entered into a new $150 million asset-based revolving credit agreement. In the third quarter of 2018, we drew $165 million on the delayed draw facility of the term loan to finance the MinuteKey acquisition. In the fourth quarter, we amended the credit agreement and added an additional $365 million in incremental term loans to finance the acquisition of Big Time. We paid approximately $20.5 million in fees associated with the refinancing activities in the year ended December 29, 2018. See Note 7 - Long-Term Debt of the Notes to the Consolidated Financial statements for additional information on the refinancing.
As part of the ongoing restructuring of our Canada segment operations, we initiated plans to restructure the operations of the Canada segment. The restructuring seeks to streamline operations in the greater Toronto area by consolidating facilities, exiting certain lines of business, and rationalizing stock keeping units (“SKUs”). The intended result of the Canada restructuring will be a more streamlined and scalable operation focused on delivering optimal service and a broad offering of products across our core categories. We incurred charges of $8.3 million, net of a gain of $6.1 million on the sale of a building, in the year ended December 29, 2018, and expect to incur additional restructuring related charges and capital expenditures in our Canada segment over the next year as we finalize and implement the plan. See Note 14 - Restructuring of the Notes to the Consolidated Financial statements for additional information.
Current Economic Conditions
Our business is impacted by general economic conditions in the North American and international markets, particularly the U.S. and Canadian retail markets including hardware stores, home centers, mass merchants, and other retailers.
We are exposed to the risk of unfavorable changes in foreign currency exchange rates for the U.S. dollar versus local currency of our suppliers located primarily in China and Taiwan. We purchase a significant variety of our products for resale from multiple vendors located in China and Taiwan. The purchase price of these products is routinely negotiated in U.S. dollar amounts rather than the local currency of the vendors and our suppliers' profit margins decrease when the U.S. dollar declines in value relative to the local currency. This puts pressure on our suppliers to increase prices to us. The U.S. dollar increased in value relative to the CNY by approximately by 7.2% in 2016, decreased by 6.3% in 2017, and increased by 5.7% in 2018. The U.S. dollar decreased in value relative to the Taiwan dollar by approximately 1.2% in 2016, decreased by 8.5% in 2017, and increased by 3.3% in 2018.
In addition, the negotiated purchase price of our products may be dependent upon market fluctuations in the cost of raw materials such as steel, zinc, and nickel used by our vendors in their manufacturing processes. The final purchase cost of our products may also be dependent upon inflation or deflation in the local economies of vendors in China and Taiwan that could impact the cost of labor used in the manufacturing of our products. We identify the directional impact of changes in our product cost, but the quantification of each of these variable impacts cannot be measured as to the individual impact on our product cost with a sufficient level of precision.
18
We are also exposed to risk of unfavorable changes in Canadian dollar exchange rate versus the U.S. dollar. Our sales in Canada are denominated in Canadian dollars while a majority of the products are sourced in U.S. dollars. A weakening of the Canadian dollar versus the U.S. dollar results in lower sales in terms of U.S. dollars while the cost of sales remains unchanged. We have a practice of hedging some of our Canadian subsidiary's purchases denominated in U.S. dollars. The U.S. dollar decreased in value relative to the Canadian dollar by approximately 3.0% in 2016, decreased by 6.6% in 2017, and increased by 8.7% in 2018. We may take pricing action, when warranted, in an attempt to offset a portion of product cost increases. The ability of our operating divisions to institute price increases and seek price concessions, as appropriate, is dependent on competitive market conditions.
We import large quantities of products which are subject to customs requirements and to tariffs and quotas set by governments through mutual agreements and bilateral actions. The recently implemented U.S. tariffs on steel and aluminum and other imported goods has increased our product costs and required us to increase prices on the affected products.
Product Revenues
The following is revenue based on products for our significant product categories:
Fastening Solutions |
Home and Access Solutions |
Consumer Connected Solutions |
Personal Protective Solutions |
Total Revenue |
||||||
Year Ended December 29, 2018 |
||||||||||
United States |
437,164 |
251,749 |
80,424 |
52,749 |
822,086 |
|||||
Canada |
109,893 |
31,509 |
518 |
1,945 |
143,865 |
|||||
Other |
6,539 |
932 |
— |
753 |
8,224 |
|||||
Consolidated |
553,596 |
284,190 |
80,942 |
55,447 |
974,175 |
|||||
Year Ended December 30, 2017 |
||||||||||
United States |
380,299 |
247,164 |
66,136 |
— |
693,599 |
|||||
Canada |
106,689 |
31,099 |
12 |
— |
137,800 |
|||||
Other |
5,936 |
1,033 |
— |
— |
6,969 |
|||||
Consolidated |
492,924 |
279,296 |
66,148 |
— |
838,368 |
|||||
Year Ended December 31, 2016 |
||||||||||
United States |
372,981 |
241,166 |
63,379 |
— |
677,526 |
|||||
Canada |
103,539 |
26,703 |
13 |
— |
130,255 |
|||||
Other |
6,068 |
1,059 |
— |
— |
7,127 |
|||||
Consolidated |
482,588 |
268,928 |
63,392 |
— |
814,908 |
Results of Operations
Results of operations for the years ended December 29, 2018 and December 30, 2017:
19
Year Ended December 29, 2018 |
Year Ended December 30, 2017 |
||||||||||||
(dollars in thousands) |
Amount |
% of Net Sales |
Amount |
% of Net Sales |
|||||||||
Net sales |
$ |
974,175 |
100.0 |
% |
$ |
838,368 |
100.0 |
% |
|||||
Cost of sales (exclusive of depreciation and amortization shown separately below) |
537,885 |
55.2 |
% |
455,717 |
54.4 |
% |
|||||||
Selling, general and administrative expenses |
320,543 |
32.9 |
% |
274,044 |
32.7 |
% |
|||||||
Depreciation |
46,060 |
4.7 |
% |
34,016 |
4.1 |
% |
|||||||
Amortization |
44,572 |
4.6 |
% |
38,109 |
4.5 |
% |
|||||||
Management fees to related party |
546 |
0.1 |
% |
519 |
0.1 |
% |
|||||||
Other income, net |
(2,267 |
) |
(0.2 |
)% |
(1,022 |
) |
(0.1 |
)% |
|||||
Income from operations |
26,836 |
2.8 |
% |
36,985 |
4.4 |
% |
|||||||
Interest expense, net of investment income |
82,775 |
8.5 |
% |
63,248 |
7.5 |
% |
|||||||
Refinancing charges |
11,632 |
1.2 |
% |
— |
— |
% |
|||||||
Loss before income taxes |
(67,571 |
) |
(6.9 |
)% |
(26,263 |
) |
(3.1 |
)% |
|||||
Income tax expense (benefit) |
2,070 |
0.2 |
% |
(84,911 |
) |
(10.1 |
)% |
||||||
Net (loss) income |
$ |
(69,641 |
) |
(7.1 |
)% |
$ |
58,648 |
7.0 |
% |
Year Ended December 29, 2018 vs December 30, 2017
Net Sales
Net sales for the year ended December 29, 2018 were $974.2 million, or $3.87 million per shipping day, compared to net sales of $838.4 million, or $3.33 million per shipping day for the year ended December 30, 2017, an increase of approximately $135.8 million. The increase was primarily driven by the acquisitions of ST Fastening Systems in the fourth quarter of 2017, MinuteKey in the third quarter of 2018, and Big Time in the fourth quarter of 2018. The acquisitions increased revenue $115.4 million in the year ended December 29, 2018 as compared to the year ended December 30, 2017. Sales of hurricane related products increased $7.9 million. Key and key accessory sales increased by $6.5 million primarily due to the key program roll out to a new key customer in 2018. Automotive keys increased $6.1 million due to the launch of a new product for duplication of programmable key remotes.
Cost of Sales
Our cost of sales was $537.9 million, or 55.2% of net sales, for the year ended December 29, 2018, an increase of $82.2 million compared to $455.7 million, or 54.4% of net sales, for the year ended December 30, 2017. The increase of 0.8% in cost of sales, expressed as a percent of net sales, in 2018 compared to 2017 was primarily due to inventory valuation adjustments in our Canada segment of $9.8 million driven by exiting certain lines of business and rationalizing stock keeping units (see Note 14 - Restructuring of the Notes to the Condensed Consolidated Financial statements for additional information). This additional expense was partially offset by an adjustment to our accrual for anti-dumping duties. We recorded a reduction of $3.8 million in cost of sales in the year ended December 29, 2018 due to an adjustment to our accrual for anti-dumping duties (see Note 15 - Commitments and Contingencies of the Notes to Consolidated Financial Statements for additional information). The remaining increase in in cost of sales, expressed as a percent of net sales, was the result of higher sales and product costs attributed to commodity inflation and tariffs.
