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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

Commission file number 1-13293

The Hillman Companies, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware		23-2874736
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

10590 Hamilton Avenue Cincinnati, Ohio		45231
(Address of principal executive offices)		(Zip Code)

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

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

 

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    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  x    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting 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		¨

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

On August 14, 2014, 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 symbol HLM.Pr.

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

INDEX

 

				PAGE(S)
PART I. FINANCIAL INFORMATION
Item 1.		Condensed Consolidated Financial Statements (Unaudited)
		Condensed Consolidated Balance Sheets			3-4
		Condensed Consolidated Statements of Comprehensive Loss			5-6
		Condensed Consolidated Statements of Cash Flows			7
		Condensed Consolidated Statement of Stockholders’ Equity			8
		Notes to Condensed Consolidated Financial Statements			9-29
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			30-44
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			45
Item 4.		Controls and Procedures			45
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings			46
Item 1A.		Risk Factors			46-55
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			55
Item 3.		Defaults upon Senior Securities			55
Item 4.		Mine Safety Disclosures			55
Item 5.		Other Information			55
Item 6.		Exhibits			56
SIGNATURES					57

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(dollars in thousands)

 

		Successor						Predecessor
		June 30, 2014						December 31, 2013
ASSETS
Current assets:
Cash and cash equivalents		$	28,695					$	34,969
Restricted investments			280						2,856
Accounts receivable, net			113,030						87,515
Inventories, net			195,316						177,580
Deferred income taxes			10,269						11,096
Other current assets			11,701						9,082
Total current assets			359,291						323,098
Property and equipment, net			94,794						95,818
Goodwill			789,072						466,227
Other intangibles, net			572,500						362,365
Restricted investments			1,718						1,530
Deferred financing fees, net			26,355						9,798
Investment in trust common securities			3,261						3,261
Other assets			1,764						2,759
Total assets		$	1,848,755					$	1,264,856
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	65,009					$	44,369
Current portion of senior term loans			5,500						3,968
Current portion of capitalized lease and other obligations			263						219
Interest payable on junior subordinated debentures			1,019						—
Accrued expenses:
Salaries and wages			27,055						11,864
Pricing allowances			6,027						6,210
Income and other taxes			4,385						3,121
Interest			—						2,674
Deferred compensation			280						2,856
Other accrued expenses			10,449						9,031
Total current liabilities			119,987						84,312
Long term senior term loans			544,500						377,641
Bank revolving credit			16,000						—
Long term capitalized lease and other obligations			451						337
Long term senior notes			330,000						271,750
Junior subordinated debentures			131,141						114,941
Deferred compensation			1,718						1,530
Deferred income taxes			174,602						120,060
Other non-current liabilities			3,217						15,391
Total liabilities			1,321,616						985,962

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(dollars in thousands)

 

		Successor						Predecessor
LIABILITIES AND STOCKHOLDERS’ EQUITY (CONTINUED)		June 30, 2014						December 31, 2013
Common stock with put options:
Common stock, $.01 par, 5,000 shares authorized, None issued and outstanding at June 30, 2014 and 161.2 issued and outstanding at December 31, 2013			—						16,975
Commitments and contingencies (Note 6)
Stockholders’ Equity:
Preferred Stock:
Preferred stock, $.01 par, 5,000 shares authorized, none issued or outstanding at June 30, 2014 and at December 31, 2013			—						—
Common Stock:
Common stock, $.01 par, 5,000 shares authorized, issued and outstanding at June 30, 2014 and 4,838.8 issued and outstanding at December 31, 2013			—						—
Additional paid-in capital			542,929						292,989
Accumulated deficit			(15,790	)					(26,199	)
Accumulated other comprehensive loss			—						(4,871	)
Total stockholders’ equity			527,139						261,919
Total liabilities and stockholders’ equity		$	1,848,755					$	1,264,856

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (Unaudited)

(dollars in thousands)

 

		Successor						Predecessor
		One Day Ended June 30, 2014						Three Months Ended June  29, 2014				Three Months Ended June  30, 2013
Net sales		$	—					$	202,598			$	192,711
Cost of sales (exclusive of depreciation and amortization shown separately below)			—						103,927				100,338
Selling, general and administrative expenses			—						100,919				59,783
Transaction, acquisition and integration expenses			22,018						31,681				2,153
Depreciation			—						7,281				6,273
Amortization			—						5,549				5,559
Management fees to related party			—						15				—
Other expense			—						211				1,032
(Loss) income from operations			(22,018	)					(46,985	)			17,573
Interest expense, net			—						11,605				12,102
Interest expense on junior subordinated debentures			—						3,153				3,153
Investment income on trust common securities			—						(94	)			(95	)
(Loss) income before income taxes			(22,018	)					(61,649	)			2,413
Income tax benefit			(6,228	)					(21,185	)			(2,250	)
Net (loss) income		$	(15,790	)				$	(40,464	)		$	4,663
Net (loss) income (from above)		$	(15,790	)				$	(40,464	)		$	4,663
Other comprehensive income (loss):
Foreign currency translation adjustments			—						3,952				(4,133	)
Total other comprehensive income (loss)			—						3,952				(4,133	)
Comprehensive (loss) income		$	(15,790	)				$	(36,512	)		$	530

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (Unaudited)

(dollars in thousands)

 

		Successor						Predecessor
		One Day Ended June 30, 2014						Six Months Ended June 29, 2014				Six Months Ended June 30, 2013
Net sales		$	—					$	357,377			$	336,630
Cost of sales (exclusive of depreciation and amortization shown separately below)			—						183,342				173,984
Selling, general and administrative expenses			—						156,762				108,152
Transaction, acquisition and integration expenses			22,018						31,681				4,182
Depreciation			—						14,149				11,815
Amortization			—						11,093				11,005
Management fees to related party			—						15				—
Other (income) expense			—						(277	)			2,135
(Loss) income from operations			(22,018	)					(39,388	)			25,357
Interest expense, net			—						23,150				24,055
Interest expense on junior subordinated debentures			—						6,305				6,305
Investment income on trust common securities			—						(189	)			(189	)
Loss before income taxes			(22,018	)					(68,654	)			(4,814	)
Income tax benefit			(6,228	)					(24,128	)			(4,892	)
Net (loss) income		$	(15,790	)				$	(44,526	)		$	78
Net (loss) income (from above)		$	(15,790	)				$	(44,526	)		$	78
Other comprehensive (loss):
Foreign currency translation adjustments			—						(95	)			(4,213	)
Total other comprehensive (loss)			—						(95	)			(4,213	)
Comprehensive loss		$	(15,790	)				$	(44,621	)		$	(4,135	)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

 

		Successor						Predecessor
		One Day Ended June 30, 2014						Six Months Ended June 29, 2014				Six Months Ended June 30, 2013
Cash flows from operating activities:
Net (loss) income		$	(15,790	)				$	(44,526	)		$	78
Adjustments to reconcile net (loss) income to net cash provided by (used for) operating activities:
Depreciation and amortization			—						25,242				22,820
Dispositions of property and equipment			—						—				39
Deferred income tax benefit			(6,228	)					(24,458	)			(6,867	)
Deferred financing and original issue discount amortization			—						1,374				1,223
Stock-based compensation expense			—						39,229				4,840
Other non-cash interest and change in value of interest rate swap			—						—				(418	)
Changes in operating items:
Accounts receivable			—						(25,267	)			(25,597	)
Inventories			—						(17,851	)			(4,419	)
Other assets			(2,321	)					8,799				(1,690	)
Accounts payable			—						20,811				7,958
Interest payable on junior subordinated debentures			—						1,019				1,019
Other accrued liabilities			(13,792	)					31,183				(1,798	)
Other items, net			(2,026	)					(3,843	)			6,653
Net cash (used for) provided by operating activities			(40,157	)					11,712				3,841
Cash flows from investing activities:
Paulin acquisition			—						—				(103,416	)
Purchase of predecessor equity securities			(727,345	)					—				—
Capital expenditures			—						(12,933	)			(14,611	)
Net cash used for investing activities			(727,345	)					(12,933	)			(118,027	)
Cash flows from financing activities:
Borrowings of senior term loans			550,000						—				76,800
Repayments of senior term loans			(384,407	)					(992	)			(1,792	)
Discount on senior term loans			—						—				(2,152	)
Borrowings on revolving credit loans			16,000						—				—
Principal payments under capitalized lease obligations			—						(84	)			(41	)
Borrowings of senior notes			330,000						—				—
Repayment of senior notes			(265,000	)					—				—
Proceeds from exercise of stock options			—						474				—
Proceeds from sale of successor equity securities			542,929						—				—
Financing fees, net			(26,355	)					—				—
Repayments of other credit obligations			—						—				(456	)
Net cash provided by (used for) financing activities			763,167						(602	)			72,359
Effect of exchange rate changes on cash			—						(116	)			(2,806	)
Net decrease in cash and cash equivalents			(4,335	)					(1,939	)			(44,633	)
Cash and cash equivalents at beginning of period			33,030						34,969				65,548
Cash and cash equivalents at end of period		$	28,695					$	33,030			$	20,915
Supplemental schedule of noncash activities:
Fixed assets acquired under capital lease		$	—					$	241			$	202

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (Unaudited)

(dollars in thousands)

 

		Common Stock				Additional Paid-in Capital				Accumulated Deficit				Accumulated Other Comprehensive Loss				Total Stockholders’ Equity
Balance at December 31, 2013 - Predecessor		$	—			$	292,989			$	(26,199	)		$	(4,871	)		$	261,919
Net loss			—				—				(44,526	)			—				(44,526	)
FMV adjustment to common stock with put options (1)			—				(4,876	)			—				—				(4,876	)
Exercise of stock options			—				804				—				—				804
Change in cumulative foreign currency translation adjustment (2)			—				—				—				(95	)			(95	)
Balance at June 29, 2014 - Predecessor			—				288,917				(70,725	)			(4,966	)			213,226
Close Predecessor’s stockholders’ equity at merger date			—				(288,917	)			70,725				4,966				(213,226	)
Issue 5,000 shares of common stock			—				542,929				—				—				542,929
Net loss (3)			—				—				(15,790	)			—				(15,790	)
Balance at June 30, 2014 - Successor		$	—			$	542,929			$	(15,790	)		$	—			$	527,139

 

(1)

Management of the Predecessor Company controlled 161.2 shares of common stock at December 31, 2013. These shares contained a put feature that allowed redemption at the holder’s option. Prior to the June 30, 2014 Merger Transaction, these shares were classified as temporary equity and adjusted to fair value.

(2)	The cumulative foreign translation adjustment is the only item of other comprehensive loss.

(3)	The net loss in the Successor period ended June 30, 2014 consists of transaction costs related to the Merger Transaction.

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands)

 

1.	Basis of Presentation:

The accompanying financial statements include the condensed consolidated accounts of The Hillman Companies, Inc. (“Hillman Companies”) and its wholly-owned subsidiaries (collectively “Hillman” or the “Company”). All significant intercompany balances and transactions have been eliminated.

On June 30, 2014, affiliates of CCMP Capital Advisors, LLC (“CCMP”) and Oak Hill Capital Partners (“OHCP”), 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”). The total consideration paid in the Merger Transaction was approximately $1,502,227 including repayment of outstanding debt and including the value of the Company’s outstanding junior subordinated debentures ($105,443 liquidation value at the time of the Merger Transaction). The merger consideration is subject to certain post-closing working capital and other adjustments.

Prior to the Merger Transaction, affiliates of OHCP owned 95.6% of the Predecessor Holdco’s outstanding common stock and certain current and former members of management owned 4.4% of the Predecessor Holdco’s outstanding common stock. Upon consummation of the Merger Transaction, affiliates of CCMP owned 80.4% of the Successor Holdco’s outstanding common stock, affiliates of OHCP owned 16.9% of the Successor Holdco’s outstanding common stock, and certain current and former members of management owned 2.7% of the Successor Holdco’s outstanding common stock.

The Company’s condensed consolidated balance sheet and its related statements of comprehensive loss, cash flows, and stockholders’ equity for the periods presented prior to June 30, 2014 are referenced herein as the predecessor financial statements (the “Predecessor” or “Predecessor Financial Statements”). The Company’s condensed consolidated balance sheet as of June 30, 2014 and its related statements of comprehensive loss, cash flows, and stockholders’ equity for the periods presented subsequent to the Merger Transaction are referenced herein as the successor financial statements (the “Successor” or “Successor Financial Statements”).

The Successor Financial Statements reflect the preliminary allocation of the aggregate purchase price of approximately $1,502,227, including the value of the Company’s junior subordinated debentures, to the assets and liabilities of Hillman based on fair values at the date of the Merger Transaction in accordance with ASC Topic 805, “Business Combinations.” The Company is in the process of obtaining third-party valuations of certain assets held by the Company at the time of the Merger Transaction, including but not limited to customer relationships, patents, licenses, property and equipment, non-compete agreements and the corresponding impact of deferred income taxes. The Company is also in the process of finalizing its fair value evaluation of inventory. Thus, the allocation of the purchase price is subject to change. Any amounts attributable to such assets are expected to be finalized during 2014.

