Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation and Principles
of Consolidation
Houston Wire &
Cable Company (the “Company”), through its wholly owned subsidiaries, provides industrial products including electrical
wire and cable, steel wire rope and hardware, and fasteners to the U.S. market through twenty-one locations in fourteen states
throughout the United States. The Company has no other business activity.
The consolidated financial
statements as of June 30, 2020 and for the three and six months ended June 30, 2020 and 2019 have been prepared following accounting
principles generally accepted in the United States (“GAAP”) for interim financial information and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In
the opinion of management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation
of the results of these interim periods have been included. The results of operations for the interim periods are not necessarily
indicative of the results that may be expected for the full year. All significant intercompany balances and transactions have been
eliminated. The Company has evaluated subsequent events through the time these financial statements in this Form 10-Q were filed
with the Securities and Exchange Commission (the “SEC”).
The preparation of
the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. The most significant estimates are those relating to the allowance
for doubtful accounts, the refund liability, the inventory obsolescence reserve, vendor rebates, the realization of deferred tax
assets and the valuation of goodwill and indefinite-lived assets. Actual results could differ materially from the estimates and
assumptions used for the preparation of the financial statements.
For further information,
refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K
for the fiscal year ended December 31, 2019 filed with the SEC.
Risks and Uncertainties
The Company is currently
subject to additional risks and uncertainties due to the COVID-19 pandemic. The pandemic, and governmental and other actions taken
in response to it, have had an adverse effect on the demand for the Company’s products and on its results of operations,
and the virus continues to spread. Capital markets and economies worldwide have been negatively impacted by the COVID-19 pandemic,
and it is possible that the impact could cause an extended local and/or global economic recession. Such economic disruption could
have a material adverse effect on our business as companies in many industries curtail and reduce capital and overall spending.
Policymakers around the globe have responded with fiscal policy actions to support specific industries and their economies as a
whole. However, the overall effectiveness of these actions remains uncertain.
The severity of the
impact of the COVID-19 pandemic on the Company’s business will depend on a number of factors, including, but not limited to, the
duration and severity of the pandemic and the extent and severity of the impact on the Company’s customers, all of which are uncertain
and cannot be predicted. The Company’s future results of operations and liquidity could be materially adversely affected by delays
in payments of outstanding receivables, supply chain disruptions, uncertain or reduced demand, and the impact of any initiatives
or programs that the Company may undertake to address financial and operational challenges faced by its customers. As of the date
of issuance of these financial statements, the extent to which the COVID-19 pandemic may materially adversely affect the Company’s
financial condition, liquidity, or results of operations is uncertain.
Recently Adopted Accounting Standards
The Financial Accounting
Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) is the sole source of authoritative
GAAP other than SEC issued rules and regulations that apply only to SEC registrants. The FASB issues an Accounting Standard Update
(“ASU”) to communicate changes to the codification. The Company considers the applicability and impact of all ASUs.
The following are ASUs that were recently adopted by the Company.
In August 2018, the
FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements
for Fair Value Measurement.” The amendments in this update eliminate, add and modify certain disclosure requirements for
fair value measurements as part of the FASB’s disclosure framework project. The Company adopted this ASU in the first quarter
of 2020, and the adoption did not have a material impact on the Company’s consolidated financial statements.
In August 2018, the
FASB issued ASU 2018-15, “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40); Customer’s
Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” The amendments
in this update require implementation costs incurred by customers in cloud computing arrangements (i.e., hosting arrangements)
to be capitalized under the same premises of authoritative guidance for internal-use software, and deferred over the non-cancellable
term of the cloud computing arrangement plus any option renewal periods that are reasonably certain to be exercised by the customer
or for which the exercise is controlled by the service provider. The Company adopted this ASU in the first quarter of 2020, and
the adoption did not have a material impact on the Company’s consolidated financial statements.
Recent Accounting Pronouncements
In November 2019,
the FASB issued ASU 2019-11, “Codification Improvements to Topic 326, Financial Instruments - Credit Losses.” This
ASU, among other narrow-scope improvements, clarifies guidance around how to report expected recoveries. This ASU permits organizations
to record expected recoveries on assets purchased with credit deterioration. In addition to other narrow technical improvements,
the ASU also reinforces existing guidance that prohibits organizations from recording negative allowances for available-for-sale
debt securities. The effective date and transition methodology are the same as in ASU 2016-13, Financial Instruments – Credit
Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The FASB deferred the effective dates of these ASUs
for smaller reporting companies (“SRC”) to fiscal years beginning after December 15, 2022. As of June 30, 2020, the
Company qualifies as a SRC and expects to adopt these ASUs in the first quarter of 2023.