Expenses
Operating expenses and other income (expenses) were $63.8 million higher for the year ended December 29, 2018 compared to the year ended December 30, 2017. The acquisition of ST Fastening Systems, MinuteKey, and Big Time added $43.9 million in operating expense, excluding transaction related expenses, in the year ended December 29, 2018. The following changes in underlying trends impacted the change in operating expenses excluding acquisitions:
• |
Selling expense, excluding acquired businesses, was $121.4 million in the year ended December 29, 2018, an increase of $1.9 million compared to $119.5 million for the year ended December 30, 2017. The increase in selling expense was primarily due to $0.9 million of additional expense for updating customer store labels for a new pricing program with the remaining increase due to higher labor and benefit costs.
|
20
• |
Warehouse and delivery expenses, excluding acquired businesses, were $116.7 million for the year ended December 29, 2018, an increase of $6.6 million compared to warehouse and delivery expenses of $110.1 million for the year ended December 30, 2017. We incurred $4.6 million of higher expense for increases in labor, benefits, freight, and equipment costs. We also incurred additional warehouse expense of $2.2 million related to restructuring activities in our Canada segment (see Note 14 - Restructuring of the Notes to the Condensed Consolidated Financial statements for additional information).
|
• |
General and administrative (“G&A”) expenses, excluding acquired businesses, were $50.2 million in the year ended December 29, 2018, an increase of $7.4 million compared to $42.8 million in the year ended December 30, 2017. In the year ended December 29, 2018 we incurred an additional $11.2 million in acquisition related costs associated with MinuteKey and Big Time. The increased acquisition expenses were partially offset by lower variable compensation expense in the current year.
|
• |
Depreciation expense, excluding acquired businesses, was $39.2 million in the year ended December 29, 2018 compared to $33.7 million in the year ended December 30, 2017. The increase was driven by our continued investment in new, state of the art key cutting technology, the KeyKrafter™ and the implementation of our ERP system in Canada.
|
• |
Amortization expense, excluding acquired businesses, of $37.8 million in the year ended December 29, 2018 was consistent with the year ended December 30, 2017.
|
• |
Other income of $2.3 million for the year ended December 29, 2018 increased $1.2 million compared to income of $1.0 million in the year ended December 30, 2017. Other income of $2.3 million for the year ended December 29, 2018 consisted of a $5.3 million net gain on the sale and disposal of property, plant, and equipment associated with the restructuring of the Canada segment, (see Note 14 - Restructuring of the Notes to the Condensed Consolidated Financial statements for additional information). The current year gain was offset by $2.0 million exchange rate losses of exchange rate losses and $0.6 million of losses on the mark-to-market adjustment of our interest rate swaps. Other income for the year ended December 30, 2017 included $1.5 million of gains on the mark-to-market adjustment of our interest rate swaps and $1.3 million of exchange rate gains. These gains were partially offset by net losses of $1.9 million as we exited certain lines of business. In both years we incurred immaterial losses on the disposal of fixed assets.
|
Interest expense, net, of $82.8 million for the year ended December 29, 2018 increased $19.5 million, compared to $63.2 million for the year ended December 30, 2017. During 2018 we refinanced our term loan and revolver, increasing the outstanding term loan by approximately $527.5 million. In connection with the refinancing, we incurred $11.6 million in refinancing charges. The increase in the term loan and additional draws on our revolving credit facility during the year led to increased interest expense. See Note 7 - Long-Term Debt of the Notes to the Condensed Consolidated Financial statements for additional information.
Results of Operations
Results of operations for the years ended December 30, 2017 and December 31, 2016:
Year Ended December 30, 2017 |
Year Ended December 31, 2016 |
||||||||||||
(dollars in thousands) |
Amount |
% of Total |
Amount |
% of
Total
|
|||||||||
Net sales |
$ |
838,368 |
100.0 |
% |
$ |
814,908 |
100.0 |
% |
|||||
Cost of sales (exclusive of depreciation and amortization shown separately below) |
455,717 |
54.4 |
% |
438,418 |
53.8 |
% |
|||||||
Selling, general and administrative expenses |
274,044 |
32.7 |
% |
265,241 |
32.5 |
% |
|||||||
Depreciation |
34,016 |
4.1 |
% |
32,245 |
4.0 |
% |
|||||||
Amortization |
38,109 |
4.5 |
% |
37,905 |
4.7 |
% |
|||||||
Management fees to related party |
519 |
0.1 |
% |
550 |
0.1 |
% |
|||||||
Other income, net |
(1,022 |
) |
(0.1 |
)% |
(966 |
) |
(0.1 |
)% |
|||||
Income from operations |
36,985 |
4.4 |
% |
41,515 |
5.1 |
% |
|||||||
Interest expense, net of investment income |
63,248 |
7.5 |
% |
63,411 |
7.8 |
% |
|||||||
Loss before income taxes |
(26,263 |
) |
(3.1 |
)% |
(21,896 |
) |
(2.7 |
)% |
|||||
Income tax benefit |
(84,911 |
) |
(10.1 |
)% |
(7,690 |
) |
(0.9 |
)% |
|||||
Net income (loss) |
$ |
58,648 |
7.0 |
% |
$ |
(14,206 |
) |
(1.7 |
)% |
21
Year Ended December 30, 2017 vs Year Ended December 31, 2016
Net Sales
Net sales for the year ended December 30, 2017 were $838.4 million, or $3.33 million per shipping day, compared to net sales of $814.9 million, or $3.22 million per shipping day, for the year ended December 31, 2016. The increase from prior year was primarily driven by volume growth with big box retailers of $8.2 million, growth in our Canada segment of $7.5 million, and the acquisition of ST Fastening Systems which added $5.9 million in net sales. Additionally, our commercial industrial sales increased $2.9 million due to higher hurricane related demand in 2017.
Cost of Sales
Our cost of sales was $455.7 million, or 54.4% of net sales, for the year ended December 30, 2017, an increase of $17.3 million compared to $438.4 million, or 53.8% of net sales, for the year ended December 31, 2016. The increase of 0.6% in cost of sales, expressed as a percent of net sales, in 2017 compared to 2016 was primarily due to $6.3 million of additional expense in the year ended December 30, 2017 for anti-dumping duties associated with nails imported from China from 2014 through 2016 (see Note 15 - Commitments and Contingencies of the Notes to Consolidated Financial Statements for additional information).
Expenses
Operating expenses and other income (expenses) were $10.7 million higher for the year ended December 30, 2017 compared to the year ended December 31, 2016. The acquisition of ST Fastening Systems added $2.1 million in operating expense, excluding transaction related expenses, in the year ended December 30, 2017. The following changes in underlying trends impacted the change in operating expenses excluding the acquisition of ST Fastening Systems:
• |
Selling expense, excluding acquired businesses, was $119.5 million in the year ended December 30, 2017, an increase of $2.7 million compared to $116.8 million for the year ended December 31, 2016. The increase in selling expense was primarily due the launch of our new product line, High & Mighty™, an innovative series of tool-free wall hangers, decorative hooks, key and hook rails, and floating shelves.
|
• |
Warehouse and delivery expenses, excluding acquired businesses, were $110.1 million for the year ended December 30, 2017, an increase of $5.0 million compared to warehouse and delivery expenses of $105.1 million for the year ended December 31, 2016. We incurred approximately $5.4 million of additional warehouse expense in 2017 associated with the operations of a new hub facility located on the U.S. West Coast, which became operational at the end of the first quarter of 2017. The remaining increase was driven by the unfavorable conversion of local currency to the U.S. dollar for our Canadian operations.
|
• |
G&A expenses, excluding acquired businesses, were $42.8 million in the year ended December 30, 2017 was consistent with $43.3 million in the year ended December 31, 2016.
|
• |
Depreciation expense, excluding acquired businesses, was $33.7 million in the year ended December 30, 2017 compared to $32.2 million in the year ended December 31, 2016. The primary reason for the increase in depreciation expense was the fixed asset additions of key and engraving machines and software related to our ERP system.
|
• |
Amortization expense, excluding acquired businesses, of $37.9 million in the year ended December 30, 2017 was consistent with the year ended December 31, 2016.
|
• |
Other income was $1.0 million for the year ended December 30, 2017 was consistent with other income for the year ended December 31, 2016.
|
Interest expense, net, was $63.2 million for the year ended December 30, 2017 was consistent with $63.4 million for the year ended December 31, 2016.
Results of Operations – Operating Segments
The following table provides supplemental information of our sales and profitability by operating segment (in thousands):
22
Year Ended December 29, 2018 |
Year Ended December 30, 2017 |
Year Ended December 31, 2016 |
|||||||||
Segment Revenues |
|||||||||||
United States |
$ |
822,086 |
$ |
693,599 |
$ |
677,526 |
|||||
Canada |
143,865 |
137,800 |
130,255 |
||||||||
Other |
8,224 |
6,969 |
7,127 |
||||||||
Total revenues |
$ |
974,175 |
$ |
838,368 |
$ |
814,908 |
|||||
Segment Income (Loss) from Operations |
|||||||||||
United States |
$ |
35,037 |
$ |
32,583 |
$ |
42,148 |
|||||
Canada |
(8,820 |
) |
2,881 |
932 |
|||||||
Other |
619 |
1,521 |
(1,565 |
) |
|||||||
Total income from operations |
$ |
26,836 |
$ |
36,985 |
$ |
41,515 |
Year Ended December 29, 2018 vs December 30, 2017
Net Sales
Net sales for the year ended December 29, 2018 increased $135.8 million compared to the net sales for the year ended December 30, 2017. Net sales for our United States operating segment increased by $128.5 million from the prior year. The increase was primarily driven by the acquisitions of ST Fastening Systems in the fourth quarter of 2017, MinuteKey in the third quarter of 2018, and Big Time in the fourth quarter of 2018. The acquisitions increased revenue $112.2 million in the year ended December 29, 2018 as compared to the year ended December 30, 2017. Sales of hurricane related products increased $7.9 million. Key and key accessory sales increased by $6.5 million primarily due to the key program roll out to a new key customer in 2018. Automotive keys increased $6.1 million due to the launch of a new product for duplication of programmable key remotes. These increases were partially offset by a decrease in our sales of Letters Numbers and Signs.
Net sales for our Canada operating segment increased by $6.1 million primarily due to the roll out of wall anchor and builders' hardware products to retail customers.
Net sales in our Other operating segment increased by $1.3 million primarily due to the acquisition of Big Time which added $0.8 million in sales for the year ended December 29, 2018.
Income (loss) from Operations
Income from operations for the year ended December 29, 2018 decreased $10.1 million compared to the year ended December 30, 2017.
Income from operations of our United States segment increased by approximately $2.5 million in the year ended December 29, 2018 to $35.0 million from $32.6 million in the year ended December 30, 2017. The acquisition of ST Fastening Systems, Minute Key, and Big Time added $4.7 million in operating income in the current year. Excluding acquisitions, operating income in our United States segment decreased by $2.3 million. The decrease was the result of higher SG&A costs, and higher depreciation expense that offset the increase in net sales. SG&A expenses were $12.9 million higher in the year ended December 29, 2018 compared to the year ended December 30, 2017 primarily due to $11.2 million in acquisition related expenses associated with MinuteKey and Big Time. We also incurred $0.9 million of additional selling expense for updating customer store labels for a new pricing program. The remaining increase was due to increases in labor, benefits, freight, and equipment costs. Depreciation expense was higher in the United States segment in the year ended December 29, 2018 due to capital expenditures for key machines and software related to our ERP system partially offset by certain assets becoming fully depreciated.