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands)

 

1.	Basis of Presentation (continued):

 

The accompanying unaudited condensed consolidated financial statements present information in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and applicable rules of Regulation S-X. Accordingly, they do not include all information or footnotes required by generally accepted accounting principles for complete financial statements. Management believes that the financial statements include all normal recurring accrual adjustments necessary for a fair presentation. Operating results for the six month period ended June 30, 2014 do not necessarily indicate the results that may be expected for the full year. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s annual report filed on Form 10-K for the year ended December 31, 2013.

The Company’s financial statements have been presented on the basis of push down accounting in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) No. 805-50-S99 (Prior authoritative literature: Staff Accounting Bulletin No. 54 Application of “Push Down” Basis of Accounting in Financial Statements of Subsidiaries Acquired by Purchase). FASB ASC 805-50-S99 states that the push down basis of accounting should be used in a purchase transaction in which the entity becomes wholly-owned by another entity. Under the push down basis of accounting, certain transactions incurred by the parent company which would otherwise be accounted for in the accounts of the parent are “pushed down” and recorded on the financial statements of the subsidiary. Accordingly, certain items resulting from the Merger Transaction have been recorded on the financial statements of the Company.

The following tables reconcile the fair value of the acquired assets and assumed liabilities to the total purchase price:

 

		Amount
Fair value of consideration transferred		$	1,396,784
Cash		$	28,695
Accounts Receivable			113,030
Inventory			195,316
Other current assets			22,250
Property and equipment			94,794
Goodwill			789,072
Intangible assets			572,500
Other non-current assets			3,482
Total assets			1,819,139
Less:
Accounts payable			(65,009	)
Deferred income taxes			(174,602	)
Junior subordinated debentures			(105,443	)
Junior subordinated debentures premium			(22,437	)
Other liabilities			(54,864	)
Net assets		$	1,396,784

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands)

 

1.	Basis of Presentation (continued):

 

The following table indicates the pro forma financial statements of the Company for the three and six months ended June 30, 2013 and 2014, respectively (including transaction costs $53,699 as discussed in Note 14). The pro forma financial statements give effect to the acquisition, on February 19, 2013, of all of the issued and outstanding Class A common shares of H. Paulin & Co., Limited (the “Paulin Acquisition”) and the Merger Transaction as if they had each occurred on January 1, 2013.

 

		Three Months Ended June 30, 2014				Six Months Ended June 30, 2014				Three Months Ended June 30, 2013				Six Months Ended June 30, 2013
Net Sales			202,598				357,377				192,711				352,560
Net Income (Loss)			1,623				(4,852	)			1,385				(38,583	)

The pro-forma results are based on assumptions that the Company believes are reasonable under the circumstances. The pro-forma results are not necessarily indicative of the operating results that would have occurred if the Paulin Acquisition and Merger Transaction had been effective January 1, 2013, nor are they intended to be indicative of results that may occur in the future. The underlying pro-forma information includes the historical results of the Company and Paulin, the Company’s financing arrangements related to the Merger Transaction, and certain purchase accounting adjustments.

Nature of Operations:

The Company is comprised of five separate business segments, the largest of which is (1) The Hillman Group, Inc. (the “Hillman Group”) operating primarily in the United States. The other business segments consist of separate subsidiaries of Hillman Group operating in (2) Canada under the names The Hillman Group Canada ULC and H. Paulin & Co., (3) Mexico under the name SunSource Integrated Services de Mexico S.A. de C.V., (4) Florida under the name All Points Industries, Inc., and (5) Australia under the name The Hillman Group Australia Pty. Ltd. Hillman Group provides merchandising services and products 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, 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. Through our field sales and service organization, Hillman complements our extensive product selection with value-added services for the retailer.

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands)

 

2.	Summary of Significant Accounting Policies:

The significant accounting policies should be read in conjunction with the significant accounting policies included in the Form 10-K for the year ended December 31, 2013. Policies included herein were updated for activity in the interim period.

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 $784 at June 30, 2014 and $703 at December 31, 2013.

Property and Equipment and Accumulated Depreciation:

Property and equipment, including assets acquired under capital leases, are carried at cost and include expenditures for new facilities and major renewals. Maintenance and repairs are charged to expense as incurred. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and the resulting gain or loss is reflected in income from operations. The accumulated depreciation was $61,370 at December 31, 2013 and zero at June 30, 2014, after adjustment to fair value in connection with the Merger Transaction.

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 condensed consolidated statements of comprehensive loss. The Company’s shipping and handling costs were $8,557 and $7,142 in the three month periods ended June 30, 2014 and 2013, respectively. The Company’s shipping and handling costs were $14,890 and $12,756 in the six month periods ended June 30, 2014 and 2013, respectively.

Use of Estimates in the Preparation of Financial Statements:

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

Reclassifications:

Certain amounts in the prior year financial statements were reclassified to conform to the current year’s presentation. These reclassifications had no impact on the prior periods’ net income or stockholders’ equity.

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands)

 

3.	Recent Accounting Pronouncements:

The FASB, the SEC, and other accounting organizations or governmental entities from time to time issue new pronouncements or new interpretations of existing accounting standards that require changes to our accounting policies and procedures. To date, the Company’s management does not believe any new pronouncements or interpretations have had a material impact on our consolidated results of operations or financial condition, but future pronouncements or interpretations could require the change of policies or procedures.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. This ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The update outlines a five-step model and related application guidance, which replaces most existing revenue recognition guidance. ASU 2014-09 is effective for us in the fiscal year ending December 31, 2017, and for interim periods within that year.

The amendments can be applied retrospectively to each prior reporting period or retrospectively with the cumulative effect of initially applying this standard recognized at the date of initial application. Early application is not permitted. We are currently assessing the impact of implementing this guidance on our consolidated results of operations and financial condition.

 

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4.	Acquisitions:

On February 19, 2013, the Company consummated the Paulin Acquisition. The aggregate purchase price of the Paulin Acquisition was $103,416 paid in cash. On March 31, 2013, H. Paulin & Co., Limited was amalgamated with The Hillman Group Canada ULC and continues as a division operating under the trade name of H. Paulin & Co. (“Paulin”).

Paulin is a leading Canadian distributor and manufacturer of fasteners, fluid system products, automotive parts, and retail hardware components. Paulin’s distribution facilities are located across Canada in Vancouver, Edmonton, Winnipeg, Toronto, Montreal, and Moncton, as well as in Flint, Michigan and Cleveland, Ohio. Paulin’s manufacturing facilities are located in Ontario, Canada. Paulin’s annual revenues were approximately $146,389 and $145,700 for 2013 and 2012, respectively.

The following table reconciles the estimated fair value of the acquired assets and assumed liabilities to the total purchase price of the Paulin Acquisition:

 

Accounts receivable		$	17,259
Inventory			55,552
Other current assets			2,701
Property and equipment			16,121
Goodwill			11,687
Intangibles			18,967
Total assets acquired			122,287
Less:
Deferred income taxes			5,437
Liabilities assumed			13,434
Total purchase price		$	103,416

The excess of the purchase price over the net assets has been allocated to goodwill and intangible assets based upon an independent valuation appraisal. The Company made a Section 338(g) election which will impact the deductibility of goodwill for tax purposes.

 

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5.	Goodwill and Other Intangible Assets:

Goodwill represents the excess purchase cost over the fair value of net assets of companies acquired in business combinations. Goodwill is an indefinite lived asset and is assessed for impairment at least annually or more frequently if a triggering event occurs. If the carrying amount of a reporting unit is greater than the fair value, impairment may be present. ASC 350 permits an entity to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount before applying the two-step goodwill impairment model. If it is determined through the qualitative assessment that a reporting unit’s fair value is more likely than not greater than its carrying value, the remaining impairment steps would be unnecessary. The qualitative assessment is optional, allowing companies to go directly to the quantitative assessment. No impairment charges were recorded by the Company in 2014 or 2013.

Goodwill amounts by reporting unit are summarized as follows:

 

		Goodwill at December 31, 2013				Acquisitions (1)				Dispositions				Other (2)				Goodwill at June 30, 2014
United States, excluding All Points		$	446,382			$	322,478			$	—			$	—			$	768,860
All Points			58				—				—				—				58
Canada			12,785				326				—				(31	)			13,080
Mexico			7,002				—				—				72				7,074
Australia			—				—				—				—				—
Total		$	466,227			$	322,804			$	—			$	41			$	789,072

 

(1)	Changes in values primarily related to the Merger Transaction.

(2)	These amounts relate to adjustments resulting from fluctuations in foreign currency exchange rates.

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. ASC 350 permits an entity to assess qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount before applying the two-step impairment model. In connection with the evaluation, an independent appraiser assessed the value of the Company’s 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 were recorded by the Company in 2014 or 2013.

 

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5.	Goodwill and Other Intangible Assets (continued):

 

Definite-lived intangible assets are amortized over their useful lives and are subject to impairment testing. The values assigned to intangible assets were determined by a preliminary appraisal. The intangible asset values may be adjusted by management for changes determined upon completion of work on the independent appraisal. Other intangibles, net, as of June 30, 2014 and December 31, 2013 consist of the following:

 

		Estimated Useful Life (Years)		June 30, 2014				Estimated Useful Life (Years)		December 31, 2013
Customer relationships		20		$	450,000			20		$	341,500
Trademarks - All Others		Indefinite			80,000			Indefinite			54,082
Trademarks - TagWorks		5			—			5			240
Patents		5-20			25,000			5-20			20,250
Quick Tag license		2			7,000			6			11,500
Laser Key license		1.5			1,500			5			1,250
KeyWorks license		6.5			4,000			10			4,100
Non-compete agreements		6.5			5,000			5-10			4,450
Intangible assets, gross					572,500						437,372
Less: Accumulated amortization					—						75,007
Other intangibles, net				$	572,500					$	362,365

The Predecessor’s amortization expense for amortizable intangible assets was $5,549 and $5,559 for the three month periods ended June 30, 2014 and 2013, respectively. The Predecessor’s amortization expense for amortizable intangible assets was $11,093 and $11,005 for the six month periods ended June 30, 2014 and 2013, respectively. The combination of the amortization expense for amortizable assets of the Successor and Predecessor for the year ended December 31, 2014 is estimated to be $26,576. For the years ended December 31, 2015, 2016, 2017, 2018, and 2019, the Successor’s amortization expense for amortizable assets is estimated to be $30,966, $28,213, $26,463, $26,463, and $25,843, respectively.

 

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6.	Commitments and Contingencies:

The Company self-insures our product liability, automotive, workers’ compensation, and general liability losses up to $250 per occurrence. Catastrophic coverage has been purchased from third party insurers for occurrences in excess of $250 up to $40,000. The two risk areas involving the most significant accounting estimates are workers’ compensation and automotive liability. Actuarial valuations performed by the Company’s outside risk insurance expert were used by the Company’s management to form the basis for workers’ compensation and automotive liability loss reserves. The actuary contemplated the Company’s specific loss history, actual claims reported, and industry trends among statistical and other factors to estimate the range of reserves required. Risk insurance reserves are comprised of specific reserves for individual claims and additional amounts expected for development of these claims, as well as for incurred but not yet reported claims. The Company believes the liability of approximately $1,435 recorded for such risk insurance reserves is adequate as of June 30, 2014.

As of June 30, 2014, the Company has provided certain vendors and insurers letters of credit aggregating $3,633 related to our product purchases and insurance coverage of product liability, workers’ compensation, and general liability.

The Company self-insures our group health claims up to an annual stop loss limit of $200 per participant. Aggregate coverage is maintained for annual group health insurance claims in excess of 125% of expected claims. Historical group insurance loss experience forms the basis for the recognition of group health insurance reserves. Provisions for losses expected under these programs are recorded based on an analysis of historical insurance claim data and certain actuarial assumptions. The Company believes the liability of approximately $2,368 recorded for such group health insurance reserves is adequate as of June 30, 2014.

On October 1, 2013, Hillman Group filed a complaint against Minute Key Inc., a manufacturer of fully-automatic, self-service key duplication kiosks, in the United States District Court for the Southern District of Ohio (Western Division), seeking a declaratory judgment of non-infringement and invalidity of a U.S. patent issued to Minute Key Inc. on September 10, 2013. Hillman Group’s filing against Minute Key Inc. was in response to a letter dated September 10, 2013 in which Minute Key Inc. alleged that Hillman Group’s FastKey™ product infringes the newly-issued patent.

On October 23, 2013, Minute Key Inc. filed an answer and counterclaim against the Hillman Group alleging patent infringement. Minute Key Inc. also requested that the court dismiss the Hillman Group’s complaint, enter judgment against the Hillman Group that we are willfully and deliberately infringing the patent, grant a permanent injunction, and award unspecified monetary damages to Minute Key Inc.