In December 2019,
the FASB issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” This ASU removes
specific exceptions to the general principles in Topic 740 in GAAP. It eliminates the need for an organization to analyze whether
certain exceptions apply in a given period. This ASU also improves financial statement preparers’ application of income tax-related
guidance and simplifies GAAP for: a) Franchise taxes that are partially based on income; b) Transactions with a government that
result in a step up in the tax basis of goodwill; c) Separate financial statements of legal entities that are not subject to tax;
and d) Enacted changes in tax laws in interim periods. For public business entities, ASU 2019-12 is effective for fiscal years
beginning after December 15, 2020, and interim periods within those fiscal years. The Company is currently assessing the impact
of this ASU on its consolidated financial statements.
2. Earnings
per Share
Basic earnings per share is calculated
by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted earnings per share include the dilutive
effects of options and unvested restricted stock awards and units.
The
following reconciles the denominator used in the calculation of diluted earnings (loss) per share:
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Three Months Ended
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Six Months Ended
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June 30,
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June 30,
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2020
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2019
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2020
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2019
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Denominator:
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Weighted average common shares outstanding for basic earnings per share
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16,442,493
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16,504,471
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16,414,976
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16,491,236
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Effect of dilutive securities
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—
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93,025
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—
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79,877
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Weighted average common shares outstanding for diluted earnings per share
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16,442,493
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16,597,496
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16,414,976
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16,571,113
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Stock awards to purchase
940,682 and 275,494 shares of common stock for the three months ended June 30, 2020 and 2019, respectively, and 961,526 and 286,141
shares for the six months ended June 30, 2020 and 2019, respectively, were not included in the diluted net income (loss) per share calculation
as their inclusion would have been anti-dilutive.
3. Debt
On March 12, 2019
and December 10, 2019, the Company, as guarantor, HWC Wire & Cable Company and Vertex, as borrowers, and Bank of America, N.A.,
as agent and lender, entered into a Second and Third Amendments, respectively, to the Fourth Amended and Restated Loan and Security
Agreement (such agreement, as so amended, the “Loan Agreement”). The Second Amendment extends the expiration date until
March 12, 2024 and the Third Amendment increased the revolving credit facility to $115 million. Under certain circumstances the
Company may request an increase in the commitment by an additional $50 million.
Portions of the loan
may be converted to LIBOR loans in minimum amounts of $1.0 million and integral multiples of $0.1 million. LIBOR loans bear interest
at the British Bankers Association LIBOR Rate plus 100 to 150 basis points based on availability, and loans not converted to LIBOR
loans bear interest at a fluctuating rate equal to the greatest of the agent’s prime rate, the federal funds rate plus 50
basis points, or 30-day LIBOR plus 150 basis points. The unused commitment fee is 25 basis points.
Availability under
the Loan Agreement is limited to a borrowing base equal to 85% of the value of eligible accounts receivable, plus the lesser of
70% of the value of eligible inventory or 90% of the net orderly liquidation value percentage of the value of eligible inventory,
in each case less certain reserves. The Loan Agreement is secured by substantially all of the property of the Company, other than
real estate.
The Loan Agreement
includes, among other things, covenants that require the Company to maintain a specified minimum fixed charge coverage ratio, unless
certain availability levels exist. Additionally, the Loan Agreement allows for the unlimited payment of dividends and repurchases
of stock, subject to the absence of events of default and maintenance of a fixed charge coverage ratio and minimum level of availability.
The Loan Agreement contains certain provisions that may cause the debt to be classified as a current liability, in accordance with
GAAP, if availability falls below certain thresholds, even though the ultimate maturity date under the Loan Agreement remains March
12, 2024. At June 30, 2020, the Company was in compliance with the availability-based covenants governing its indebtedness.
The carrying
amount of long-term debt approximates fair value as it bears interest at variable rates. The fair value is a Level 2 measurement
as defined in ASC Topic 820, “Fair Value Measurement.”
On May 4, 2020, the
Company received a $6.2 million Paycheck Protection Program (“PPP”) loan from Bank of America (“Lender”),
funded under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), pursuant to a Promissory Note
issued by the Company to Lender. The Company will use the funds to pay its payroll related expenses as well as rent expenses, as
allowed by the terms of the loan. The Company intends to apply for loan forgiveness in the third quarter 2020. Under current rules, which could still be clarified further, the Company believes it will achieve around 80-90% forgiveness. The forgiveness
amount will be equal to the amount that the Company uses for the approved expenses, a minimum of 60% on payroll related expenses
and up to 40% on non-payroll expenses. If the total of the loan is not forgiven, the Company will have two years from the funded
date of May 4, 2020 to repay the balance of the PPP loan to Bank of America. No principal or interest payments will be due prior
to the end of the six-month deferment period and the interest rate on the balance of the loan will not exceed 1.0% per annum.