Income from operations of our Canada segment decreased by $11.7 million in the year ended December 29, 2018 to a loss of $8.8 million as compared to income of $2.9 million in the year ended December 30, 2017. The increase in sales was offset by net restructuring charges of $8.3 million in restructuring related charges for our Canada segment consisting of inventory valuation adjustments, asset impairments, labor and severance, and consulting costs, partially offset by a gain on the sale of real estate. See Note 14 - Restructuring of the Notes to the Consolidated Financial statements for additional information. Additionally, in the year ended December 29, 2018 we incurred exchange rate losses of $1.8 million compared to gains of $0.9 million in the year ended December 30, 2017.
23
Year Ended December 30, 2017 vs Year Ended December 31, 2016
Net Sales
Net sales for the year ended December 30, 2017 increased $23.5 million compared to the net sales for the year ended December 31, 2016. Net sales for our United States operating segment increased by $16.1 million primarily driven by $8.2 million of volume growth with big box retailers and the acquisition of ST Fastening Systems which added $5.9 million in net sales. Additionally, our U.S. commercial industrial sales increased $2.9 million due to higher hurricane related demand in 2017.
Net sales for our Canada operating segment increased by $7.5 million. The increase was due to $5.3 million in retail volume and $2.2 million from the favorable impact of conversion of the local currency to U.S. dollars. The revenue impact of the remaining operating segments was not material to the overall variance between the two periods.
Income (loss) from Operations
Income from operations for the year ended December 30, 2017 decreased $4.5 million compared to the year ended December 31, 2016.
Income from operations of our United States segment decreased by approximately $9.6 million in the year ended December 30, 2017 to $32.6 million as compared to $42.1 million in the year ended December 31, 2016. The decrease was the result of higher cost of goods sold as a percentage of net sales, higher SG&A costs, and higher depreciation expense that offset the increase in net sales. Our cost of goods sold was 52.0% of net sales for the year ended December 30, 2017 compared to 51.1% of net sales for the year ended December 31, 2016 primarily due to $6.3 million of additional expense in the year ended December 30, 2017 for anti-dumping duties associated with nails imported from China from 2014 through 2016 (see Note 15 - Commitments and Contingencies of the Notes to Consolidated Financial Statements for additional information). SG&A expenses were $8.5 million higher in the year ended December 30, 2017 compared to the year ended December 31, 2016 primarily due to $5.4 million in higher warehousing costs for expenses associated with our new hub facility located on the West Coast. Selling expense increased $3.2 million primarily due to costs associated with the launch of our new product line, High & Mighty™, an innovative series of tool-free wall hangers, decorative hooks, key and hook rails, and floating shelves. Depreciation expense was $1.3 million higher in the United States segment in the year ended December 30, 2017 due to capital expenditures for key and engraving machines and software related to our ERP system partially offset by certain assets becoming fully depreciated.
Income from operations of our Canada segment increased by $2.0 million in the year ended December 30, 2017 to $2.9 million as compared to $0.9 million in the year ended December 31, 2016. The increase was due to higher sales and a decrease in cost of goods sold as a percentage of sales that was partially offset by higher SG&A expense related to restructuring charges in the year ended December 30, 2017. Cost of goods sold as a percentage of sales was 65.8% in the year ended December 30, 2017 as compared to 66.4% in the year ended December 31, 2016 due to change in product mix.
In the year ended December 31, 2016, we decided to exit the Australia market following the withdrawal from Australia of a key customer and we recorded charges of $1.0 million in the Other segment related to the write-off of inventory and other assets. In the year ended December 30, 2017, we fully liquidated our Australian subsidiary and reclassified the cumulative translation adjustment to income. The $0.6 million cumulative translation adjustment gain was recorded as Other Income on the Consolidated Statement of Comprehensive Income (Loss).
Income Taxes
Year Ended December 29, 2018 vs December 30, 2017
In the year ended December 29, 2018, we recorded income tax expense of $2.1 million on a pre-tax loss of $67.6 million. The effective income tax rate was (3.1)% for the year ended December 29, 2018. In the year ended December 30, 2017, we recorded an income tax benefit of $84.9 million on a pre-tax loss of $26.3 million. The effective income tax rate was 323.3% for the year ended December 30, 2017.
The effective income tax rate differed from the federal statutory tax rate in the year ended December 29, 2018 primarily due to the provisions established with the Tax Cuts and Jobs Act of 2017 (“2017 Tax Act”). We recorded approximately $11.7 million in income tax expense attributable to certain provisions of the 2017 Tax Act. The Company recorded a valuation allowance of $6.1 million for certain U.S. federal net operating losses that are subject to the dual consolidated loss limitation rules. Additionally, the Company recorded $2.2 million in income tax expense for certain non-deductible acquisition costs attributable
24
to the MinuteKey and Big Time acquisitions. The remaining differences between the effective income tax rate and the federal statutory rate in the year ended December 29, 2018 were attributable to state and foreign income taxes.
On December 22, 2017, the 2017 Tax Act was signed into law making significant changes to the Internal Revenue Code. Changes include, among other things, a permanent corporate rate reduction to 21% from 35%, implementing a modified territorial system including a mandatory deemed repatriation on certain unrepatriated earnings of foreign subsidiaries (“Transition Tax”), and providing for additional first-year depreciation that allows full expensing of qualified property placed into service after September 27, 2017.
During 2017, the Company recorded a provisional $75 million deferred income tax benefit for the remeasurement of its net deferred tax liabilities. Additionally, the Company did not record a provision for the Transition Tax in 2017 given the lack of historical earnings in the Company's foreign subsidiaries. During 2018, the Company did not significantly adjust the provisional estimate from the provisional calculations. In 2018, the Company became subject to certain provisions of the 2017 Tax Act including computations related to Global Intangible Low Taxed Income ("GILTI"), and the IRC §163(j) interest limitation ("Interest Limitation") (see Note 6 - Income Taxes of the Notes to Consolidated Financial Statements for additional information).
Year Ended December 30, 2017 vs. December 31, 2016
In the year ended December 30, 2017, we recorded an income tax benefit of $84.9 million on a pre-tax loss of $26.3 million. The effective income tax rate was 323.3% for the year ended December 30, 2017. In the year ended December 31, 2016, we recorded an income tax benefit of $7.7 million on a pre-tax loss of $21.9 million. The effective income tax rate was 35.1% for the year ended December 31, 2016.
The effective income tax rate differed from the federal statutory tax rate in the year ended December 30, 2017 primarily due to the remeasurement of our net deferred tax liabilities required by the 2017 Tax Act. We recorded approximately $75 million of an income tax benefit as a result of the remeasurement. The remaining differences between the effective income tax rate and the federal statutory rate in the year ended December 30, 2017 were attributable to other provisions of the 2017 Tax Act and state and foreign income taxes.
Liquidity and Capital Resources
Cash Flows
The statements of cash flows reflect the changes in cash and cash equivalents for the years ended December 29, 2018, December 30, 2017 and December 31, 2016 by classifying transactions into three major categories: operating, investing, and financing activities.
Operating Activities
Net cash provided by operating activities for the year ended December 29, 2018 was approximately $7.5 million. Operating cash flows for the year ended December 29, 2018 were unfavorably impacted by lower net income driven by increased interest expense and acquisition related costs along with an increase in inventory due to commodity inflation and new business wins. This was partially offset by an increase in accounts payable due to changes in payment terms and increased inventory purchases and a decrease in accounts receivable. Net cash provided by operating activities for the year ended December 30, 2017 was approximately $82.9 million and was favorably impacted by our focus on reducing net working capital which translated to improvements in inventory and accounts payable. Net cash provided by operating activities for the year ended December 31, 2016 was approximately $77.5 million and was favorably impacted by our focus on reducing net working capital which translated to improvements in accounts receivable and inventory.
Investing Activities
Net cash used for investing activities was $572.6 million, $100.1 million, and $41.4 million for the years ended December 29, 2018, December 30, 2017 and December 31, 2016, respectively. In the year ended December 29, 2018 we acquired MinuteKey and Big Time and made a final working capital true up payment for ST Fastening Systems which equated a total net cash outflow of approximately $501.0 million. Additionally, in the year ended December 30, 2017, we acquired ST Fastening Systems with a cash payment of $47.2 million (see Note 5 - Acquisitions of the Notes to Consolidated Financial Statements for
25
additional information). Finally, cash was used in all periods to invest in new, state of the art key cutting technology, the KeyKrafter™, as well as engraving machines and the implementation of our ERP system in Canada.
Financing Activities
Net cash provided by financing activities was $581.9 million for the year ended December 29, 2018. On May 31, we entered into a new term credit agreement consisting of a new funded term loan of $530.0 million and $165.0 million delayed draw term loan facility. Concurrently, we entered into a new $150.0 million asset-based revolving credit agreement. The proceeds were used to refinance in full all outstanding revolving credit and term loans under the existing credit agreement. In the third quarter of 2018, we drew $165.0 million on the delayed draw facility of the term loan to finance the MinuteKey acquisition. In the fourth quarter, we amended the credit agreement and added an additional $365.0 million in incremental term loans to finance the acquisition of Big Time. We paid approximately $20.5 million in fees associated with the refinancing activities in the year ended December 29, 2018. See Note 7 - Long-Term Debt of the Notes to the Consolidated Financial statements for additional information on the refinancing. Our revolver draws, net, were a source of cash of $88.7 million in the year ended December 29, 2018. Additionally, in the year ended December 29, 2018 we paid a dividend of $3.8 million to Holdco for the purchase of shares of Holdco stock from former members of management.
Net cash provided by financing activities was $14.4 million for the year ended December 30, 2017. The borrowings on revolving credit loans provided $35.5 million. The Company used $16.0 million of cash for the repayment of revolving credit loans and $5.5 million for principal payments on the senior term loans.
Net cash used for financing activities was $33.2 million for the year ended December 31, 2016. The borrowings on revolving credit loans provided $16.0 million. The Company used $44.0 million of cash for the repayment of revolving credit loans and $5.5 million for principal payments on the senior term loans.
Liquidity
We believe that projected cash flows from operations and Revolver availability will be sufficient to fund working capital and capital expenditure needs for the next 12 months.
Our working capital (current assets minus current liabilities) position of $280.0 million as of December 29, 2018 represents an increase of $89.0 million from the December 30, 2017 level of $191.0 million.