 

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6.	Commitments and Contingencies (continued):

 

Following a status conference on March 5, 2014, the court assigned the case for mediation. Prior to the mediation, Minute Key Inc. filed two motions on March 17, 2014 seeking to voluntarily withdraw its counterclaim alleging infringement by Hillman Group and also to dismiss Hillman Group’s complaint for non-infringement and invalidity. Both motions remain pending before the court. The court-ordered mediation was held on April 23, 2014 but no settlement was reached. Shortly after the mediation session, however, Minute Key Inc. provided Hillman Group with a covenant promising not to sue for infringement of the newly-issued patent against any existing Hillman Group product, including the FastKey™ and Key Express™ products.

Hillman Group filed motions on May 9, 2014 seeking to add additional claims to the case against Minute Key Inc. under Federal and Ohio state unfair competition statutes. These motions also remain pending before the court.

Because the lawsuit remains in a preliminary stage, it is not yet possible to assess the impact, if any, that the lawsuit will have on the Company. However, Hillman Group intends to continue to pursue the lawsuit vigorously and believes that it has meritorious claims for invalidity of Minute Key Inc.’s patent and for Minute Key Inc.’s unfair competition.

On July 14, 2014, PrimeSource Building Products, Inc., a supplier of products and materials in the building, construction, and do-it-yourself industries (“PrimeSource”), filed a complaint against Hillman Group in the United States District Court for the Northern District of Texas (Dallas Division) alleging trademark infringement, unfair competition, and unjust enrichment. On July 30, 2014, PrimeSource filed a motion for preliminary injunction. On August 8, 2014, Hillman Group filed a motion to dismiss the complaint and also intends to file a memorandum in opposition to the motion regarding PrimeSource’s preliminary injunction motion.

Because the lawsuit is in a preliminary stage, it is not yet possible to assess the impact, if any, that the lawsuit will have on the Company. However, Hillman Group believes that it has meritorious defenses to the claims and intends to defend the lawsuit vigorously.

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

 

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7.	Related Party Transactions:

Gregory Mann and Gabrielle Mann are employed by the All Points subsidiary of Hillman. All Points leases an industrial warehouse and office facility from companies under the control of the Manns. The Company has recorded rental expense for the lease of this facility on an arm’s length basis. The rental expense for the lease of this facility was $82 for the three month periods ended June 30, 2014 and 2013. The rental expense for the lease of this facility was $165 for the six month periods ended June 30, 2014 and 2013.

In connection with the Paulin Acquisition, the Company entered into three leases for five properties containing industrial warehouse, manufacturing plant, and office facilities on February 19, 2013. The owners of the properties under one lease are relatives of Richard Paulin, who is employed by The Hillman Group Canada ULC, 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. The Company has recorded rental expense for the three leases on an arm’s length basis. The rental expense for the lease of this facility was $190 and $201 for the three month periods ended June 30, 2014 and 2013, respectively. The rental expense for the lease of this facility was $376 and $293 for the six month periods ended June 30, 2014 and 2013, respectively.

 

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8.	Income Taxes:

The Company’s policy is to estimate income taxes for interim periods based on estimated annual effective tax rates. These are derived, in part, from expected pre-tax income or loss. Accordingly, the Company applied an estimated annual effective tax rate to the interim period pre-tax loss in the one day Successor period ended June 30, 2014, the six and three month Predecessor periods ended June 29, 2014, and the six and three month Predecessor periods ended June 30, 2013 to calculate the income tax benefit in accordance with the principal method prescribed by ASC 740-270, the accounting guidance established for computing income taxes in interim periods.

The effective income tax rate was 28.3% for the one day Successor period ended June 30, 2014. The effective income tax rates were 35.1% and 101.6% for the six month Predecessor periods ended June 29, 2014 and June 30, 2013, respectively. The effective income tax rates were 34.4% and -93.2% for the three month Predecessor periods ended June 29, 2014 and June 30, 2013, respectively.

The effective income tax rate differed from the federal statutory rate in the one day Successor period ended June 30, 2014 and the six and three month Predecessor periods ended June 29, 2014 primarily due to certain non-deductible costs associated with the Merger Transaction. The effective income tax rate also differed from the federal statutory rate in the six and three month Predecessor periods ended June 29, 2014 due to a current period benefit caused by the effect of changes in certain state income tax rates on the Company’s deferred tax assets and liabilities. The effective income tax rate differed from the federal statutory rate in the six and three month Predecessor periods ended June 30, 2013 primarily due to a current period benefit caused by the effect of changes in certain state income tax rates on the Company’s deferred tax assets and liabilities and the reduction of valuation reserves related to certain deferred tax assets. The remaining differences between the federal statutory rate and the effective tax rate in the one day Successor period ended June 30, 2014 was primarily due to state income taxes. The remaining differences between the federal statutory rate and the effective tax rate in the six and three month Predecessor periods ended June 29, 2014 and June 30, 2013 were primarily due to state and foreign income taxes.

 

9.	Long-Term Debt:

Concurrent with the consummation of the Merger Transaction, Hillman Companies and certain of its subsidiaries closed on a $620,000 senior secured credit facility (the “Senior Facilities”), consisting of a $550,000 term loan and a $70,000 revolving credit facility (“Revolver”). The term loan portion of the Senior Facilities has a seven year term and the Revolver has a five year term. For the first fiscal quarter after June 30, 2014, the Senior Facilities provide term loan borrowings at interest rates based on a LIBOR plus a LIBOR Spread of 3.50%, or an Alternate Base Rate (“ABR”) plus an ABR Spread of 2.50%. The LIBOR is subject to a minimum floor rate of 1.00% and the ABR is subject to a minimum floor of 2.00%. Additionally, the Senior Facilities provide Revolver borrowings at interest rates based on a LIBOR plus a LIBOR Spread of 3.25%, or an ABR plus an ABR Spread of 2.25%. There is no minimum floor rate for Revolver loans. After the initial fiscal quarter, the borrowing rate shall be adjusted quarterly on a prospective basis on each adjustment date based upon total leverage ratio for initial term loans and the senior secured leverage ratio for Revolver loans.

 

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9.	Long-Term Debt (continued):

 

Concurrent with the consummation of the Merger Transaction, Hillman Group issued $330,000 aggregate principal amount of its senior notes due July 15, 2022 (the “6.375% Senior Notes”), which are guaranteed by Hillman Companies and its domestic subsidiaries other than the Hillman Group Capital Trust. Hillman Group pays interest on the 6.375% Senior Notes semi-annually on January 15 and July 15 of each year.

Prior to the consummation of the Merger Transaction, the Company, through Hillman Group, was party to a Senior Credit Agreement (the “Prior Credit Agreement”), consisting of a $30,000 revolving credit line and a $384,400 term loan. The facilities under the Prior Credit Agreement had a maturity date of May 28, 2017. In addition, the Company, through Hillman Group, had issued $265,000 in aggregate principal amount of 10.875% Senior Notes that were scheduled to mature on June 1, 2018. In connection with the Merger Transaction, both the Prior Credit Agreement and the 10.875% Senior Notes were repaid and terminated.

The Company pays interest to the Hillman Group Capital Trust (“Trust”) on the Junior Subordinated Debentures underlying the Trust Preferred Securities at the rate of 11.6% per annum on their face amount of $105,443, or $12,231 per annum in the aggregate. The Trust will redeem the Trust Preferred Securities when the Junior Subordinated Debentures are repaid, or at maturity on September 30, 2027. The Trust distributes an equivalent amount to the holders of the Trust Preferred Securities. 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 a Deferral Period, the Company is required to accrue the full amount of all interest payable, and such deferred interest payable would become immediately payable by the Company at the end of the Deferral Period. There were no deferrals of distribution payments to holders of the Trust Preferred Securities in 2014 or 2013.

The Senior Facilities provide for customary events of default, including but not limited to, payment defaults, breach of representations or covenants, cross-defaults, bankruptcy events, failure to pay judgments, attachment of its assets, change of control, and the issuance of an order of dissolution. Certain of these events of default are subject to notice and cure periods or materiality thresholds. The Company is also required to comply, in certain circumstances, with a senior secured net leverage ratio covenant. This covenant only applies if, at the end of a fiscal quarter, there are outstanding Revolver borrowings in excess of 35% of the total revolving commitments. As of June 30, 2014, the Revolver loan amount of $16,000 and outstanding letters of credit of approximately $3,600 represented 28% of total revolving commitments and this financial covenant was not in effect. The occurrence of an event of default permits the lenders under the Senior Facilities to accelerate repayment of all amounts due. The Company was in compliance with all provisions and covenants of the Senior Facilities as of June 30, 2014.

 

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10.	Common and Preferred Stock:

The Hillman Companies has one class of common stock, with 5,000 shares authorized, issued, and outstanding as of June 30, 2014. All outstanding shares of Hillman Companies common stock are owned by Successor Holdco.

Under the terms of the Stockholders Agreement for the Predecessor Holdco common stock, (the “Predecessor Stockholders Agreement”), management shareholders had the ability to put their shares back to Predecessor Holdco under certain conditions, including death or disability. ASC 480-10-S99 requires shares to be classified outside of permanent equity if they can be redeemed and the redemption is not solely within the control of the issuer. Further, if it is determined that redemption of the shares is probable, the shares are marked to redemption value which equals fair value at each balance sheet date with the change in fair value recorded in additional paid-in capital. Accordingly, the 161.2 shares of common stock held by management at December 31, 2013 were recorded outside permanent equity and were adjusted to the fair value of $16,975. The terms of the HMAN Group Holdings Inc. 2014 Equity Incentive Plan (the “Successor Equity Incentive Plan”) for Successor Holdco common stock does not grant put rights to management shareholders and no common stock held by management at June 30, 2014 is recorded outside permanent equity.

The Hillman Companies has one class of preferred stock, with 5,000 shares authorized and none issued or outstanding as of June 30, 2014.

 

11.	Stock-Based Compensation:

Effective May 28, 2010, the Predecessor established the OHCP HM Acquisition Corp. 2010 Stock Option Plan, as amended (the “Predecessor Option Plan”), pursuant to which Predecessor Holdco granted non-qualified stock options for the purchase of Predecessor Holdco common stock. Immediately prior to the consummation of the Merger Transaction, there were outstanding options to purchase 44,180 shares of Predecessor Holdco common stock. In connection with the Merger Transaction, the Predecessor Option Plan was terminated, and all options outstanding thereunder were cancelled. Upon consummation of the Merger Transaction, each outstanding option to purchase shares of Predecessor Holdco common stock was converted into the right to receive, in cash, a portion of the merger consideration in the Merger Transaction.

Option holders were not required by the terms of the Predecessor Option Plan or the Predecessor Stockholders Agreement to hold the shares for any period of time following exercise. Liability classification was required because this arrangement permits the holders to put the shares back without being exposed to the risks and rewards of the shares for a reasonable period of time. Consistent with past practice, the Company has elected to use the intrinsic value method to value the options. Immediately prior to the cancelation of the Predecessor Option Plan, the stock option liability was $48,517.

Effective June 30, 2014, Successor Holdco established the HMAN Group Holdings Inc. 2014 Equity Incentive Plan, pursuant to which Successor Holdco may grant options, stock appreciation rights, restricted stock, and other stock-based awards for up to an aggregate of 44,021 shares of its common stock. The Successor Equity Incentive Plan is administered by a committee of the Successor Holdco board of directors. Such committee determines the terms of each stock-based award grant under the Successor Equity Incentive Plan, except that the exercise price of any granted options and the grant price of any granted stock appreciation rights may not be lower than the fair market value of one share of common stock of Successor Holdco as of the date of grant. As of June 30, 2014, no stock-based awards have been granted under the Successor Equity Incentive Plan.

 

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12.	Derivatives and Hedging:

The Company uses derivative financial instruments to manage our exposures to (1) interest rate fluctuations on our floating rate senior debt; (2) price fluctuations in metal commodities used in our key products; and (3) 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.

Interest Rate Swap Agreements - On June 24, 2010, the Company entered into a forward Interest Rate Swap Agreement (the “2010 Swap”) with a two-year term for a notional amount of $115,000. The forward start date of the 2010 Swap was May 31, 2011 and it terminated on May 31, 2013. The 2010 Swap fixed the interest rate at 2.47% plus the applicable interest rate margin.

The 2010 Swap was initially designated as a cash flow hedge. Effective April 18, 2011, the Company executed the second amendment to the Prior Credit Agreement which modified the interest rate on the prior senior facilities (the “Prior Senior Facilities”). The critical terms for the 2010 Swap no longer matched the terms of the amended Prior Senior Facilities and the 2010 Swap was de-designated.

The 2010 Swap had no value at June 30, 2014 or at December 31, 2013. Adjustments of $418 to the fair value of the 2010 Swap were recorded in the second quarter of 2013 as a reduction in interest expense in the statement of condensed consolidated comprehensive loss for the favorable change in fair value since December 31, 2012.

Interest Rate Cap Agreements - On May 20, 2013, the Company entered into an Interest Rate Cap Agreement (the “2013 Rate Cap No. 1”) with a two-year term for a notional amount of $150,000 and the maximum LIBOR interest rate set at 1.25%. 2013 Rate Cap No. 1 became effective on May 28, 2013 and was terminated effective as of June 19, 2014.