4. Impairment of Goodwill and Intangible
Assets
The Company tests
goodwill and indefinite lived intangibles for impairment at least annually or more frequently whenever events or circumstances
occur indicating that it might be impaired. During the first and second quarter of 2020, the Company’s market capitalization
declined significantly, driven by current macroeconomic and geopolitical conditions due in large part to the COVID-19 outbreak,
which has contributed to a decline in demand for the Company’s products, a decline in overall financial performance, partially
due to the decline in oil prices, and decline in industry and market conditions. Based on these events, the Company concluded that
it was more-likely-than-not that the fair values of certain of its reporting units were less than their carrying values. Therefore,
the Company performed an interim goodwill impairment test for both the first and second quarter.
Goodwill impairment
is evaluated at each of the four reporting units. The Company determined the fair values of two reporting units with goodwill and
certain of its indefinite lived intangibles exceeded their respective carrying values. The amount of goodwill at June 30, 2020 for the two reporting units, Southern Wire and Vertex, were $12.5 million and $9.8 million, respectively, and the Vertex reporting unit has a negative carrying value. Additionally, the Company determined the
fair value of its Vertex reporting unit’s tradenames was below its carrying value, and as a result recorded an impairment
charge of $0.1 million in June 2020. The Company also determined the fair value of its Southwest reporting unit’s tradenames
was below its carrying value, and as a result, recorded an impairment charge of $0.1 million in June 2020 and $0.2 million in March
2020.
5. Income Taxes
The effective tax
rate for the six months ended June 30, 2020 was 14.3%, compared to 27.5% for the same period in 2019. Compared to the U.S. statutory
rate, the effective tax rate was impacted by state income taxes and nondeductible expenses. Due to the continuing uncertainty in
the Company’s industry, the Company has utilized the method of recording income taxes on a year-to-date effective tax rate
for the six months ended June 30, 2020. The Company will evaluate its use of this method each quarter until such time as a return
to the annualized estimated effective tax rate method is deemed appropriate.
The CARES Act was
signed into law on March 27, 2020. The CARES Act contains several tax law changes for corporations, including modifications for
net operating loss carrybacks, the refundability of prior-year minimum tax liability, limitations on business interest and limitations
on charitable contribution deductions. These benefits did not impact the Company’s tax provision for the three months ended
June 30, 2020.
6. Incentive Plans
Stock Option Awards
There were no stock option awards granted
during the first six months of 2020 or 2019.
Restricted Stock Awards and Restricted Stock Units
On June 26, 2020,
the Board of Directors granted 10,000 restricted stock units to the newly named executive chairman of the board. The award shall
vests in two equal installments on June 26, 2021 and June 26, 2022. The award entitles the executive chairman of the board to receive
a number of shares of the Company’s common stock equal to the number of vested restricted stock units, together with dividend
equivalents from the date of grant, at such time as his service on the board terminates for any reason.
Following the Annual
Meeting of Stockholders on May 7, 2019, the Company granted restricted stock units with a grant date value of $60,000 to each non-employee
director who was elected and re-elected, for an aggregate of 58,920 restricted stock units. Each award of restricted stock units
vested at the date of the 2020 Annual Meeting of Stockholders. Each non-employee director is entitled to receive a number of shares
of the Company’s common stock equal to the number of vested restricted stock units, together with dividend equivalents from
the date of grant, at such time as the director’s service on the board terminates for any reason. The Company did not grant
equity awards to the non-employee directors following the 2020 Annual Meeting.
On March 12,
2019, the Board of Directors granted 52,910
performance stock units to the Company’s President and CEO and 13,228
performance stock units to the CFO. Each grant of performance stock units vests on December
31, 2021, based on and subject to the Company’s achievement of cumulative EBITDA and stock price performance
goals over a three year period, as long as the grantee is then employed by the
Company, and upon vesting will be settled in shares of our common stock. Any dividends declared will be accrued and paid to
the grantee if and when the related shares vest.
Total stock-based
compensation cost was $0.4 million for each of the three months ended June 30, 2020 and 2019, and $0.8 million for the six months
ended June 30, 2020 and $0.7 million for the six months ended June 30, 2019, and is included in salaries and commissions for employees,
and in other operating expenses for non-employee directors.
7. Commitments and Contingencies
The Company had outstanding under the Loan
Agreement letters of credit totaling $0.7 million to certain vendors as of June 30, 2020.
From time to time,
the Company is involved in lawsuits that are brought against it in the normal course of business. The Company is not currently
a party to any legal proceedings that it expects, either individually or in the aggregate, to have a material adverse effect on
the Company’s consolidated financial position, cash flows, or results from operations.