Contractual Obligations
Our contractual obligations as of December 29, 2018 are summarized below:
Payments Due |
|||||||||||||||||||
(dollars in thousands) |
Total |
Less Than
One Year
|
1 to 3
Years
|
3 to 5
Years
|
More Than
Five Years
|
||||||||||||||
Junior Subordinated Debentures (1)
|
$ |
108,704 |
$ |
— |
$ |
— |
$ |
— |
$ |
108,704 |
|||||||||
Interest on Jr Subordinated Debentures |
107,025 |
12,231 |
24,463 |
24,463 |
45,868 |
||||||||||||||
Long Term Senior Term Loans |
1,058,263 |
10,609 |
21,218 |
21,218 |
1,005,218 |
||||||||||||||
Bank Revolving Credit Facility |
108,200 |
— |
— |
108,200 |
— |
||||||||||||||
6.375% Senior Notes |
330,000 |
— |
— |
330,000 |
— |
||||||||||||||
KeyWorks License Agreement |
784 |
363 |
421 |
— |
— |
||||||||||||||
Interest payments (2)
|
503,981 |
92,516 |
182,209 |
144,936 |
84,320 |
||||||||||||||
Operating Leases |
83,584 |
17,326 |
28,041 |
21,553 |
16,664 |
||||||||||||||
Deferred Compensation Obligations |
1,905 |
545 |
— |
— |
1,360 |
||||||||||||||
Capital Lease Obligations |
1,213 |
376 |
550 |
72 |
215 |
||||||||||||||
Other Obligations |
1,602 |
683 |
735 |
184 |
— |
||||||||||||||
Uncertain Tax Position Liabilities |
1,101 |
— |
1,101 |
— |
— |
||||||||||||||
Total Contractual Cash Obligations (3)
|
$ |
2,306,362 |
$ |
134,649 |
$ |
258,738 |
$ |
650,626 |
$ |
1,262,349 |
(1) |
The Junior Subordinated Debentures liquidation value is approximately $108,704.
|
(2) |
Interest payments for borrowings under the Senior Facilities, the 6.375% Senior Notes, and Revolver borrowings. Interest payments on the variable rate Senior Term Loans were calculated using the actual interest rate of 6.34% as of |
26
December 29, 2018. Interest payments on the 6.375% Senior Notes were calculated at their fixed rate. Interest payments on the variable rate Revolver borrowings were calculated using the actual interest rate of 3.94% as of December 29, 2018.
(3) |
All of the contractual obligations noted above are reflected on the Company's consolidated balance sheet as of December 29, 2018 except for the interest payments, purchase obligations, and operating leases.
|
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K under the Securities Exchange Act of 1934, as amended.
Related Party Transactions
The Company has recorded aggregate management fee charges and expenses from the Oak Hill Funds and CCMP of approximately $0.5 million for each of the years ended December 29, 2018 and December 30, 2017, and $0.6 million for the year ended December 31, 2016.
We recorded proceeds from the sale of Holdco stock to members of management and the Board of Directors of $0.5 million for the year ended December 30, 2017 and $0.5 million for the year ended December 31, 2016. No such sales were recorded in the year ended December 29, 2018.
In the year ended December 29, 2018, the Company paid a dividend of approximately $3.8 million to Holdco for the purchase of 4,200 shares of Holdco stock from former members of management. No such dividends were paid in fiscal 2017 nor fiscal 2016.
Gregory Mann and Gabrielle Mann are employed by Hillman. Hillman leases an industrial warehouse and office facility from companies under the control of the Manns. We have recorded rental expense for the lease of this facility on an arm's length basis. Our rental expense for the lease of this facility was $0.4 million for each of the years ended December 29, 2018 and December 30, 2017, and $0.3 million for the year ended December 31, 2016.
The Company has three leases for five properties containing industrial warehouse, manufacturing plant, and office facilities in Canada. The owners of the properties under one lease are relatives of Richard Paulin, who was employed by The Hillman Group Canada ULC until his retirement effective April 30, 2017, and the owner of the properties under the other two leases is a company which is owned by Richard Paulin and certain of his relatives. We have recorded rental expense for the three leases on an arm's length basis. Rental expense for these facilities was $0.7 million for the years ended December 29, 2018, and December 30, 2017 and $0.6 million for the year ended December 31, 2016.
Critical Accounting Policies and Estimates
Our accounting policies are more fully described in Note 2 - Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements. As disclosed in that note, 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. Future events cannot be predicted with certainty and, therefore, actual results could differ from those estimates. The following section describes our critical accounting policies.
Revenue Recognition:
Revenue is recognized when control of goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Sales and other taxes we collect concurrent with revenue-producing activities are excluded from revenue.
We offer a variety of sales incentives to our customers primarily in the form of discounts, rebates, and slotting fees. Discounts are recognized in the consolidated financial statements at the date of the related sale. Rebates are based on the revenue to date and the contractual rebate percentage to be paid. A portion of the cost of the rebate is allocated to each underlying sales transaction. Discounts, rebates, and slotting fees are included in the determination of net sales.
27
We also establish reserves for customer returns and allowances. The reserve is established based on historical rates of returns and allowances. The reserve is adjusted quarterly based on actual experience. Returns and allowances are included in the determination of net sales.
Our performance obligations under our arrangements with customers are providing products, in-store merchandising services, and access to key duplicating and engraving equipment. Generally, the price of the merchandising services and the access to the key duplicating and engraving equipment is included in the price of the related products. Control of products is transferred at the point in time when the customer accepts the goods. Judgment was required in applying the new revenue standard in determining the time at which to recognize revenue for the in-store services and the access to key duplicating and engraving equipment. Our obligation to provide in-store service and access to key duplicating and engraving equipment is satisfied when control of the related products is transferred. Therefore, consistent with the practice prior to the adoption of ASC 606, the entire amount of consideration related to the sale of products, in-store merchandising services, and access to key duplicating and engraving equipment is recognized upon the customer’s acceptance of the products. The revenues for all performance obligations are recognized upon the customer's acceptance of the products.
The costs to obtain a contract are insignificant, and generally contract terms do not extend beyond one year. Therefore, these costs are expensed as incurred. Freight and shipping costs and the cost of our in-store merchandising services teams are recognized in selling, general, and administrative expense when control over products is transferred to the customer.
We used the practical expedient regarding the existence of a significant financing component as payments are due in less than one year after delivery of the products.
See Note 2 - Summary of Significant Accounting Policies of the Notes to the Consolidated Financial statements for information on disaggregated revenue by product category.
Inventory Realization:
Inventories consisting predominantly of finished goods are valued at the lower of cost or net realizable value, cost being determined principally on the weighted average cost method. The historical usage rate is the primary factor used in assessing the net realizable value of excess and obsolete inventory. A reduction in the carrying value of an inventory item from cost to net realizable value is recorded for inventory with excess on-hand quantities as determined based on historic and projected sales, product category, and stage in the product life cycle. We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate our excess and obsolete inventory reserve. However, if our estimates regarding excess and obsolete inventory are inaccurate, we may be exposed to losses or gains that could be material. A 5% difference in actual excess and obsolete inventory reserved for at December 29, 2018, would have affected net earnings by approximately $1.4 million in fiscal 2018.
Goodwill:
We have adopted ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment which eliminates Step 2 from the goodwill impairment test and instead requires an entity to perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. If, after assessing the totality of events or circumstances, we determine that the fair value of a reporting unit is less than the carrying value, then we would recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to the reporting unit.
Our annual impairment assessment is performed for the reporting units as of October 1. In 2018, 2017, and 2016, an independent appraiser assessed the value of our reporting units based on a discounted cash flow model and multiple of earnings. Assumptions critical to our fair value estimates under the discounted cash flow model include the discount rate, projected average revenue growth and projected long-term growth rates in the determination of terminal values. The results of the quantitative assessments in 2018, 2017, and 2016 indicated that the fair value of each reporting unit was in excess of its carrying value.
Intangible Assets:
We evaluate our indefinite-lived intangible assets (primarily trademarks and trade names) for impairment annually or more frequently if events and circumstances indicate that it is more likely than not that the fair value of an indefinite-lived intangible asset is below its carrying amount. In connection with the evaluation, an independent appraiser assessed the fair value of our indefinite-lived intangible assets based on a relief from royalties, excess earnings, and lost profits discounted cash flow model. An impairment charge is recorded if the carrying amount of an indefinite-lived intangible asset exceeds the estimated fair value
28
on the measurement date. No impairment charges related to indefinite-lived intangible assets were recorded in 2018, 2017, or 2016 as a result of the quantitative annual impairment test.
Income Taxes:
Deferred income taxes are computed using the asset and liability method. Under this method, deferred income taxes are recognized for temporary differences between the financial reporting basis and income tax basis of assets and liabilities, based on enacted tax laws and statutory tax rates applicable to the periods in which the temporary differences are expected to reverse. Valuation allowances are provided for tax benefits where it is more likely than not that certain tax benefits will not be realized. Adjustments to valuation allowances are recorded for changes in utilization of the tax related item. For additional information, see Note 6 - Income Taxes, of the Notes to the Consolidated Financial Statements.
In accordance with guidance regarding the accounting for uncertainty in income taxes, we recognize a tax position if, based solely on its technical merits, it is more likely than not to be sustained upon examination by the relevant taxing authority.
If a tax position does not meet the more likely than not recognition threshold, we do not recognize the benefit of that position in our financial statements. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to be recognized in the financial statements.
Business Combinations:
As we enter into business combinations, we perform acquisition accounting requirements including the following:
•Identifying the acquirer
•Determining the acquisition date
•Recognizing and measuring the identifiable assets acquired and the liabilities assumed, and
•Recognizing and measuring goodwill or a gain from a bargain purchase
We complete valuation procedures and record the resulting fair value of the acquired assets and assumed liabilities based upon the valuation of the business enterprise and the tangible and intangible assets acquired. Enterprise value allocation methodology requires management to make assumptions and apply judgment to estimate the fair value of assets acquired and liabilities assumed. If estimates or assumptions used to complete the enterprise valuation and estimates of the fair value of the acquired assets and assumed liabilities significantly differed from assumptions made, the resulting difference could materially affect the fair value of net assets.