On May 20, 2013, the Company entered into an Interest Rate Cap Agreement (the “2013 Rate Cap No. 2”) with a two-year term for a notional amount of $75,000 and the maximum LIBOR interest rate set at 1.25%. 2013 Rate Cap No. 2 became effective on May 28, 2013 and was terminated effective as of June 19, 2014.

The fair value of the interest rate caps was zero and $53 as of June 30, 2014 and December 31, 2013, respectively. Prior to their termination on June 19, 2014, the interest rate caps were reported on the condensed consolidated balance sheets in other non-current assets.

The Company’s interest rate cap agreements did not qualify for hedge accounting treatment because they did not meet the provisions specified in ASC 815, Derivatives and Hedging (“ASC 815”). Accordingly, the unrealized loss of $12 and realized gain of $2 on these derivatives was recognized on the condensed consolidated statement of comprehensive loss in the second quarter of 2014.

 

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12.	Derivatives and Hedging (continued):

 

Foreign Currency Forward Contract - During 2013, the Company entered into multiple foreign currency forward contracts (the “2013 FX Contracts”) with maturity dates ranging from July 2013 to December 2014 and a total notional amount of C$42,050. The 2013 FX Contracts fixed the Canadian to U.S. dollar forward exchange rate at points ranging from 1.02940 to 1.08210. The purpose of the 2013 FX Contracts was to manage the Company’s exposure to fluctuations in the exchange rate of the Canadian dollar.

During the first and second quarters of 2014, the Company entered into multiple foreign currency forward contracts (the “2014 FX Contracts”) with maturity dates ranging from March 2014 to March 2015 and a total notional amount of C$15,696. The 2014 FX Contracts fixed the Canadian to U.S. dollar forward exchange rate at points ranging from 1.11000 to 1.12670. The purpose of the 2014 FX Contracts was to manage the Company’s exposure to fluctuations in the exchange rate of the Canadian dollar.

The total fair value of the 2013 FX Contracts and 2014 FX Contracts was ($331) and ($42) as of June 30, 2014 and December 31, 2013, respectively, and was reported on the condensed consolidated balance sheets in other current liabilities. An increase in other expense of $289 was recorded in the statement of comprehensive loss for the unfavorable change in fair value from December 31, 2013.

The Company’s FX Contracts did not qualify for hedge accounting treatment because they did not meet the provisions specified in ASC 815. Accordingly, the gain or loss on these derivatives was recognized in current earnings.

The Company does not enter into derivative transactions for speculative purposes and, therefore, holds no derivative instruments for trading purposes.

 

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13.	Fair Value Measurements:

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. The guidance also establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. Assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:

 

Level 1:		Quoted market prices in active markets for identical assets or liabilities.
Level 2:		Observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3:		Unobservable inputs reflecting the reporting entity’s own assumptions.

The accounting guidance establishes a hierarchy which requires an entity to maximize the use of quoted market prices and minimize the use of unobservable inputs. An asset or liability’s level is based on the lowest level of input that is significant to the fair value measurement.

The following tables set forth the Company’s financial assets and liabilities that were measured at fair value on a recurring basis during the period, by level, within the fair value hierarchy:

 

		As of June 30, 2014
		Level 1				Level 2				Level 3				Total
Trading securities		$	1,998			$	—			$	—			$	1,998
Foreign exchange forward contracts			—				(331	)			—				(331	)

 

		As of December 31, 2013
		Level 1				Level 2				Level 3				Total
Trading securities		$	4,386			$	—			$	—			$	4,386
Interest rate caps			—				53				—				53
Foreign exchange forward contracts			—				(42	)			—				(42	)

Trading securities are valued using quoted prices on an active exchange. Trading securities represent assets held in a Rabbi Trust to fund deferred compensation liabilities and are included as restricted investments on the accompanying condensed consolidated balance sheets.

For the three months ended June 30, 2014 and 2013, the unrealized gains (losses) on these securities of $77 and ($69), respectively, were recorded as other income. For the six months ended June 30, 2014 and 2013, the unrealized gains on these securities of $95 and $69, respectively, were recorded as other income. An offsetting entry for the same amount, adjusting the deferred compensation liability and compensation expense within SG&A, was also recorded.

The Company utilizes interest rate cap and interest rate swap contracts to manage our targeted mix of fixed and floating rate debt, and these contracts are valued using observable benchmark rates at commonly quoted intervals during the term of the cap and swap contracts.

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands)

 

13.	Fair Value Measurements (continued):

 

Prior to their termination on June 19, 2014, the interest rate caps were reported on the condensed consolidated balance sheets in other non-current assets.

The 2010 Swap expired in May 2013 and had no value as of June 30, 2014.

The Company utilizes foreign exchange forward contracts to manage our exposure to currency fluctuations in the Canadian dollar versus the U.S. dollar. The forward contracts were valued using observable benchmark rates at commonly quoted intervals during the term of the forward contracts.

As of June 30, 2014, the foreign exchange forward contracts were included in other current liabilities on the accompanying condensed consolidated balance sheet.

The fair value of the Company’s fixed rate senior notes and junior subordinated debentures as of June 30, 2014 and December 31, 2013 were determined by utilizing current trading prices obtained from indicative market data. As a result, the fair value measurement of the Company’s senior term loans is considered to be Level 2.

 

		June 30, 2014								December 31, 2013
		Carrying Amount				Estimated Fair Value				Carrying Amount				Estimated Fair Value
6.375% Senior Notes		$	330,000			$	330,000			$	—			$	—
10.875% Senior Notes			—				—				271,750				285,538
Junior Subordinated Debentures			131,141				131,141				114,941				131,480

The carrying amounts of the Company’s cash and cash equivalents, accounts receivable, and accounts payable approximate fair value because of the short term maturity of these instruments and the carrying value of the variable rate senior term loans approximates fair value as the interest rate is variable and approximates current market rates.

 

14.	Transaction, Acquisition, and Integration Expenses:

In the three and six month periods ended June 29, 2014, the Predecessor incurred $31,681 in transaction expenses primarily for investment banking, legal, and advisory services related to the Merger Transaction. In the one day period ended June 30, 2014, the Successor incurred $22,018 in transaction expenses primarily for legal, professional, and other advisory services in connection with the acquisition of the Company. The Successor transaction expenses include a payment of $15,000 to CCMP Capital Advisors for services related to the Merger Transaction.

The Predecessor incurred $2,153 and $4,182 in the three and six month periods ended June 30, 2013, respectively, for acquisition and integration costs related to the Paulin Acquisition.

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands)

 

15.	Segment Reporting:

The Company’s segment reporting structure uses the Company’s management reporting structure as the foundation for how the Company manages our business. The Company periodically evaluates our segment reporting structure in accordance with ASC 350-20-55 and we have concluded that we have five reportable segments as of June 30, 2014. During 2013, the operations of the Paulin Acquisition were combined into the operations of the Canada segment. The United States segment, excluding All Points, and the Canada segment are considered material by the Company’s management as of June 30, 2014. The segments are as follows:

 

•

United States – excluding the All Points division

 

•

All Points

 

•

Canada

 

•

Mexico

 

•

Australia

The United States segment distributes fasteners and related hardware items, threaded rod, keys, key duplicating systems, accessories, and identification items, such as tags and letters, numbers, and signs to hardware stores, home centers, mass merchants, and other retail outlets primarily in the United States. This segment also provides innovative pet identification tag programs to a leading pet products retail chain using a unique, patent-protected/patent-pending technology and product portfolio.

The All Points segment is a Florida-based distributor of commercial and residential fasteners catering to the hurricane protection industry in the southern United States. All Points has positioned itself as a major supplier to manufacturers of railings, screen enclosures, windows, and hurricane shutters.

The Canada segment distributes fasteners and related hardware items, threaded rod, keys, key duplicating systems, accessories, and identification items, such as tags and letters, numbers, and signs to hardware stores, home centers, mass merchants, industrial distributors, automotive aftermarket distributors, and other retail outlets and industrial Original Equipment Manufacturers (“OEMs”) in Canada. The Canada segment also produces fasteners, stampings, fittings, and processes threaded parts for automotive suppliers and industrial OEMs.

The Mexico segment distributes fasteners and related hardware items to hardware stores, home centers, mass merchants, and other retail outlets in Mexico.

The Australia segment distributes keys, key duplicating systems, and accessories to home centers and other retail outlets in Australia.

The Company uses profit or loss from operations to evaluate the performance of our segments. Profit or loss from operations is defined as income from operations before interest and tax expenses. Hillman accounts for intersegment sales and transfers as if the sales or transfers were to third parties, at current market prices. Segment revenue excludes sales between segments, which is consistent with the segment revenue information provided to the Company’s chief operating decision maker. Segment Income (Loss) from Operations for Mexico and Australia include insignificant costs allocated from the United States, excluding All Points segment, while the remaining operating segments do not include any allocations.

The transaction expenses incurred in connection with the Merger Transaction were recorded in the United States segment. For further information, see Note 14, Transaction, Acquisition, and Integration Expenses.

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands)

 

15.	Segment Reporting (continued):

 

The table below presents revenues and income from operations for our reportable segments for the three and six months ended June 30, 2014 and 2013.

 

		Successor						Predecessor
		One Day Ended June 30, 2014						Three Months Ended June  29, 2014				Three Months Ended June  30, 2013
Revenues
United States excluding All Points		$	—					$	150,901			$	142,851
All Points			—						5,674				5,881
Canada			—						43,846				42,073
Mexico			—						1,886				1,703
Australia			—						291				203
Total revenues		$	—					$	202,598			$	192,711
Segment (Loss) Income from Operations
United States excluding All Points		$	(22,018	)				$	(51,467	)		$	15,108
All Points			—						598				613
Canada			—						3,760				2,251
Mexico			—						200				116
Australia			—						(76	)			(515	)
Total (loss) income from operations		$	(22,018	)				$	(46,985	)		$	17,573

 

		Successor						Predecessor
		One Day Ended June 30, 2014						Six Months   Ended June 29, 2014				Six Months   Ended June 30, 2013
Revenues
United States excluding All Points		$	—					$	269,009			$	261,696
All Points			—						10,238				10,534
Canada			—						73,867				60,385
Mexico			—						3,620				3,670
Australia			—						643				345
Total revenues		$	—					$	357,377			$	336,630
Segment (Loss) Income from Operations
United States excluding All Points		$	(22,018	)				$	(44,830	)		$	22,152
All Points			—						896				984
Canada			—						4,214				2,417
Mexico			—						446				512
Australia			—						(114	)			(708	)
Total (loss) income from operations		$	(22,018	)				$	(39,388	)		$	25,357

 

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THE HILLMAN COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands)

 

15.	Segment Reporting (continued):

 

Assets by segment as of June 30, 2014 and December 31, 2013 were as follows:

 

		Successor						Predecessor
		June 30, 2014						December 31, 2013
Assets
United States excluding All Points		$	1,513,875					$	936,008
All Points			9,253						8,379
Canada			305,696						300,906
Mexico			18,033						17,964
Australia			1,898						1,599
Total Assets		$	1,848,755					$	1,264,856

 

		Successor						Predecessor
		June 30, 2014						December 31, 2013
Cash and cash equivalents
United States excluding All Points		$	24,692					$	27,632
All Points			168						714
Canada			2,411						5,039
Mexico			1,416						1,570
Australia			8						14
Total Cash and cash equivalents		$	28,695					$	34,969

 

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Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The following discussion provides information which the Company’s management believes is relevant to an assessment and understanding of the Company’s operations and financial condition. This discussion should be read in conjunction with the condensed consolidated financial statements and accompanying notes in addition to the consolidated statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Forward-Looking Statements

Certain disclosures related to acquisitions, refinancing, capital expenditures, resolution of pending litigation, and realization of deferred tax assets contained in this quarterly 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. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” “project,” or the negative of such terms or other similar expressions.

These forward-looking statements are not historical facts, but rather are based on management’s current expectations, assumptions, and projections about future events. Although management believes that the expectations, assumptions, and projections on which these forward-looking statements are based are reasonable, they nonetheless could prove to be inaccurate, and as a result, the forward-looking statements based on those expectations, assumptions, and projections also could be inaccurate. Forward-looking statements are not guarantees of future performance. Instead, forward-looking statements are subject to known and unknown risks, uncertainties, and assumptions that may cause the Company’s strategy, planning, actual results, levels of activity, performance, or achievements to be materially different from any strategy, planning, future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. Actual results could differ materially from those currently anticipated as a result of a number of factors, including the risks and uncertainties discussed under the caption “Risk Factors” set forth in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. Given these uncertainties, current or prospective investors are cautioned not to place undue reliance on any such forward-looking statements.

All forward-looking statements attributable to the Company or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements included in this report and the risks and uncertainties discussed under the caption “Risk Factors” set forth in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013; they should not be regarded as a representation by the Company or any other individual. We undertake no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this report might not occur or be materially different from those discussed.

 

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General

The Hillman Companies, Inc. and its wholly-owned subsidiaries (collectively, “Hillman” or the “Company”) are one of the largest providers of hardware-related products and related merchandising services to retail markets in North America. The Company’s principal business is operated through its wholly-owned subsidiary, The Hillman Group, Inc. (the “Hillman Group”). Hillman Group sells our products to hardware stores, home centers, mass merchants, pet supply stores, and other retail outlets principally in the United States, Canada, Mexico, Australia, 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 (“LNS”). The Company supports our product sales with value added services including design and installation of merchandising systems and maintenance of appropriate in-store inventory levels.

Merger Transaction

On June 30, 2014, affiliates of CCMP Capital Advisors, LLC (“CCMP”) and Oak Hill Capital Partners (“OHCP”), 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”). The total consideration paid in the Merger Transaction was approximately $1.5 billion including repayment of outstanding debt and including the value of the Company’s outstanding junior subordinated debentures ($105.4 million liquidation value at the time of the Merger Transaction). The merger consideration is subject to certain post-closing working capital and other adjustments.

Prior to the Merger Transaction, affiliates of OHCP owned 95.6% of the Predecessor Holdco’s outstanding common stock and certain current and former members of management owned 4.4% of the Predecessor Holdco’s outstanding common stock. Upon consummation of the Merger Transaction, affiliates of CCMP owned 80.4% of the Successor Holdco’s outstanding common stock, affiliates of OHCP owned 16.9% of the Successor Holdco’s outstanding common stock, and certain current and former members of management owned 2.7% of the Successor Holdco’s outstanding common stock.

The Company’s condensed consolidated balance sheet and its related statements of comprehensive loss, cash flows, and stockholders’ equity for the periods presented prior to June 30, 2014 are referenced herein as the predecessor financial statements (the “Predecessor” or “Predecessor Financial Statements”). The Company’s condensed consolidated balance sheet as of June 30, 2010 and its related statements of comprehensive loss, cash flows, and stockholders’ equity for the periods presented subsequent to the Merger Transaction are referenced herein as the successor financial statements (the “Successor” or “Successor Financial Statements”). The Predecessor Financial Statements do not reflect certain transaction amounts that were incurred at the close of the Merger Transaction.

Financing Arrangements

Concurrent with the consummation of the Merger Transaction, Hillman Companies and certain of its subsidiaries closed on a $620.0 million senior secured credit facility (the “Senior Facilities”), consisting of a $550.0 million term loan and a $70.0 million revolving credit facility (“Revolver”). The term loan portion of the Senior Facilities has a seven year term and the Revolver has a five year term. For the first fiscal

 

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quarter after June 30, 2014, the Senior Facilities provide term loan borrowings at interest rates based on a LIBOR plus a LIBOR Spread of 3.50%, or an Alternate Base Rate (“ABR”) plus an ABR Spread of 2.50%. The LIBOR is subject to a minimum floor rate of 1.00% and the ABR is subject to a minimum floor of 2.00%. Additionally, the Senior Facilities provide Revolver borrowings at interest rates based on a LIBOR plus a LIBOR Spread of 3.25%, or an ABR plus an ABR Spread of 2.25%. There is no minimum floor rate for Revolver loans. After the initial fiscal quarter, the borrowing rate shall be adjusted quarterly on a prospective basis on each adjustment date based upon total leverage ratio for initial term loans and the senior secured leverage ratio for Revolver loans.

Concurrent with the consummation of the Merger Transaction, Hillman Group issued $330.0 million aggregate principal amount of its senior notes due July 15, 2022 (the “6.375% Senior Notes”), which are guaranteed by Hillman Companies and its domestic subsidiaries other than the Hillman Group Capital Trust. Hillman Group pays interest on the 6.375% Senior Notes semi-annually on January 15 and July 15 of each year.

Prior to the consummation of the Merger Transaction, the Company, through Hillman Group, was party to a Senior Credit Agreement (the “Prior Credit Agreement”), consisting of a $30.0 million revolving credit line and a $384.4 million term loan. The facilities under the Prior Credit Agreement had a maturity date of May 28, 2017. In addition, the Company, through Hillman Group, had issued $265.0 million in aggregate principal amount of 10.875% Senior Notes that were scheduled to mature on June 1, 2018. In connection with the Merger Transaction, both the Prior Credit Agreement and the 10.875% Senior Notes were repaid and terminated.

In September 1997, The Hillman Group Capital Trust, a Grantor trust (the “Trust”), completed a $105.4 million underwritten public offering of 4,217,724 11.6% Trust Preferred Securities. The Trust invested the proceeds from the sale of the preferred securities in an equal principal amount of 11.6% Junior Subordinated Debentures of Hillman due September 2027. The Company pays interest to the Trust on the Junior Subordinated Debentures underlying the Trust Preferred Securities at the rate of 11.6% per annum on their face amount of $105.4 million, or $12.2 million per annum in the aggregate. The Trust distributes an equivalent amount to the holders of the Trust Preferred Securities. 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 a Deferral Period, the Company is required to accrue the full amount of all interest payable, and such deferred interest payable would become immediately payable by the Company at the end of the Deferral Period.

The Senior Facilities provide for customary events of default, including but not limited to, payment defaults, breach of representations or covenants, cross-defaults, bankruptcy events, failure to pay judgments, attachment of its assets, change of control, and the issuance of an order of dissolution. Certain of these events of default are subject to notice and cure periods or materiality thresholds. The Company is also required to comply, in certain circumstances, with a senior secured net leverage ratio covenant. This covenant only applies if, at the end of a fiscal quarter, there are outstanding Revolver borrowings in excess of 35% of the total revolving commitments. As of June 30, 2014, the Revolver loan amount of $16 million and outstanding letters of credit of $3.6 million represented 28% of total revolving commitments and this financial covenant was not in effect. The occurrence of an event of default permits the lenders under the Senior Facilities to accelerate repayment of all amounts due. The Company was in compliance with all provisions and covenants of the Senior Facilities as of June 30, 2014.

 

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Acquisitions

On February 19, 2013, the Company acquired all of the issued and outstanding Class A common shares of H. Paulin & Co., Limited (the “Paulin Acquisition”). The aggregate purchase price of the Paulin Acquisition was $103.4 million paid in cash. On March 31, 2013, H. Paulin & Co., Limited was amalgamated with The Hillman Group Canada ULC and continues as a division operating under the trade name of H. Paulin & Co. (“Paulin”).

Paulin is a leading Canadian distributor and manufacturer of fasteners, fluid system products, automotive parts, and retail hardware components. Paulin’s distribution facilities are located across Canada in Vancouver, Edmonton, Winnipeg, Toronto, Montreal, and Moncton, as well as in Flint, Michigan, and Cleveland, Ohio. Paulin’s manufacturing facilities are located in Ontario, Canada. Paulin’s annual revenues were approximately $146.4 million for 2013.

 

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Results of Operations

The following analysis of results of operations includes a brief discussion of the factors that affected the Company’s operating results and a comparative analysis of the periods for the one day ended June 30, 2014, the three months ended June 29, 2014, and three months ended June 30, 2013.

 

		Successor								Predecessor
		One Day ended June 30, 2014								Three Months ended June 29, 2014								Three Months ended June 30, 2013
(dollars in thousands)		Amount				% of Total				Amount				% of Total				Amount				% of Total
Net sales		$	—			n/a				$	202,598				100.0	%		$	192,711				100.0	%
Cost of sales (exclusive of depreciation and amortization shown separately below)			—			n/a					103,927				51.3	%			100,338				52.1	%
Selling			—			n/a					28,195				13.9	%			25,705				13.3	%
Warehouse & delivery			—			n/a					22,248				11.0	%			20,794				10.8	%
General & administrative			—			n/a					11,755				5.8	%			8,704				4.5	%
Stock compensation			—			n/a					38,721				19.1	%			4,580				2.4	%
Transaction, acquisition and integration (a)			22,018			n/a					31,681				15.6	%			2,153				1.1	%
Depreciation			—			n/a					7,281				3.6	%			6,273				3.3	%
Amortization			—			n/a					5,549				2.7	%			5,559				2.9	%
Management fees to related party			—			n/a					15				0.0	%			—				0.0	%
Other expense			—			n/a					211				0.1	%			1,032				0.5	%
(Loss) income from operations			(22,018	)		n/a					(46,985	)			-23.2	%			17,573				9.1	%
Interest expense, net			—			n/a					11,605				5.7	%			12,102				6.3	%
Interest expense on junior subordinated notes			—			n/a					3,153				1.6	%			3,153				1.6	%
Investment income on trust common securities			—			n/a					(94	)			0.0	%			(95	)			0.0	%
(Loss) income before income taxes			(22,018	)		n/a					(61,649	)			-30.4	%			2,413				1.3	%
Income tax benefit			(6,228	)		n/a					(21,185	)			-10.5	%			(2,250	)			-1.2	%
Net (loss) income		$	(15,790	)		n/a				$	(40,464	)			-20.0	%		$	4,663				2.4	%

 

(a)	Represents expenses for investment banking, legal and other professional fees incurred in connection with the Merger Transaction and the Paulin Acquisition.

 

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Current Economic Conditions

The Company’s 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. In recent quarters, operations have been negatively impacted by the slow, uneven growth in the U.S. economy and the retail market we sell into. Although there have been certain signs of improvement in the economy and stabilization of domestic credit markets from the height of the financial crisis, general expectations do not call for significant economic growth to return in the near term and may have the effect of reducing consumer spending which could adversely affect our results of operations during the remainder of 2014 and 2015.

The Company is sensitive to inflation or deflation present in the economies of the United States and foreign suppliers located primarily in Taiwan and China. Unfavorable exchange rate fluctuations have increased the costs for many of our products. The Company may take pricing action in an attempt to offset a portion of the product cost increases. The ability of the Company’s operating divisions to institute price increases and seek price concessions, as appropriate, is dependent on competitive market conditions.

The Three Months Ended June 29, 2014 vs the Three Months Ended June 30, 2013

Net Sales

Net sales for the second quarter of 2014 were $202.6 million, an increase of $9.9 million compared to net sales of $192.7 million for the second quarter of 2013. The increase in revenue was primarily the result of sales improvement of fastener and key products in our national accounts customers together with the Paulin business which contributed approximately $1.6 million in incremental net sales to the second quarter of 2014.

Expenses

Operating expenses were higher for the three months ended June 29, 2014 than the three months ended June 30, 2013. The primary reason for the increase in operating expenses was the incremental costs resulting from higher sales volume together with administrative, stock compensation, and transaction expense incurred in connection with the Merger Transaction. The following changes in underlying trends impacted the change in operating expenses:

 

•

The Company’s cost of sales was $103.9 million, or 51.3% of net sales, in the second quarter of 2014, an increase of $3.6 million compared to $100.3 million, or 52.1% of net sales, in the second quarter of 2013. The primary reason for the increase in cost of sales in the second quarter of 2014 was the increase in net sales of $9.9 million from the prior year period. Purchasing efficiencies and stable inventory prices allowed the cost of sales expressed as a percentage of net sales to improve from the prior year in spite of incremental Paulin business which carries a higher cost of sales percentage.

 

•

Selling expense was $28.2 million, or 13.9% of net sales, in the second quarter of 2014, an increase of $2.5 million compared to $25.7 million, or 13.3% of net sales, in the second quarter of 2013. The increase in selling expense was the result of higher set up costs on customer displays, commissions on key vending sales, and sales service payroll and payroll benefit related expenditures.

 

•

Warehouse and delivery expense was $22.2 million, or 11.0% of net sales, in the second quarter of 2014, an increase of $1.4 million compared to warehouse and delivery expense of $20.8 million, or 10.8% of net sales, in the second quarter of 2013. In the second quarter of 2014, higher warehouse and delivery expenses were attributable to the higher sales volume and higher freight and delivery costs.

 

•

General and administrative (“G&A”) expenses were $11.8 million in the second quarter of 2014, an increase of $3.1 million compared to $8.7 million in the second quarter of 2013. The G&A expenses in the 2014 period include compensation related cost from the Merger Transaction of approximately $2.7 million.

 

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•

Stock compensation expenses from stock options primarily related to the Merger Transaction resulted in cost of $38.7 million in the second quarter of 2014. The stock compensation expense was $4.6 million in the second quarter of 2013. The increase in stock compensation expense was the result of an increase in the fair value of the underlying common stock and accelerated vesting of stock options as a result of the Merger Transaction.

 

•

Transaction expenses of $31.7 million in the second quarter of 2014 represent costs for investment banking, legal, and other expenses incurred in connection with the Merger Transaction. Acquisition and integration costs of $2.2 million in the second quarter of 2013 were the result of the Paulin Acquisition and integration.

 

•

Depreciation expense was $7.3 million in the second quarter of 2014 compared to $6.3 million in the second quarter of 2013. The increase in depreciation relates primarily to the increasing placement of FastKey machines in Walmart stores during the first six months of 2014 and the last six months of 2013.

 

•

Interest expense, net, was $11.6 million in the second quarter of 2014 compared to $12.1 million in the second quarter of 2013. The decrease in interest expense was primarily the result of a 50 basis point reduction in the interest rate for the Prior Credit Agreement as a result of an amendment to the credit agreement dated December 19, 2013.