The calculation of the fair value of the tangible assets, including property, plant and equipment, utilizes the cost approach, which computes the cost to replace the asset, less accrued depreciation resulting from physical deterioration, functional obsolescence and external obsolescence. The calculation of the fair value of the identified intangible assets are determined using cash flow models following the income approach or a discounted market-based methodology approach. Significant inputs include estimated revenue growth rates, gross margins, operating expenses, and estimated attrition, royalty and discount rates. Goodwill is recorded as the difference in the fair value of the acquired assets and assumed liabilities and the purchase price.
Recent Accounting Pronouncements:
Recently issued accounting standards are described in Note 3 - Recent Accounting Pronouncements of the Notes to Consolidated Financial Statements.
Item 7A – Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Exposure
We are exposed to the impact of interest rate changes as borrowings under the Senior Facilities bear interest at variable interest rates. It is our policy to enter into interest rate swap and interest rate cap transactions only to the extent considered necessary to meet our objectives.
Based on our exposure to variable rate borrowings at December 29, 2018, after consideration of our LIBOR floor rate and interest rate swap agreements, a one percent (1%) change in the weighted average interest rate for a period of one year would change the annual interest expense by approximately $10.2 million.
Foreign Currency Exchange
29
We are exposed to foreign exchange rate changes of the Canadian and Mexican currencies as it impacts the $146.3 million tangible and intangible net asset value of our Canadian and Mexican subsidiaries as of December 29, 2018. The foreign subsidiaries net tangible assets were $81.8 million and the net intangible assets were $64.4 million as of December 29, 2018.
We utilize foreign exchange forward contracts to manage the exposure to currency fluctuations in the Canadian dollar versus the U.S. Dollar. See Note 12 - Derivatives and Hedging, of the Notes to the Consolidated Financial Statements.
Item 8 – Financial Statements and Supplementary Data.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULE
Page(s) |
|
Consolidated Financial Statements: |
|
Financial Statement Schedule: |
|
30
Report of Management on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of The Hillman Companies, Inc. and its consolidated subsidiaries; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of The Hillman Companies, Inc. and its consolidated subsidiaries are being made only in accordance with authorizations of management and directors of The Hillman Companies, Inc. and its consolidated subsidiaries, as appropriate; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the assets of The Hillman Companies, Inc. and its consolidated subsidiaries that could have a material effect on the consolidated financial statements.
Our management, with the participation of our principal executive officer and principal financial officer, assessed the effectiveness of our internal control over financial reporting as of December 29, 2018, the end of our fiscal year. Management based its assessment on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management's assessment included evaluation of such elements as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment. This assessment is supported by testing and monitoring performed under the direction of management.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluations of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Accordingly, even an effective system of internal control over financial reporting will provide only reasonable assurance with respect to financial statement preparation.
Based on its assessment, our management has concluded that our internal control over financial reporting was effective, as of December 29, 2018, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States. Management's assessment of and conclusion on the effectiveness of its internal control over financial reporting did not include the internal controls of MinuteKey and Big Time Products, the companies it acquired during fiscal 2018, which were included in the 2018 consolidated financial statements. These acquired companies constituted $547,408 thousand or 23% of the Company’s total assets as of December 29, 2018, and $74,032 thousand or 8% of total net revenues, for the year end December 29, 2018.We reviewed the results of management's assessment with the Audit Committee of The Hillman Companies, Inc.
This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only management's report in this annual report.
/s/ GREGORY J. GLUCHOWSKI, JR. |
/s/ ROBERT O. KRAFT |
|||
Gregory J. Gluchowski, Jr. |
Robert O. Kraft |
|||
President and Chief Executive Officer |
Chief Financial Officer |
|||
Dated: |
March 28, 2019 |
Dated: |
March 28, 2019 |
31
Report of Independent Registered Public Accounting Firm
The Stockholders and Board of Directors
The Hillman Companies, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of The Hillman Companies, Inc. and subsidiaries (the Company) as of December 29, 2018 and December 30, 2017, the related consolidated statements of comprehensive income (loss), stockholder’s equity, and cash flows for each of the years in the three‑year period ended December 29, 2018, and the related notes and financial statement schedule II - Valuation Accounts (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 29, 2018 and December 30, 2017, and the results of their operations and their cash flows for each of the years in the three‑year period ended December 29, 2018, in conformity with U.S. generally accepted accounting principles.
Change in Accounting Principle
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for revenue recognition on December 31, 2017 due to the modified retrospective adoption of ASU 2014-09, Revenue from Contracts with Customers (Topic 606).
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ KPMG LLP
We have served as the Company’s auditor since 2010.
Cincinnati, Ohio
March 28, 2019
32
THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
December 29, 2018 |
December 30, 2017 |
||||||
ASSETS |
|||||||
Current assets: |
|||||||
Cash and cash equivalents |
$ |
28,234 |
$ |
9,937 |
|||
Accounts receivable, net of allowances of $846 ($1,121 - 2017) |
110,799 |
78,994 |
|||||
Inventories, net |
320,281 |
219,479 |
|||||
Other current assets |
18,727 |
11,850 |
|||||
Total current assets |
478,041 |
320,260 |
|||||
Property and equipment, net of accumulated depreciation of $131,169 ($98,674 - 2017) |
208,279 |
153,143 |
|||||
Goodwill |
803,847 |
620,503 |
|||||
Other intangibles, net of accumulated amortization of $176,677 ($132,659 - 2017) |
930,525 |
693,195 |
|||||
Other assets |
10,778 |
12,116 |
|||||
Total assets |
$ |
2,431,470 |
$ |
1,799,217 |
|||
LIABILITIES AND STOCKHOLDERS' EQUITY |
|||||||
Current liabilities: |
|||||||
Accounts payable |
$ |
135,059 |
$ |
74,051 |
|||
Current portion of debt and capital lease obligations |
10,985 |
5,706 |
|||||
Accrued expenses: |
|||||||
Salaries and wages |
9,881 |
9,784 |
|||||
Pricing allowances |
5,404 |
5,908 |
|||||
Income and other taxes |
3,325 |
4,146 |
|||||
Interest |
15,423 |
9,717 |
|||||
Other accrued expenses |
17,941 |
19,911 |
|||||
Total current liabilities |
198,018 |
129,223 |
|||||
Long-term debt |
1,586,084 |
989,674 |
|||||
Deferred income taxes, net |
200,696 |
145,728 |
|||||
Other non-current liabilities |
7,565 |
7,189 |
|||||
Total liabilities |
1,992,363 |
1,271,814 |
|||||
Commitments and Contingencies (Note 15) |
— |
— |
|||||
Stockholder's Equity: |
|||||||
Preferred stock, $.01 par, 5,000 shares authorized, none issued and outstanding at December 29, 2018 and December 30, 2017 |
— |
— |
|||||
Common stock, $.01 par, 5,000 shares authorized, issued and outstanding at December 29, 2018 and December 30, 2017 |
— |
— |
|||||
Additional paid-in capital |
549,528 |
551,518 |
|||||
Retained earnings (accumulated deficit) |
(72,831 |
) |
2,422 |
||||
Accumulated other comprehensive loss |
(37,590 |
) |
(26,537 |
) |
|||
Total stockholder's equity |
439,107 |
527,403 |
|||||
Total liabilities and stockholder's equity |
$ |
2,431,470 |
$ |
1,799,217 |
The Notes to Consolidated Financial Statements are an integral part of these statements.
33
THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(dollars in thousands)
Year Ended December 29, 2018 |
Year Ended December 30, 2017 |
Year Ended December 31, 2016 |
|||||||||
Net sales |
$ |
974,175 |
$ |
838,368 |
$ |
814,908 |
|||||
Cost of sales (exclusive of depreciation and amortization shown separately below) |
537,885 |
455,717 |
438,418 |
||||||||
Selling, general and administrative expenses |
320,543 |
274,044 |
265,241 |
||||||||
Depreciation |
46,060 |
34,016 |
32,245 |
||||||||
Amortization |
44,572 |
38,109 |
37,905 |
||||||||
Management fees to related party |
546 |
519 |
550 |
||||||||
Other income |
(2,267 |
) |
(1,022 |
) |
(966 |
) |
|||||
Income from operations |
26,836 |
36,985 |
41,515 |
||||||||
Interest expense, net |
70,545 |
51,018 |
51,181 |
||||||||
Interest expense on junior subordinated debentures |
12,608 |
12,608 |
12,608 |
||||||||
Investment income on trust common securities |
(378 |
) |
(378 |
) |
(378 |
) |
|||||
Refinancing costs |
11,632 |
— |
— |
||||||||
Loss before income taxes |
(67,571 |
) |
(26,263 |
) |
(21,896 |
) |
|||||
Income tax expense (benefit) |
2,070 |
(84,911 |
) |
(7,690 |
) |
||||||
Net income (loss) |
$ |
(69,641 |
) |
$ |
58,648 |
$ |
(14,206 |
) |
|||
Net income (loss) from above |
$ |
(69,641 |
) |
$ |
58,648 |
$ |
(14,206 |
) |
|||
Other comprehensive income (loss): |
|||||||||||
Foreign currency translation adjustments |
(11,053 |
) |
7,845 |
808 |
|||||||
Total other comprehensive income (loss) |
(11,053 |
) |
7,845 |
808 |
|||||||
Comprehensive income (loss) |
$ |
(80,694 |
) |
$ |
66,493 |
$ |
(13,398 |
) |
The Notes to Consolidated Financial Statements are an integral part of these statements.