The One Day Ended June 30, 2014

The Merger Transaction was consummated on June 30, 2014 and no revenue or operating expenses were incurred in this one day period. Transaction expenses of $22.0 million represent costs for legal, professional, diligence, and other expenses incurred by the Successor in connection with the Merger Transaction.

 

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Results of Operations (continued)

 

The following analysis of results of operations includes a brief discussion of the factors that affected the Company’s operating results and a comparative analysis of the periods for the one day ended June 30, 2014, the six months ended June 29, 2014, and six months ended June 30, 2013.

 

		Successor								Predecessor
		One Day ended June 30, 2014								Six Months ended June 29, 2014								Six Months ended June 30, 2013
(dollars in thousands)		Amount				% of Total				Amount				% of Total				Amount				% of Total
Net sales		$	—			n/a				$	357,377				100.0	%		$	336,630				100.0	%
Cost of sales (exclusive of depreciation and amortization shown separately below)			—			n/a					183,342				51.3	%			173,984				51.7	%
Selling			—			n/a					55,312				15.5	%			48,965				14.5	%
Warehouse & delivery			—			n/a					41,449				11.6	%			37,155				11.0	%
General & administrative			—			n/a					20,772				5.8	%			17,191				5.1	%
Stock compensation expense			—			n/a					39,229				11.0	%			4,841				1.4	%
Transaction, acquisition and integration (a)			22,018			n/a					31,681				8.9	%			4,182				1.2	%
Depreciation			—			n/a					14,149				4.0	%			11,815				3.5	%
Amortization			—			n/a					11,093				3.1	%			11,005				3.3	%
Management fees to related party			—			n/a					15				0.0	%			—				0.0	%
Other (income) expense			—			n/a					(277	)			-0.1	%			2,135				0.6	%
(Loss) income from operations			(22,018	)		n/a					(39,388	)			-11.0	%			25,357				7.5	%
Interest expense, net			—			n/a					23,150				6.5	%			24,055				7.1	%
Interest expense on junior subordinated notes			—			n/a					6,305				1.8	%			6,305				1.9	%
Investment income on trust common securities			—			n/a					(189	)			-0.1	%			(189	)			-0.1	%
Loss before income taxes			(22,018	)		n/a					(68,654	)			-19.2	%			(4,814	)			-1.4	%
Income tax benefit			(6,228	)		n/a					(24,128	)			-6.8	%			(4,892	)			-1.5	%
Net (loss) income		$	(15,790	)		n/a				$	(44,526	)			-12.5	%		$	78				0.0	%

The Six Months Ended June 29, 2014 vs the Six Months Ended June 30, 2013

Net Sales

Net sales for the first six months of 2014 were $357.4 million, an increase of $20.7 million compared to net sales of $336.6 million for the first six months of 2013. The increase in revenue was primarily attributable to the inclusion of the Paulin business which contributed approximately $14.2 million in incremental net sales to the first six months of 2014 and approximately $6.5 million primarily from sales improvement of fastener and key products in our national accounts customers.

 

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Expenses

Operating expenses were higher for the six months ended June 29, 2014 than the six months ended June 30, 2013. The primary reason for the increase in operating expenses was the result of administrative, stock compensation, and transaction expense incurred in connection with the Merger Transaction. In addition, incremental operating expenses resulted from the inclusion of the Paulin business for the entire first six months of 2014 compared to approximately 4.5 months of the first six months of 2013. The following changes in underlying trends impacted the change in operating expenses:

 

•

The Company’s cost of sales was $183.3 million, or 51.3% of net sales, in the first six months of 2014, an increase of $9.4 million compared to $174.0 million, or 51.7% of net sales, in the first six months of 2013. The primary reason for the increase in cost of sales was the inclusion of the Paulin business in the entire first six months of 2014. Purchasing efficiencies and stable inventory prices allowed the cost of sales expressed as a percentage of net sales to improve from the prior year in spite of incremental Paulin business which carries a higher cost of sales percentage.

 

•

Selling expense was $55.3 million, or 15.5% of net sales, in the first six months of 2014, an increase of $6.3 million compared to $49.0 million, or 14.5% of net sales, in the first six months of 2013. An increase of approximately $1.4 million in the first six months of 2014 was attributable to the new Paulin business. The selling costs from the remaining Hillman businesses were approximately $4.9 million higher than the comparable 2013 period as a result of higher set up costs on customer displays, commissions on key vending sales, and sales service payroll and payroll benefit related expenditures.

 

•

Warehouse and delivery expense was $41.4 million, or 11.6% of net sales, in the first six months of 2014, an increase of $4.3 million compared to warehouse and delivery expense of $37.2 million, or 11.0% of net sales, in the first six months of 2013. In the first six months of 2014, additional warehouse and delivery expenses of approximately $2.7 million was attributable to the new Paulin business and incremental costs from higher sales volume and freight rates contributed to the remaining unfavorable variance to the prior year period.

 

•

General and administrative (“G&A”) expenses were $20.8 million in the first six months of 2014, an increase of $3.6 million compared to $17.2 million in the first six months of 2013. The G&A expenses in the 2014 period included approximately $2.7 million of compensation related cost from the Merger Transaction and approximately $1.2 million of additional costs from the inclusion of the Paulin business.

 

•

Stock compensation expenses from stock options primarily related to the Merger Transaction resulted in cost of $39.2 million in the first six months of 2014. The stock compensation expense was $4.2 million in the first six months of 2013. The increase in stock compensation expense was the result of an increase in the fair value of the underlying common stock and accelerated vesting of stock options as a result of the Merger Transaction.

 

•

Transaction expenses of $31.7 million in the first six months of 2014 represent costs for investment banking, legal, and other expenses incurred in connection with the Merger Transaction. Acquisition and integration costs were $4.2 million in the first six months of 2013 as a result of the Paulin Acquisition and integration.

 

•

Depreciation expense was $14.1 million in the first six months of 2014, an increase of $2.3 million compared to $11.8 million in the first six months of 2013. Depreciation expense of approximately $1.3 million was attributable to the fixed assets acquired in the Paulin Acquisition. The remaining increase in depreciation relates primarily to the increased placement of FastKey machines in Walmart stores during the first six months of 2014 and the last six months of 2013.

 

•

Interest expense, net, was $23.2 million in the first six months of 2014 compared to $24.1 million in the first six months of 2013. The decrease in interest expense was primarily the result of a 50 basis point reduction in the interest rate for the Prior Senior Facilities as a result of an amendment to the credit agreement dated December 19, 2013.

 

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The One Day Ended June 30, 2014

The Merger Transaction was consummated on June 30, 2014 and no revenue or operating expenses were incurred in this one day period. Transaction expenses of $22.0 million represent costs for legal, professional, diligence, and other expenses incurred by the Successor in connection with the Merger Transaction.

Income Taxes

In the one day Successor period ended June 30, 2014, the Company recorded an income tax benefit of $6.2 million on a pre-tax loss of $22.0 million. The effective income tax rate was 28.3% for the one day Successor period ended June 30, 2014. In the six month Predecessor period ended June 29, 2014, the Company recorded an income tax benefit of $24.1 million on a pre-tax loss of $68.6 million. In the three month Predecessor period ended June 29, 2014, the Company recorded an income tax benefit of $21.2 million on a pre-tax loss of $61.6 million. The effective income tax rates were 35.1% and 34.4% for the six and three month Predecessor periods ended June 29, 2014.

In the six month Predecessor period ended June 30, 2013, the Company recorded an income tax benefit of $4.9 million on a pre-tax loss of $4.8 million. In the three month Predecessor period ended June 30, 2013, the Company recorded an income tax benefit of $2.2 million on a pre-tax income of $2.4 million. The effective income tax rates were 101.6% and -93.2% for the six and three month Predecessor periods ended June 30, 2013.

The difference between the effective income tax rate and the federal statutory rate in the one day Successor period ended June 30, 2014 and the six and three month Predecessor periods ended June 29, 2014 was affected by certain non-deductible costs associated with the Merger Transaction. The difference between the effective income tax rate and the federal statutory rate in the six and three month Predecessor periods ended June 29, 2014 was also affected by changes, in the second quarter, in certain state income tax rates used in computing the Company’s deferred tax assets and liabilities. The remaining differences between the federal statutory rate and the effective tax rate in the one day Successor period ended June 30, 2014 was primarily due to state income taxes. The remaining differences between the effective income tax rate and the federal statutory rate in the six and three month Predecessor periods ended June 29, 2014 was primarily due to state and foreign income taxes.

The difference between the effective income tax rate and the federal statutory rate in the six and three month Predecessor periods ended June 30, 2013 was affected by a valuation reserve recorded to offset the deferred tax assets of a foreign subsidiary. The effective income tax rate in the six and three month Predecessor periods ended June 30, 2013 was affected by the change, in the second quarter, of the estimated annual effective tax rate used to compute the interim tax provision as required by ASC 740-270, the accounting guidance established for computing income taxes in interim periods. The net effect of the change was recorded in the current period as required by the accounting standard. The effective income tax rate in the six and three month Predecessor periods ended June 30, 2013 was also affected by changes, in the second quarter, in certain state income tax rates used in computing the Company’s deferred tax assets and liabilities and a reduction of valuation reserves related to certain deferred tax assets. The remaining differences between the effective income tax rate and the federal statutory rate in the six and three month Predecessor periods ended June 30, 2013 was primarily due to state and foreign income taxes.

 

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Liquidity and Capital Resources

Cash Flows

The statements of cash flows reflect the changes in cash and cash equivalents for the one day ended June 30, 2014 (Successor), six months ended June 29, 2014 (Predecessor), and the six months ended June 30, 2013 (Predecessor) by classifying transactions into three major categories: operating, investing, and financing activities. The cash flows from the Merger Transaction are separately discussed below.

Merger Transaction

In connection with the Merger Transaction, Successor Holdco issued common stock for $542.9 million in cash. Proceeds from borrowings under the Senior Facilities provided an additional $566.0 million and proceeds from the 6.375% Senior Notes provided $330.0 million, less net aggregate financing fees of $26.4 million. The debt and equity proceeds were used to repay the existing senior debt, 10.875% Senior Notes, and accrued interest thereon of $657.6 million, to repurchase the existing shareholders’ common equity and stock options of $727.3 million. The remaining proceeds were used to pay transaction expenses of $22.0 million and prepaid expenses of $0.1 million.

Operating Activities

Net cash provided by operating activities for the six months ended June 29, 2014 of $11.7 million was the result of the net loss adjusted for non-cash items of $41.3 million for depreciation, amortization, deferred taxes, deferred financing, and stock-based compensation together with cash related adjustments of $14.9 million for routine operating activities represented by changes in accounts receivable, inventories, accounts payable, accrued liabilities, and other assets. In the first six months of 2014, routine operating activities used cash through an increase in accounts receivable of $25.2 million, an increase in inventories of $17.9 million, and an increase in other items of $3.8 million. This was partially offset by an increase in accounts payable of $20.8 million, an increase in other accrued liabilities of $31.2 million, decrease in other assets of $8.8 million, and an increase of $1.0 million in interest payable on the junior subordinated debentures. In the first six months of 2014, increases in the accounts payable and accrued liabilities provided cash that was primarily used for seasonal increases in accounts receivable and inventory.

Net cash provided by operating activities for the six months ended June 30, 2013 of $3.8 million was the result of the net income adjusted for non-cash items of $21.6 million for depreciation, amortization, deferred taxes, deferred financing, stock-based compensation, and non-cash interest which was offset by cash related adjustments of $17.9 million for routine operating activities represented by changes in accounts receivable, inventories, accounts payable, accrued liabilities, and other assets. In the first six months of 2013, routine operating activities used cash through an increase in accounts receivable of $25.6 million, an increase in inventories of $4.4 million, a decrease in other accrued liabilities of $1.8 million and increase in other items of $6.7 million. This was partially offset by increase in other assets of $1.7 million, an increase in accounts payable of $8.0 million, and an increase of $1.0 million in interest payable on the junior subordinated debentures. In the first six months of 2013, the increase in accounts receivable was the primary use of cash flow from operating activities for the period.

 

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Investing Activities

Net cash used for investing activities was $12.9 million for the six months ended June 29, 2014. Capital expenditures for the six months ended June 29, 2014 totaled $12.9 million, consisting of $6.7 million for key duplicating machines, $2.9 million for engraving machines, $2.8 million for computer software and equipment, and $0.5 million for machinery and equipment.

Net cash used for investing activities was $118.0 million for the six months ended June 30, 2013. The Company used $103.4 million for the Paulin Acquisition. Capital expenditures for the six months totaled $14.6 million, consisting of $8.6 million for key duplicating machines, $1.7 million for engraving machines, $2.8 million for computer software and equipment, and $1.5 million for machinery and equipment.

Financing Activities

Net cash used for financing activities was $0.6 million for the six months ended June 29, 2014. The Company received cash of $0.5 million from the exercise of stock options and used cash to pay $1.0 million in principal payments on the senior term loans under the Senior Facilities and $0.1 million in principal payments under capitalized lease obligations.

Net cash provided by financing activities was $72.4 million for the six months ended June 30, 2013. The borrowings on senior term loans provided $74.6 million, net of the discount of $2.2 million, and were used together with a portion of the borrowings on the 10.875% Senior Notes to pay the purchase price of the Paulin Acquisition and for other corporate purposes. In addition, the Company used cash to pay $1.8 million in principal payments on the senior term loans under the Prior Senior Facilities and $0.5 million in principal payments on other credit obligations.

Liquidity

The Company’s management believes 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.

The Company’s working capital (current assets minus current liabilities) position of $239.3 million as of June 30, 2014 represents an increase of $0.5 million from the December 31, 2013 level of $238.8 million.

 

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Contractual Obligations

The Company’s contractual obligations in thousands of dollars as of June 30, 2014 were as follows:

 

						Payments Due
Contractual Obligations		Total				Less Than 1 Year				1 to 3 Years				3 to 5 Years				More Than 5 Years
Junior Subordinated Debentures (1)		$	131,141			$	—			$	—			$	—			$	131,141
Interest on Jr Subordinated Debentures			162,066				12,231				24,463				24,463				100,909
Senior Term Loans			550,000				5,500				11,000				11,000				522,500
Bank Revolving Credit Facility			16,000				—				—				16,000				—
6.375% Senior Notes			330,000				—				—				—				330,000
KeyWorks License Agreement			2,585				426				807				750				602
Interest Payments (2)			336,471				45,769				90,839				89,906				109,957
Operating Leases			62,246				9,509				12,707				9,999				30,031
Deferred Compensation Obligations			1,998				280				—				—				1,718
Capital Lease Obligations			800				300				384				99				17
Purchase Obligations (3)			1,050				350				350				350				—
Other Obligations			1,435				783				522				130				—
Uncertain Tax Position Liabilities			465				—				—				55				410
Total Contractual Cash Obligations (4)		$	1,596,257			$	75,148			$	141,072			$	152,752			$	1,227,285

 

(1)	The junior subordinated debentures liquidation value is approximately $108,704.

(2)

Interest payments for borrowings under the Senior Facilities and the 6.375% Senior Notes. Interest payments on the variable rate Senior Term Loans were calculated using the actual interest rate of 4.50% as of June 30, 2014. Interest payments on the 6.375% Senior Notes were calculated at their fixed rate.

(3)

The Company has a purchase agreement with our supplier of key blanks which requires minimum purchases of 100 million key blanks per year. To the extent minimum purchases of key blanks are below 100 million, the Company must pay the supplier $0.0035 per key multiplied by the shortfall. Since the inception of the contract in 1998, the Company has purchased more than the requisite 100 million key blanks per year from the supplier. In 2013, the Company extended this contract for an additional three years.

(4)	All of the contractual obligations noted above are reflected on the Company’s condensed consolidated balance sheet as of June 30, 2014 except for the interest payments, purchase obligations, and operating leases.

 

As of June 30, 2014, the Company had no material purchase commitments for capital expenditures.

Off-Balance Sheet Arrangements

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

 

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Borrowings

As of June 30, 2014, the Company had $50.4 million available under the Senior Facilities. The Company had approximately $566.7 million of outstanding debt under its Senior Facilities at June 30, 2014, consisting of $550.0 million in a term loan, $16.0 million in Revolver borrowings, and $0.7 million in capitalized lease and other obligations. The term loan consisted of a $550.0 million Term B-2 Loan at an interest rate of 4.5%. The Revolver borrowings consisted of $16.0 million at an interest rate of 3.40% and the capitalized lease obligations were at various interest rates.

At June 30, 2014 and December 31, 2013, the Company’s borrowings were as follows:

 

		Successor														Predecessor
		June 30, 2014														December 31, 2013
(dollars in thousands)		Facility Amount				Outstanding Amount				Interest Rate						Facility Amount				Outstanding Amount				Interest Rate
Term B-2 Loan						$	550,000				4.50	%								$	385,399				3.75	%
Revolving credit facility		$	70,000				16,000				3.40	%				$	30,000				—				—
Capital leases & other obligations							714				various										556				various
Total secured credit							566,714														385,955
Senior notes							330,000				6.375	%									265,000				10.875	%
Total borrowings						$	896,714													$	650,955

Descriptions of the Company’s credit agreement governing the Senior Facilities, as amended, and the Senior Notes are contained in the “Financing Arrangements” section of this report on Form 10-Q.

Terms of the Senior Facilities subject the Company to a revolving facility test condition whereby a senior secured leverage ratio covenant of no greater than 6.5 times last twelve months Adjusted Ebitda comes into effect if more than 35% of the total Revolver commitment is drawn or utilized in letters of credit at the end of a fiscal quarter. If this covenant comes into effect, it may restrict the Company’s ability to incur debt, make investments, pay dividends to holders of the Trust Preferred Securities, or undertake certain other business activities. As of June 30, 2014, the total revolving credit commitment of the Company was 28.0% utilized.

Adjusted Ebitda for the twelve months ended June 30, 2014 is $135,935. Adjusted Ebitda is defined as loss from operations ($-30,322), plus depreciation ($27,130), amortization ($22,200), stock compensation expense ($43,394), restructuring costs ($3,329), transaction costs ($55,220), acquisition and integration costs ($6,141), foreign exchange losses ($491), management fees ($92), losses on dispositions of PP&E ($738), other ($421) and pro forma cost savings ($7,101).

 

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Critical Accounting Policies and Estimates

Significant accounting policies and estimates are summarized in the notes to the condensed consolidated financial statements. Some accounting policies require management to exercise significant judgment in selecting the appropriate assumptions for calculating financial estimates. Such judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, known trends in our industry, terms of existing contracts, and other information from outside sources, as appropriate. Management believes that these estimates and assumptions are reasonable based on the facts and circumstances as of June 30, 2014, however, actual results may differ from these estimates under different assumptions and circumstances.

Our critical accounting policies and estimates are discussed in the “Critical Accounting Policies and Estimates” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the Securities and Exchange Commission. In addition, our most significant accounting policies are discussed in Note 2 and elsewhere in the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2013, which includes audited financial statements.

 

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Item 3.

Quantitative and Qualitative Disclosures About Market Risk

The Company is exposed to the impact of interest rate changes as borrowings under the Senior Facilities bear interest at variable interest rates. It is the Company’s policy to enter into interest rate swap and interest rate cap transactions only to the extent considered necessary to meet our objectives.

Based on the Company’s exposure to variable rate borrowings at June 30, 2014, 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 $5.7 million.

The Company is exposed to foreign exchange rate changes of the Australian, Canadian, and Mexican currencies as it impacts the $125.5 million tangible and intangible net asset value of our Australian, Canadian, and Mexican subsidiaries as of June 30, 2014. The foreign subsidiaries net tangible assets were $80.5 million and the net intangible assets were $45.0 million as of June 30, 2014.

The Company utilizes foreign exchange forward contracts to manage the exposure to currency fluctuations in the Canadian dollar versus the U.S. Dollar.

Item 4.

Controls and Procedures

Disclosure Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the chief executive officer and the chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based upon that evaluation, the Company’s chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures were effective, as of June 30, 2014, in ensuring that material information relating to the Company required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including the chief executive officer and the chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the quarter ended June 30, 2014 and that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II

OTHER INFORMATION

Item 1. – Legal Proceedings.

The information set forth under Note 6 to the accompanying condensed consolidated financial statements included in this Quarterly Report on Form 10-Q is incorporated herein by reference.

Item 1A. – Risk Factors.

An investment in the Company’s securities involves certain risks as discussed below. However, the risks set forth below are not the only risks that the Company faces, 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, the Company’s business, financial condition, and results of operations could be materially adversely affected. You should consider carefully the risks described below and all other information in this Form 10-Q, including the Company’s financial statements and the related notes and schedules thereto, prior to making an investment decision with regard to the Company’s securities. The risk factors presented below represent an update to all of our risk factors disclosed in Part I, Item IA of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 as a result of the Merger Transaction.

A prolonged economic downturn may adversely impact demand for our products, reduce access to credit, and cause our customers and others with which we do business to suffer financial hardship, all of which could adversely impact our business, results of operations, financial condition, and cash flows.

Our business, financial condition, and results of operations have and may continue to be affected by various economic factors. The U.S. economy is experiencing an uneven recovery following a protracted slowdown, and the future economic environment may continue to be challenging. The economic slowdown has led to reduced consumer and business spending and any delay in the recovery could lead to further reduced spending in the foreseeable future, including by our customers. In addition, economic conditions, including decreased access to credit, may result in financial difficulties leading to restructurings, bankruptcies, liquidations, and other unfavorable events for our customers, suppliers, and other service providers. If such conditions deteriorate in 2014 or through 2015, our industry, business, and results of operations may be materially adversely impacted.

The Company’s business is impacted by general economic conditions in the U.S., Canada, and other international markets, particularly the U.S. retail markets including hardware stores, home centers, mass merchants, and other retailers. In recent quarters, operations have been negatively impacted by the slow growth in the U.S. economy, including higher unemployment figures, and the contraction of the retail market. Although there have been certain signs of improvement in the economy and stabilization of domestic credit markets from the height of the financial crisis, general expectations do not call for significant economic growth to return in the near term and may have the effect of reducing consumer spending which could adversely affect our results of operations during the next year.

If the current weakness continues in the retail markets including hardware stores, home centers, mass merchants, and other retail outlets in North America, or general recessionary conditions worsen, it could have a material adverse effect on the Company’s business.

In the past several years, the Company’s business has been adversely affected by the decline in the North American economy, particularly with respect to retail markets including hardware stores, home centers, lumberyards, and mass merchants. It is possible that this softness will continue or further deteriorate in 2014 or through 2015. To the extent that this decline persists or deteriorates, there is likely to be an unfavorable impact on demand for Company products which could have a material adverse effect on sales, earnings, and cash flows. In addition, due to current economic conditions, it is possible that certain customers’ credit-worthiness may erode and result in increased write-offs of customer receivables.

The Company operates 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,

 

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such as merchandising design, in-store service, and inventory management. The Company encounters competition from a large number of regional and national distributors, some of which have greater financial resources than the Company and may offer a greater variety of products. If these competitors are successful, the Company’s business, financial condition, and results of operations may be materially adversely affected.

To compete successfully, the Company 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. The Company also faces the risk that our competitors will introduce innovative new products that compete with the Company’s products. The Company’s 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.

The Company’s business may be adversely affected by seasonality.

In general, the Company has 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, the Company’s 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 the Company’s business.

The Company’s three largest customers constituted approximately 39.7% of net sales and 44.2% of the year-end accounts receivable balance for 2013. Each of these customers is a big box chain store. As a result, the Company’s 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 current economic slowdown, 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 the Company’s business. The Company’s inability to penetrate new channels of distribution may also have a negative impact on our future sales and business.

Successful sales and marketing efforts depend on the Company’s ability to recruit and retain qualified employees.

The success of the Company’s 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. The Company must therefore continue to 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 the Company’s ability to implement our growth strategy.

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

Exposure to foreign currency risk results because the Company, through our global operations, enters into transactions and makes investments denominated in multiple currencies. The Company’s predominant exposures are in Canadian, Australian, Mexican, and Asian currencies, including the Chinese Renminbi (“RMB”). In preparing the Company’s 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

 

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rates. With respect to the effects on translated earnings, if the U.S. dollar strengthens relative to local currencies, the Company’s earnings could be negatively impacted. The Company does not make a practice of hedging our non-U.S. dollar earnings.

The Company sources many products from China and other Asian countries for resale in other regions. To the extent that the RMB or other currencies appreciate with respect to the U.S. dollar, the Company may experience cost increases on such purchases. The RMB appreciated against the U.S. dollar by 2.8% in 2013, 1.0% in 2012, and 4.6% in 2011. Significant appreciation of the RMB or other currencies in countries where the Company sources our products could adversely impact the Company’s profitability. In addition, the Company’s foreign subsidiaries 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. The Company has a practice of hedging some of its Canadian subsidiary’s purchases denominated in U.S. dollars. The Company 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.

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

The Company’s products are manufactured of metals, including but not limited to steel, aluminum, zinc, and copper. Additionally, the Company uses other commodity-based materials in the manufacture of LNS that are resin-based and subject to fluctuations in the price of oil. The Company is 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 the Company is unable to mitigate these inflation increases through various customer pricing actions and cost reduction initiatives, the Company’s financial condition may be adversely affected. Conversely, in the event that there is deflation, the Company may experience pressure from our customers to reduce prices. There can be no assurance that the Company 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 the Company’s 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, Australia, Latin America, and the Caribbean. Because we sell our 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;

 

•

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

 

•

difficulties associated with repatriating cash in a tax-efficient manner.

 

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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.

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

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

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

Acquisitions have formed a significant part of our growth strategy in the past, including the acquisition of Paulin in 2013, and may continue to do so. If we are unable to identify suitable acquisition candidates or obtain financing needed to complete an acquisition, our growth strategy may not succeed.