34
THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Year Ended December 29, 2018 |
Year Ended December 30, 2017 |
Year Ended December 31, 2016 |
|||||||||
Cash flows from operating activities: |
|||||||||||
Net income (loss) |
$ |
(69,641 |
) |
$ |
58,648 |
$ |
(14,206 |
) |
|||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: |
|||||||||||
Depreciation and amortization |
90,632 |
72,125 |
70,150 |
||||||||
(Gain) loss on dispositions of property and equipment |
(5,988 |
) |
1,140 |
364 |
|||||||
Impairment of long lived assets |
837 |
1,569 |
— |
||||||||
Deferred income taxes |
394 |
(85,874 |
) |
(8,076 |
) |
||||||
Deferred financing and original issue discount amortization |
2,455 |
2,530 |
2,627 |
||||||||
Loss on debt restructuring |
11,632 |
— |
— |
||||||||
Stock-based compensation expense |
1,590 |
2,484 |
2,280 |
||||||||
(Gain) loss on disposition of Australia assets |
— |
(638 |
) |
1,047 |
|||||||
Other non-cash interest and change in value of interest rate swap |
607 |
(1,481 |
) |
(706 |
) |
||||||
Changes in operating items: |
|||||||||||
Accounts receivable |
7,934 |
(2,777 |
) |
2,485 |
|||||||
Inventories |
(68,978 |
) |
13,800 |
23,668 |
|||||||
Other assets |
(1,496 |
) |
517 |
(2,697 |
) |
||||||
Accounts payable |
41,092 |
9,305 |
(2,280 |
) |
|||||||
Other accrued liabilities |
(3,523 |
) |
11,562 |
2,931 |
|||||||
Other items, net |
— |
— |
(94 |
) |
|||||||
Net cash provided by operating activities |
7,547 |
82,910 |
77,493 |
||||||||
Cash flows from investing activities: |
|||||||||||
Acquisitions of businesses, net of cash acquired |
(500,989 |
) |
(47,188 |
) |
— |
||||||
Capital expenditures |
(71,621 |
) |
(51,410 |
) |
(41,355 |
) |
|||||
Other investing activities |
— |
(1,500 |
) |
— |
|||||||
Net cash used for investing activities |
(572,610 |
) |
(100,098 |
) |
(41,355 |
) |
|||||
Cash flows from financing activities: |
|||||||||||
Borrowings on senior term loans, net of discount |
1,050,050 |
— |
— |
||||||||
Repayments of senior term loans |
(532,488 |
) |
(5,500 |
) |
(5,500 |
) |
|||||
Borrowings of revolving credit loans |
165,550 |
35,500 |
16,000 |
||||||||
Repayments of revolving credit loans |
(76,850 |
) |
(16,000 |
) |
(44,000 |
) |
|||||
Financing fees, net |
(20,520 |
) |
— |
— |
|||||||
Principal payments under capitalized lease obligations |
(235 |
) |
(124 |
) |
(215 |
) |
|||||
Dividend to Holdco |
(3,780 |
) |
— |
— |
|||||||
Proceeds from exercise of stock options |
200 |
— |
— |
||||||||
Proceeds from sale of Holdco stock |
— |
500 |
500 |
||||||||
Net cash provided by (used for) financing activities |
581,927 |
14,376 |
(33,215 |
) |
|||||||
Effect of exchange rate changes on cash |
1,433 |
(1,357 |
) |
(202 |
) |
||||||
Net increase (decrease) in cash and cash equivalents |
18,297 |
(4,169 |
) |
2,721 |
|||||||
Cash and cash equivalents at beginning of period |
9,937 |
14,106 |
11,385 |
||||||||
Cash and cash equivalents at end of period |
$ |
28,234 |
$ |
9,937 |
$ |
14,106 |
The Notes to Consolidated Financial Statements are an integral part of these statements.
35
THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(dollars in thousands)
Common
Stock
|
Additional
Paid-in
Capital
|
Retained Earnings (Accumulated Deficit) |
Accumulated
Other
Comprehensive
(Loss)
|
Total Stockholder's Equity |
|||||||||||||||
Balance at December 31, 2015 |
$ |
— |
$ |
545,754 |
$ |
(42,020 |
) |
$ |
(35,190 |
) |
$ |
468,544 |
|||||||
Net Loss |
— |
— |
(14,206 |
) |
— |
(14,206 |
) |
||||||||||||
Stock-based compensation |
— |
2,280 |
— |
— |
2,280 |
||||||||||||||
Proceeds from sale of Holdco shares of stock |
— |
500 |
— |
— |
500 |
||||||||||||||
Change in cumulative foreign currency translation adjustment |
— |
— |
— |
808 |
808 |
||||||||||||||
Balance at December 31, 2016 |
$ |
— |
$ |
548,534 |
$ |
(56,226 |
) |
$ |
(34,382 |
) |
$ |
457,926 |
|||||||
Net Income |
— |
— |
58,648 |
— |
58,648 |
||||||||||||||
Stock-based compensation |
— |
2,484 |
— |
— |
2,484 |
||||||||||||||
Proceeds from sale of Holdco shares of stock |
— |
500 |
— |
— |
500 |
||||||||||||||
Change in cumulative foreign currency translation adjustment |
— |
— |
— |
7,845 |
7,845 |
||||||||||||||
Balance at December 30, 2017 |
$ |
— |
$ |
551,518 |
$ |
2,422 |
$ |
(26,537 |
) |
$ |
527,403 |
||||||||
Net Loss |
— |
— |
(69,641 |
) |
— |
(69,641 |
) |
||||||||||||
Stock-based compensation |
— |
1,590 |
— |
— |
1,590 |
||||||||||||||
Proceeds from exercise of stock options |
— |
200 |
— |
— |
200 |
||||||||||||||
Dividend to Holdco |
— |
(3,780 |
) |
— |
— |
(3,780 |
) |
||||||||||||
Cumulative effect of change in accounting principles |
— |
— |
(5,612 |
) |
— |
(5,612 |
) |
||||||||||||
Change in cumulative foreign currency translation adjustment |
— |
— |
— |
(11,053 |
) |
(11,053 |
) |
||||||||||||
Balance at December 29, 2018 |
$ |
— |
$ |
549,528 |
$ |
(72,831 |
) |
$ |
(37,590 |
) |
$ |
439,107 |
The Notes to Consolidated Financial Statements are an integral part of these statements.
36
THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
1. Basis of Presentation:
The accompanying financial statements include the consolidated accounts of The Hillman Companies, Inc. and its wholly-owned subsidiaries (collectively “Hillman” or the “Company”). Unless the context requires otherwise, references to "Hillman," "we," "us," "our," or "our Company" refer to The Hillman Companies, Inc. and its wholly-owned subsidiaries. The consolidated financial statements included herein have been prepared in accordance with accounting standards generally accepted in the United States of America (U.S. GAAP) and include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated. References to 2018, 2017, and 2016 are for fiscal years ended December 29, 2018, December 30, 2017, and December 31, 2016, respectively.
We are a wholly-owned subsidiary of HMAN Group Holdings Inc. (“Holdco”). Affiliates of CCMP Capital Advisors, LLC (“CCMP”) own 80.5% of Holdco's outstanding common stock, affiliates of Oak Hill Capital Partners III, L.P., Oak Hill Capital Management Partners III, L.P. and OHCP III HC RO, L.P. (collectively “Oak Hill Funds”) own 17.0% of Holdco's outstanding common stock, and certain current and former members of management own 2.5% of Holdco's outstanding common stock.
Beginning with fiscal year 2017, the Company has changed from a calendar year ending on December 31 to a 52-53 week fiscal year ending on the last Saturday in December 2017, effective beginning with the first quarter of 2017. In a 52 week fiscal year, each of the Company’s quarterly periods will comprise 13 weeks. The additional week in a 53 week fiscal year is added to the fourth quarter, making such quarter consist of 14 weeks. The Company’s first 53 week fiscal year will occur in fiscal year 2022. The Company made the fiscal year change on a prospective basis and has not adjusted operating results for prior periods. The change does not materially impact the comparability of quarters or year ended 2018 to the quarters or years ended 2017 or 2016. The adoption of a 52-53 week year was not deemed a change in fiscal year for purposes of reporting subject to Rule 13a-10 or 15d-10; hence, no transition reports are required.
Nature of Operations:
The Company is comprised of three separate business segments, operating United States, Canada, and Mexico. In prior years, the Company had operations in Australia under the name The Hillman Group Australia Pty. Ltd. In the year ended December 31, 2016, the Company decided to exit the Australia market following the withdrawal from Australia of a key customer and recorded charges of $1,047 related to the write-off of inventory and other assets. In the year ended December 30, 2017, the Company fully liquidated its Australian subsidiary and reclassified the cumulative translation adjustment to income. The $638 gain was recorded as other income on the Consolidated Statement of Comprehensive Income (Loss) in year ended December 30, 2017.
Hillman Group provides and, on a limited basis, produces products such as fasteners and related hardware items; threaded rod and metal shapes; keys, key duplication systems, and accessories; personal protective equipment such as gloves and eye-wear; builder's hardware; and identification items, such as tags and letters, numbers, and signs, to retail outlets, primarily hardware stores, home centers and mass merchants, pet supply stores, grocery stores, and drug stores. The Canada segment also produces fasteners, stampings, fittings, and processes threaded parts for automotive suppliers, industrial Original Equipment Manufacturers (“OEMs”), and industrial distributors.
On November 8, 2017, the Company entered into an Asset Purchase Agreement with Hargis Industries, LP doing business as ST Fastening Systems ("STFS") and other related parties, pursuant to which Hillman acquired substantially all of the assets, and assumed certain liabilities, of ST Fastening Systems. ST Fastening Systems, which is located in Tyler, Texas, specializes in manufacturing and distributing threaded self-drilling fasteners, foam closure strips, and other accessories to the steel-frame, post-frame, and residential building markets. Pursuant to the terms of the Agreement, the Company paid a purchase price of $47,339 which reflects finalized purchase accounting adjustments for the ST Fastening Systems acquisition as of fiscal year-end 2018. The ST Fastening Systems business is included in the Company’s United States reportable segment. See Note 5 - Acquisitions for additional information.
On August 10, 2018, the Company completed the acquisition of Minute Key Holdings, Inc. ("MinuteKey"), an innovative leader in self-service key duplicating kiosks for a total consideration of $156,289. MinuteKey has existing operations in the United States and Canada and be included in Hillman's United States and Canada reportable segments. See Note 5 - Acquisitions for additional information.
37
THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
On October 1, 2018, the Company completed the acquisition of Big Time Products ("Big Time"), a leading provider of personal protection and work gear products ranging from work gloves, tool belts and jobsite storage, for total consideration of $348,834. Big Time has existing operations throughout North America and its operating results reside within the Company's United States, Canada and Mexico reportable segments. See Note 5 - Acquisitions for additional information.