Historically, the Company’s growth strategy has relied on acquisitions that either expand or complement our businesses in new or existing markets, including the Paulin Acquisition in 2013, which expanded our presence in Canada. However, there can be no assurance that the Company will be able to identify or acquire acceptable acquisition candidates on terms favorable to the Company and in a timely manner, if at all, to the extent necessary to fulfill Hillman’s growth strategy.

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

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 the Company were required to write down all or part of our goodwill or indefinite-lived tradenames, our results of operations could be materially adversely affected.

As a result of the Merger Transaction, the Company has $789.1 million of goodwill and $80.0 million of indefinite-lived trade names recorded on our Consolidated Balance Sheet at June 30, 2014. The Company is required to periodically determine if our goodwill or indefinite-lived trade names have become impaired, in which case we would

 

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write down the impaired portion of the intangible asset. If the Company were required to write down all or part of our goodwill or indefinite-lived trade names, our net income could be materially adversely affected.

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

The Company believes that our proprietary computer software programs are an integral part of our business and growth strategies. Hillman depends 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), the Company may suffer disruption in its ability to manage and operate its business.

There can be no assurance that the precautions which the Company has 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 the Company’s business and results of operations.

In addition, we are in the process of implementing a new 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 new 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. The Company attempts 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.

 

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Risks relating to the Senior Notes and our Indebtedness

The Company has significant indebtedness that could affect operations and financial condition and prevent the Company from fulfilling our obligations under the notes.

The Company has a significant amount of indebtedness. On June 30, 2014, total indebtedness was $1,002.1 million, consisting of $105.4 million of indebtedness of Hillman and $896.7 million of indebtedness of Hillman Group.

The Company’s substantial indebtedness could have important consequences to investors in Hillman securities. For example, it could:

 

•

make it more difficult for the Company to satisfy obligations to holders of the notes;

 

•

increase the Company’s 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 the Company at a competitive disadvantage compared to competitors that have less debt; and

 

•

limit the Company’s ability to borrow additional funds.

In addition, the indenture governing our notes and senior secured credit facilities contain financial and other restrictive covenants that will limit the ability to engage in activities that may be in the Company’s 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.

The decline of general economic conditions in the U.S. capital markets over the past several years has reduced the availability of credit for a number of companies. This may impact our ability to borrow additional funds, if necessary.

Despite current indebtedness levels, the Company may still be able to incur substantially more debt. This could further exacerbate the risks associated with the Company’s substantial leverage.

The Company may be able to incur substantial additional indebtedness in the future. The terms of the indenture do not fully prohibit the Company or our subsidiaries from doing so. The senior secured credit facilities permit additional borrowing of up to $70.0 million on the revolving credit facility and all of those borrowings would rank senior to the notes and the guarantees. If new debt is added to our current debt levels, the related risks that the Company and our subsidiaries now face could intensify.

To service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control.

The ability to make payments on and to refinance our indebtedness, including the notes, and to fund planned capital expenditures and research and development efforts, will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory, and other factors that are beyond our control.

The Company cannot assure you that our business will generate sufficient cash flow from operations, that currently anticipated cost savings and operating improvements will be realized on schedule, or that future borrowings will be available under our credit facility in an amount sufficient to enable the Company to pay our indebtedness, including the notes, or to fund our other liquidity needs. The Company may need to

 

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refinance all or a portion of our indebtedness, including the notes on or before maturity. The Company cannot assure you that we will be able to refinance any of our indebtedness, including our credit facility and the notes, on commercially reasonable terms or at all.

The failure to meet certain financial covenants required by our credit agreements may materially and adversely affect assets, financial position, and cash flows.

Certain of the Company’s 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 maximum allowed senior secured leverage requirement is 6.50x, excluding the junior subordinated debentures, as of June 30, 2014. A breach of the leverage 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.

The Company is permitted to create unrestricted subsidiaries, which are not to be subject to any of the covenants in the indenture, and the Company may not be able to rely on the cash flow or assets of those unrestricted subsidiaries to pay our indebtedness.

Unrestricted subsidiaries are not subject to the covenants under the indenture governing the notes. Unrestricted subsidiaries may enter into financing arrangements that limit their ability to make loans or other payments to fund payments in respect of the notes. Accordingly, the Company may not be able to rely on the cash flow or assets of unrestricted subsidiaries to pay any of our indebtedness, including the notes.

The Company is subject to fluctuations in interest rates.

All of our indebtedness incurred in connection with the Senior Facilities has variable rate interest. Increases in borrowing rates will increase our cost of borrowing, which may affect our results of operations and financial condition.

The Company may choose to redeem notes when prevailing interest rates are relatively low.

The Company may choose to redeem the notes from time to time, especially when prevailing interest rates are lower than the rate borne by the notes. If prevailing rates are lower at the time of redemption, an investor would not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as the interest rate on the notes being redeemed. The redemption right also may adversely impact an investor’s ability to sell notes as the optional redemption date or period approaches.

Federal and state statutes allow courts, under specific circumstances, to void guarantees and require note holders to return payments received from guarantors.

Under the federal bankruptcy law and comparable provisions of state fraudulent transfer laws, a guarantee could be voided, or claims in respect of a guarantee could be subordinated to all other debts of that guarantor if, among other things, the guarantor, at the time it incurred the indebtedness evidenced by its guarantee:

 

•

received less than reasonably equivalent value or fair consideration for the incurrence of such guarantee; and

 

•

was insolvent or rendered insolvent by reason of such incurrence; or

 

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•

was engaged in a business or transaction for which the guarantor’s remaining assets constituted unreasonably small capital; or

 

•

intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature.

In addition, any payment by that guarantor pursuant to its guarantee could be voided and required to be returned to the guarantor, or to a fund for the benefit of the creditors of the guarantor.

The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a guarantor would be considered insolvent if:

 

•

the sum of its debts, including contingent liabilities, was greater than the fair saleable value of all of its assets; or

 

•

if the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or

 

•

it could not pay its debts as they become due.

On the basis of historical financial information, recent operating history, and other factors, the Company’s management believes that each guarantor, after giving effect to its guarantee of the notes, will not be insolvent, have unreasonably small capital for the business in which it is engaged, or have incurred debts beyond its ability to pay such debts as they mature. The Company’s management can make no assurances as to what standard a court would apply in making these determinations or that a court would agree with our conclusions in this regard.

The Company may not be able to fulfill our repurchase obligations with respect to the notes upon a change of control.

If the Company experiences certain specific change of control events, the Company will be required to offer to repurchase all of our outstanding notes at 101% of the principal amount of such notes plus accrued and unpaid interest to the date of repurchase. The Company can make no assurances that it will have available funds sufficient to pay the change of control purchase price for any or all of the notes that might be tendered in the change of control offer.

The definition of change of control in the indenture governing the notes includes a phrase relating to the direct or indirect sale, transfer, conveyance, or other disposition of “all or substantially all” of our and our restricted subsidiaries’ assets, taken as a whole. Although there is a limited body of case law interpreting the phrase “substantially all”, there is no precise established definition of the phrase under applicable law. Accordingly, the ability of a holder of notes to require us to repurchase such notes as a result of a sale, transfer, conveyance, or other disposition of less than all of our restricted subsidiaries’ assets taken as a whole to another person or group may be uncertain. In addition, a recent Delaware Chancery Court decision raised questions about the enforceability of provisions, which are similar to those in the indenture governing the notes, related to the triggering of a change of control as a result of a change in the composition of a board of directors. Accordingly, the ability of a holder of notes to require us to repurchase notes as a result of a change in the composition of our board of directors may be uncertain.

In addition, our credit facility contains, and any future credit agreement likely will contain, restrictions or prohibitions on our ability to repurchase the notes under certain circumstances. If a change of control event occurs at a time when we are prohibited from repurchasing the notes, we may seek the consent of our lenders to purchase the notes or could attempt to refinance the borrowings that contain these prohibitions or restrictions. If we do not obtain our lenders’ consent or refinance these borrowings, we will not be able to repurchase the notes. Accordingly, the

 

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holders of the notes may not receive the change of control purchase price for their notes in the event of a sale or other change of control, which will give the trustee and the holders of the notes the right to declare an event of default and accelerate the repayment of the notes.

A financial failure by us or our subsidiaries may result in the assets of any or all of those entities becoming subject to the claims of all creditors of those entities.

A financial failure by us or our subsidiaries could affect payment of the notes if a bankruptcy court were to substantively consolidate us and our subsidiaries. If a bankruptcy court substantively consolidated us and our subsidiaries, the assets of each entity would become subject to the claims of creditors of all entities. This would expose holders of notes not only to the usual impairments arising from bankruptcy, but also to potential dilution of the amount ultimately recoverable because of the larger creditor base. Furthermore, forced restructuring of the notes could occur through the “cram-down” provisions of the bankruptcy code. Under these provisions, the notes could be restructured over holders’ objections as to their general terms, primarily interest rate and maturity.

A holder’s right to receive payments on the notes could be adversely affected if any of our non-guarantor subsidiaries declare bankruptcy, liquidate, or reorganize.

Some but not all of our subsidiaries guarantee the notes. In the event of a bankruptcy, liquidation, or reorganization of any of our non-guarantor subsidiaries, holders of their indebtedness and their trade creditors will generally be entitled to payment of their claims from the assets of those subsidiaries before any assets are made available for distribution to us.

As of June 30, 2014, the notes were effectively junior to $27.4 million of indebtedness and other current liabilities (including trade payables) of our non-guarantor subsidiaries. Our non-guarantor subsidiaries held $162.1 million of our consolidated assets as of June 30, 2014.

Restrictions imposed by the indenture governing the 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 Credit Facilities and the indenture governing the notes restrict us and our subsidiaries 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;

 

•

create restrictions on the payment of 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 comply, under certain circumstances, with a minimum senior secured net leverage ratio covenant. 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 New Term Loan Facility. If the indebtedness under our Senior Facilities or the notes were to be accelerated, our

 

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assets may not be sufficient to repay such indebtedness in full. In particular, noteholders will be paid only if we have assets remaining after we pay amounts due on our secured indebtedness, including our Senior Credit Facilities. We have pledged a significant portion of our assets as collateral under our Senior Credit 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, including the notes. 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 and the indenture governing the notes 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 will 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, including the notes, is affected by the cash flow generated by our subsidiaries.

Our subsidiaries own substantially all of our assets and conduct substantially all of our operations. Accordingly, repayment of our indebtedness, including the notes, 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 only indebtedness, including the notes. 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, including the notes.

Item 2. – Unregistered Sales of Equity Securities and Use of Proceeds.

Not Applicable

Item 3. – Defaults Upon Senior Securities.

Not Applicable

Item 4. – Mine Safety Disclosures.

Not Applicable

Item 5. – Other Information.

Not Applicable

 

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Item 6. – Exhibits.

 

a)	Exhibits, including those incorporated by reference.

 

2.1		Agreement and Plan of Merger, dated May 16, 2014, among HMAN Group Holdings Inc., HMAN Intermediate Holdings Corp., HMAN Merger Sub Corp., OHCP HM Acquisition Corp. and the Representative (as defined therein) (1)
4.1 *		Indenture, dated as of June 30, 2014, among HMAN Finance Sub Corp., HMAN Intermediate Finance Sub Corp., as guarantor, and Wells Fargo Bank, National Association, as Trustee
4.2 *		First Supplemental Indenture, dated as of June 30, 2014, among The Hillman Group, Inc. and certain guarantors party thereto, and Wells Fargo Bank, National Association, as Trustee
10.1 *		Credit Agreement, dated as of June 30, 2014, by and among HMAN Finance Sub Corp., to be merged with and into The Hillman Group, Inc., Hillman Investment Company, HMAN Intermediate Finance Sub Corp., to be merged with and into The Hillman Companies Inc., the subsidiaries of the borrower from time to time party thereto, the financial institutions party thereto as lenders and Barclays Bank plc, as administrative agent for such lenders
10.2 *		2014 Equity Incentive Plan
31.1 *		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d- 14(a) under the Exchange Act
31.2 *		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d- 14(a) under the Exchange Act
32.1 *		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 *		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1 *		Supplemental Consolidating Guarantor and Non-Guarantor Financial Information.
101 **		The following financial information from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, filed with the Securities and Exchange Commission on August 14, 2014, formatted in eXtensible Business Reporting Language: (i) Condensed Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013, (ii) Condensed Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2014 and 2013, (iii) Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013, (iv) Condensed Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2014, and (v) Notes to Condensed Consolidated Financial Statements.

 

 

(1)	Filed as an exhibit to the Current Report on Form 8-K filed on May 19, 2014.

*	Filed herewith.

**

This exhibit will not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 (15 U.S.C. 78r), or otherwise subject to the liability of that section. Such exhibit will not be deemed to be incorporated by reference into any filing under the Securities Act or Securities Exchange Act, except to the extent that the Company specifically incorporates it by reference.

 

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SIGNATURES

Pursuant to the requirements of the Exchange Act, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

THE HILLMAN COMPANIES, INC.

 

/S/    ANTHONY A. VASCONCELLOS				/S/    HAROLD J. WILDER
Anthony A. Vasconcellos				Harold J. Wilder
Chief Financial Officer				Controller
				(Chief Accounting Officer)

DATE: August 14, 2014

 

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