2. Summary of Significant Accounting Policies:
Cash and Cash Equivalents:
Cash and cash equivalents consist of commercial paper, U.S. Treasury obligations, and other liquid securities purchased with initial maturities less than 90 days and are stated at cost which approximates fair value. The Company has foreign bank balances of approximately $6,943 and $6,035 at December 29, 2018 and December 30, 2017, respectively. The Company maintains cash and cash equivalent balances with financial institutions that exceed federally insured limits. The Company has not experienced any losses related to these balances. Management believes its credit risk is minimal.
Restricted Investments:
The Company's restricted investments are trading securities carried at fair market value which represent assets held in a Rabbi Trust to fund deferred compensation liabilities owed to the Company's employees. See Note 9 - Deferred Compensation Plan.
Accounts Receivable and Allowance for Doubtful Accounts:
The Company establishes the allowance for doubtful accounts using the specific identification method and also provides a reserve in the aggregate. The estimates for calculating the aggregate reserve are based on historical collection experience. Increases to the allowance for doubtful accounts result in a corresponding expense. The Company writes off individual accounts receivable when collection becomes improbable. The allowance for doubtful accounts was $846 and $1,121 as of December 29, 2018 and December 30, 2017, respectively.
In the years ended December 29, 2018 and December 30, 2017, the Company entered into agreements to sell, on an ongoing basis and without recourse, certain trade accounts receivable. The buyer is responsible for servicing the receivables. The sale of the receivables is accounted for in accordance with Financial Accounting Standards Board (“FASB”) ASC 860, Transfers and Servicing. Under that guidance, receivables are considered sold when they are transferred beyond the reach of the Company and its creditors, the purchaser has the right to pledge or exchange the receivables, and the Company has surrendered control over the transferred receivables. The Company has received proceeds from the sales of trade accounts receivable of approximately $215,833 and $214,527 for the years ended December 29, 2018 and December 30, 2017, respectively, and has included the proceeds in net cash provided by operating activities in the consolidated statements of cash flows. Related to the sale of accounts receivable, the Company recorded losses of approximately $2,233 and $1,426 for the years ended December 29, 2018 and December 30, 2017, respectively.
Inventories:
Inventories consisting predominantly of finished goods are valued at the lower of cost or net realizable value, cost being determined principally on the weighted average cost method. The historical usage rate is the primary factor used in assessing the net realizable value of excess and obsolete inventory. A reduction in the carrying value of an inventory item from cost to net realizable value is recorded for inventory with excess on-hand quantities as determined based on historic and projected sales, product category, and stage in the product life cycle.
Property and Equipment:
Property and equipment are carried at cost and include expenditures for new facilities and major renewals. Capital leases are recorded at the present value of minimum lease payments. For financial accounting purposes, depreciation is computed on the straight-line method over the estimated useful lives of the assets, generally two to 25 years. Assets acquired under capital leases are depreciated over the terms of the related leases. Maintenance and repairs are charged to expense as incurred. The Company capitalizes certain costs that are directly associated with the development of internally developed software, representing the historical cost of these assets. Once the software is completed and placed into service, such costs are amortized over the estimated useful lives. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and the resulting gain or loss is reflected in income (loss) from operations.
38
THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
Property and equipment, net, consists of the following at December 29, 2018 and December 30, 2017:
Estimated
Useful Life
|
|||||||||
(Years) |
2018 |
2017 |
|||||||
Land |
n/a |
$ |
20 |
$ |
1,117 |
||||
Buildings |
25 |
341 |
1,976 |
||||||
Leasehold improvements |
3-13 |
8,273 |
6,530 |
||||||
Machinery and equipment |
2-10 |
271,061 |
190,209 |
||||||
Computer equipment and software |
2-5 |
53,471 |
41,345 |
||||||
Furniture and fixtures |
6-8 |
2,629 |
1,671 |
||||||
Construction in process |
3,653 |
8,969 |
|||||||
Property and equipment, gross |
339,448 |
251,817 |
|||||||
Less: Accumulated depreciation |
131,169 |
98,674 |
|||||||
Property and equipment, net |
$ |
208,279 |
$ |
153,143 |
Goodwill:
The Company has adopted ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which eliminates Step 2 from the goodwill impairment test and instead requires an entity to perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. If, after assessing the totality of events or circumstances, we determine that the fair value of a reporting unit is less than the carrying value, then we would recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to the reporting unit.
The Company’s annual impairment assessment is performed for its reporting units as of October 1. An independent appraiser assessed the value of the reporting units based on a discounted cash flow model and multiple of earnings. Assumptions critical to our fair value estimates under the discounted cash flow model include the discount rate, projected average revenue growth and projected long-term growth rates in the determination of terminal values. The results of the quantitative assessment in 2018, 2017, and 2016 indicated that the fair value of each reporting unit was in excess of its carrying value.
No impairment charges were recorded in the years ended December 29, 2018, December 30, 2017, or December 31, 2016.
Goodwill amounts by reporting unit are summarized as follows:
Goodwill at |
Goodwill at |
||||||||||||||||||
December 30, 2017 |
Acquisitions(1)
|
Dispositions |
Other(2)
|
December 29, 2018 |
|||||||||||||||
United States (excl. recent acquisitions) |
$ |
577,556 |
$ |
— |
$ |
— |
$ |
— |
$ |
577,556 |
|||||||||
ST Fastening Systems |
8,881 |
— |
— |
164 |
9,045 |
||||||||||||||
MinuteKey |
— |
58,289 |
— |
— |
58,289 |
||||||||||||||
Big Time Products |
— |
127,323 |
— |
— |
127,323 |
||||||||||||||
Canada (excl. recent acquisitions) |
30,372 |
— |
— |
(2,434 |
) |
27,938 |
|||||||||||||
MinuteKey Canada |
— |
— |
— |
— |
— |
||||||||||||||
Big Time Products Canada |
— |
— |
— |
— |
— |
||||||||||||||
Mexico (excl. recent acquisitions) |
3,694 |
— |
— |
2 |
3,696 |
||||||||||||||
Big Time Products Mexico |
— |
— |
— |
— |
— |
||||||||||||||
Total |
$ |
620,503 |
$ |
185,612 |
$ |
— |
$ |
(2,268 |
) |
$ |
803,847 |
(1) |
See Note 5 - Acquisitions for additional information regarding the MinuteKEY and Big Time Products acquisitions.
|
(2) |
The "Other" change to goodwill relates to adjustments resulting from fluctuations in foreign currency exchange rates for the Canada and Mexico reporting units and adjustments to the opening balance sheet for the acquisition of ST Fastening Systems ("STFS"). STFS was acquired in the fourth quarter of 2017. |
39
THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
Intangible Assets:
Intangible assets are stated at the lower of cost or fair value. With the exception of certain trade names, intangible assets are amortized on a straight-line basis over periods ranging from 5 to 20 years, representing the period over which we expect to receive future economic benefits from these assets.
Other intangibles, net, as of December 29, 2018 and December 30, 2017 consist of the following:
Estimated |
|||||||||
Useful Life
(Years)
|
December 29, 2018 |
December 30, 2017 |
|||||||
Customer relationships |
13-20 |
$ |
939,880 |
$ |
703,399 |
||||
Trademarks - Indefinite |
Indefinite |
85,228 |
85,759 |
||||||
Trademarks - Other |
5-15 |
26,700 |
300 |
||||||
Technology and patents |
7-12 |
55,394 |
36,396 |
||||||
Intangible assets, gross |
1,107,202 |
825,854 |
|||||||
Less: Accumulated amortization |
176,677 |
132,659 |
|||||||
Intangible assets, net |
$ |
930,525 |
$ |
693,195 |
Estimated annual amortization expense for intangible assets subject to amortization at December 29, 2018 for the next five fiscal years is as follows:
Fiscal Year Ended |
Amortization Expense |
||
2019 |
$ |
58,706 |
|
2020 |
$ |
58,676 |
|
2021 |
$ |
58,359 |
|
2022 |
$ |
58,042 |
|
2023 |
$ |
58,042 |
The Company also evaluates indefinite-lived intangible assets (primarily trademarks and trade names) for impairment annually or more frequently if events and circumstances indicate that it is more likely than not that the fair value of an indefinite-lived intangible asset is below its carrying amount. In connection with the evaluation, an independent appraiser assessed the fair value of our indefinite-lived intangible assets based on a relief from royalties, excess earnings, and lost profits discounted cash flow model. An impairment charge is recorded if the carrying amount of an indefinite-lived intangible asset exceeds the estimated fair value on the measurement date. No impairment charges related to indefinite-lived intangible assets were recorded by the Company in 2018, 2017, or 2016 as a result of the quantitative annual impairment test.
Long-Lived Assets:
The Company evaluates its long-lived assets, including definite-lived intangibles assets, for impairment including an evaluation based on the estimated undiscounted future cash flows as events or changes in circumstances indicate that the carrying amount of such assets may not be fully recoverable. In the year ended December 29, 2018, the Company recorded an impairment charge of $837 related to exiting certain lines of business recorded within other income/expense on the Consolidated Statements of Comprehensive Income. See Note 14 - Restructuring of Notes to the Consolidated Financial Statements for more details. In the year ended December 30, 2017, the Company recorded an impairment charge of $1,569 related to the exit of a pilot program in the kiosk business in our U.S. operating segment. The charge was recorded to other income/expense in the statement of comprehensive income. No impairment charges were recognized for long-lived assets in the fiscal year ended December 31, 2016.
Income Taxes:
40
THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
Deferred income taxes are computed using the asset and liability method. Under this method, deferred income taxes are recognized for temporary differences between the financial reporting basis and income tax basis of assets and liabilities, based on enacted tax laws and statutory tax rates applicable to the periods in which the temporary differences are expected to reverse. Valuation allowances are provided for tax benefits where management estimates it is more likely than not that certain tax benefits will not be realized. Adjustments to valuation allowances are recorded for changes in utilization of the tax related item. See Note 6 - Income Taxes for additional information.
In accordance with guidance regarding the accounting for uncertainty in income taxes, the Company recognizes a tax position if, based solely on its technical merits, it is more likely than not to be sustained upon examination by the relevant taxing authority. If a tax position does not meet the more likely than not recognition threshold, the Company does not recognize the benefit of that position in its consolidated financial statements. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to be recognized in the consolidated financial statements.
Risk Insurance Reserves:
The Company self-insures our product liability, automotive, workers' compensation, and general liability losses up to $250 per occurrence. Our policy is to estimate reserves based upon a number of factors, including known claims, estimated incurred but not reported claims, and outside actuarial analysis. The outside actuarial analysis is based on historical information along with certain assumptions about future events. These reserves are classified as other current and other long-term liabilities within the balance sheets.
The Company self-insures our group health claims up to an annual stop loss limit of $250 per participant. Historical group insurance loss experience forms the basis for the recognition of group health insurance reserves.
Retirement Benefits:
Certain employees of the Company are covered under a profit-sharing and retirement savings plan. The plan provides for a matching contribution for eligible employees of 50% of each dollar contributed by the employee up to 6% of the employee's compensation. In addition, the plan provides an annual contribution in amounts authorized by the Board of Directors, subject to the terms and conditions of the plan.
Hillman Canada sponsors a Deferred Profit Sharing Plan (“DPSP”) and a Group Registered Retirement Savings Plan (“RRSP”) for all qualified, full-time employees, with at least three months of continuous service. DPSP is an employer-sponsored profit sharing plan registered as a trust with the Canada Revenue Agency (“CRA”). On a periodic basis, Hillman Canada shares business profits with employees by contributing to the DPSP on each employee's behalf. Employees do not contribute to the DPSP. There is no minimum required contribution; however, DPSPs are subject to maximum contribution limits set by the CRA. The DPSP is offered in conjunction with a RRSP. All eligible employees may contribute an additional voluntary amount of up to eight percent of the employee's gross earnings. Hillman Canada is required to match 100% of all employee contributions up to 2% of the employee's compensation. The assets of the RRSP are held separately from those of Hillman Canada in independently administered funds.
Retirement benefit costs were $2,567, $2,222, and $2,101 in the years ended December 29, 2018, December 30, 2017, and December 31, 2016, respectively.
Revenue Recognition:
Revenue is recognized when control of goods or services is transferred to our customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. Sales and other taxes the Company collects concurrent with revenue-producing activities are excluded from revenue.
The Company offers a variety of sales incentives to its customers primarily in the form of discounts and rebates. Discounts are recognized in the consolidated financial statements at the date of the related sale. Rebates are based on the revenue to date and the contractual rebate percentage to be paid. A portion of the cost of the rebate is allocated to each underlying sales transaction. Discounts and rebate are included in the determination of net sales.
41
THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
The Company also establishes reserves for customer returns and allowances. The reserve is established based on historical rates of returns and allowances. The reserve is adjusted quarterly based on actual experience. Returns and allowances are included in the determination of net sales.
The following table disaggregates our revenue by product category.
Fastening Solutions |
Home and Access Solutions |
Consumer Connected Solutions |
Personal Protective Solutions |
Total Revenue |
||||||
Year Ended December 29, 2018 |
||||||||||
United States |
437,164 |
251,749 |
80,424 |
52,749 |
822,086 |
|||||
Canada |
109,893 |
31,509 |
518 |
1,945 |
143,865 |
|||||
Other |
6,539 |
932 |
— |
753 |
8,224 |
|||||
Consolidated |
553,596 |
284,190 |
80,942 |
55,447 |
974,175 |
|||||
Year Ended December 30, 2017 |
||||||||||
United States |
380,299 |
247,164 |
66,136 |
— |
693,599 |
|||||
Canada |
106,689 |
31,099 |
12 |
— |
137,800 |
|||||
Other |
5,936 |
1,033 |
— |
— |
6,969 |
|||||
Consolidated |
492,924 |
279,296 |
66,148 |
— |
838,368 |
|||||
Year Ended December 31, 2016 |
||||||||||
United States |
372,981 |
241,166 |
63,379 |
— |
677,526 |
|||||
Canada |
103,539 |
26,703 |
13 |
— |
130,255 |
|||||
Other |
6,068 |
1,059 |
— |
— |
7,127 |
|||||
Consolidated |
482,588 |
268,928 |
63,392 |
— |
814,908 |
Fastening solutions revenues consist primarily of the delivery of fasteners, anchors, and specialty products as well as in-store merchandising services for the related product category.
Home and access solutions revenues consist primarily of the delivery of keys and key accessories, builders’ hardware, wall hanging, threaded rod products, letters, numbers, and signs (“LNS”) as well as in-store merchandising services for the related product categories and access to our proprietary key duplicating equipment.
Consumer connected solutions revenues consist primarily of sales of keys and identification tags through self service key duplication and engraving kiosks.
Personal protective solutions revenues consist primarily of the delivery of personal protective equipments such as gloves and eye-wear as well as in-store merchandising services for the related product category.
The Company’s performance obligations under its arrangements with customers are providing products, in-store merchandising services, and access to key duplicating and engraving equipment. Generally, the price of the merchandising services and the access to the key duplicating and engraving equipment is included in the price of the related products. Control of products is transferred at the point in time when the customer accepts the goods. Judgment was required in applying the new revenue standard in determining the time at which to recognize revenue for the in-store services and the access to key duplicating and engraving equipment. The Company’s obligation to provide in-store service and access to key duplicating and engraving equipment is satisfied when control of the related products is transferred. Therefore, consistent with the practice prior to the adoption of ASC 606, the entire amount of consideration related to the sale of products, in-store merchandising services, and access to key duplicating and engraving equipment is recognized upon the customer’s acceptance of the products. The revenues for all performance obligations are recognized upon the customer's acceptance of the products.
42
THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
The costs to obtain a contract are insignificant, and generally contract terms do not extend beyond one year. Therefore, these costs are expensed as incurred. Freight and shipping costs and the cost of our in-store merchandising services teams are recognized in selling, general, and administrative expense when control over products is transferred to the customer.
The Company used the practical expedient regarding the existence of a significant financing component as payments are due in less than one year after delivery of the products.
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 consolidated statements of comprehensive income (loss).
Shipping and handling costs were $42,458, $39,205, and $36,283 in the years ended December 29, 2018, December 30, 2017, and December 31, 2016, respectively.
Research and Development:
The Company expenses research and development costs consisting primarily of internal wages and benefits in connection with improvements to the Company's fastening product lines along with the key duplicating and engraving machines. The Company's research and development costs were $2,181, $2,216, and $2,277 in the years ended December 29, 2018, December 30, 2017, and December 31, 2016, respectively.
Common Stock:
The Hillman Companies, Inc. has one class of common stock. All outstanding shares of The Hillman Companies, Inc. common stock are owned by Holdco. The management shareholders of Holdco do not have the ability to put their shares back to Holdco.
Stock Based Compensation:
The Company has a stock-based employee compensation plan pursuant to which Holdco may grant options, stock appreciation rights, restricted stock, and other stock-based awards. Hillman reflects the options granted by HoldCo in its stand-alone consolidated financial statements in accordance with ASC 718. The Company uses a Black-Scholes option pricing model to determine the fair value of stock options on the dates of grant. The Black-Scholes pricing model requires various assumptions, including expected term, which is based on our historical experience and expected volatility which is estimated based on the average historical volatility of similar entities with publicly traded shares. The Company also makes assumptions regarding the risk-free interest rate and the expected dividend yield. The risk-free interest rate is based on the U.S. Treasury interest rate whose term is consistent with the expected term of the share-based award. The dividend yield on our common stock is assumed to be zero since we do not pay dividends and have no current plans to do so in the future. Determining the fair value of stock options at the grant date requires judgment, including estimates for the expected life of the share-based award, stock price volatility, dividend yield, and interest rate. These assumptions may differ significantly between grant dates because of changes in the actual results of these inputs that occur over time.
Stock-based compensation expense is recognized using a fair value based recognition method. Stock-based compensation cost is estimated at the grant date based on the fair value of the award and is recognized as expense over the requisite vesting period or performance period of the award on a straight-line basis. The stock-based compensation expense is recorded in general and administrative expenses. The plan is more fully described in Note 11 - Stock Based Compensation.
Fair Value of Financial Instruments:
The Company uses the accounting guidance that applies to all assets and liabilities that are being measured and reported on a fair value basis. The guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy requires an entity to maximize the use of observable inputs, where available, and minimize the use of unobservable inputs when measuring fair value. Whenever possible, quoted prices in active markets are used to determine the fair value of the Company's financial instruments.
43
THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
Derivatives and Hedging:
The Company uses derivative financial instruments to manage its exposures to (1) interest rate fluctuations on its floating rate senior debt and (2) fluctuations in foreign currency exchange rates. The Company measures those instruments at fair value and recognizes 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. The Company enters into derivative instrument transactions with financial institutions acting as the counter-party. The Company does not enter into derivative transactions for speculative purposes and, therefore, holds no derivative instruments for trading purposes.
The relationships between hedging instruments and hedged items are formally documented, in addition to the risk management objective and strategy for each hedge transaction. For interest rate swaps, the notional amounts, rates, and maturities of our interest rate swaps are closely matched to the related terms of hedged debt obligations. The critical terms of the interest rate swap are matched to the critical terms of the underlying hedged item to determine whether the derivatives used for hedging transactions are highly effective in offsetting changes in the cash flows of the underlying hedged item. If it is determined that a derivative ceases to be a highly effective hedge, the hedge accounting is discontinued and all subsequent derivative gains and losses are recognized in the statement of comprehensive income or loss.
Derivative instruments designated in hedging relationships that mitigate exposure to the variability in future cash flows of the variable-rate debt and foreign currency exchange rates are considered cash flow hedges. The Company records all derivative instruments in other assets or other liabilities on the consolidated balance sheets at their fair values. If the derivative is designated as a cash flow hedge and the hedging relationship qualifies for hedge accounting, the effective portion of the change in the fair value of the derivative is recorded in other comprehensive income or loss. The change in fair value for instruments not qualifying for hedge accounting are recognized in the statement of comprehensive income or loss in the period of the change. See Note 12 - Derivatives and Hedging.
Translation of Foreign Currencies:
The translation of the Company's Canadian