HOUSTON WIRE & CABLE COMPANY You should read the following discussion in conjunction with our consolidated
financial statements and related notes appearing elsewhere in this Form 10-K. In
addition to historical information, this discussion contains forward-looking
statements that involve risks, uncertainties and assumptions that could cause
actual results to differ materially from our expectations. Factors that could
cause such differences include those described in "Risk Factors" and elsewhere
in this Form 10-
Overview
Since our founding 45 years ago, we have grown to be a large provider of industrial products to the U.S. market. Today, we serve over 8,500 customers. Our products are used in MRO activities and related projects, as well as for larger-scale projects in the utility, industrial and infrastructure markets and a diverse range of industrial applications including communications, energy, engineering and construction, general manufacturing, mining, infrastructure, oilfield services, petrochemical, transportation, utility, wastewater treatment and food and beverage. In the past few years, activity in the MRO market has fluctuated, while the level of competition has increased.
Our revenue is driven in part by the level of capital spending within the end-markets we serve. Because many of these end-markets defer capital expenditures during periods of economic downturns, our business has experienced cyclicality. Our revenue has been and will continue to be impacted by fluctuations in capital spending and by our ability to drive demand through our sales and marketing initiatives and the continued development and marketing of our private branded products, such as LifeGuardTM. In 2020, we were negatively impacted by the COVID-19 pandemic by reducing economic activity and demand for our products, especially in the oil and gas industry, which is our biggest market. Although economic activity and commodity prices have recently begun to show signs of recovery, we cannot yet predict how long the pandemic will continue to have a negative impact on our sales and level of demand.
Our direct costs will continue to be influenced significantly by the prices we pay our suppliers to procure the products we distribute to our customers. Changes in these costs may result, for example, from increases or decreases in raw material costs, changes in our relationships with suppliers or changes in vendor rebates. Our operating expenses will continue to be affected by our investment in sales, marketing and customer support personnel and commissions paid to our sales force for revenue and profit generated. Some of our operating expenses are related to our fixed infrastructure, including rent, utilities, information technology, administrative salaries, maintenance, insurance and supplies. To meet our customers' needs for an extensive product offering and short delivery times, we will need to continue to maintain adequate inventory levels. Our ability to obtain this inventory will depend, in part, on our relationships with suppliers.
Critical Accounting Policies and Estimates
Critical accounting policies are those that both are important to the accurate portrayal of a company's financial condition and results of operations, and require subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
In order to prepare financial statements that conform to accounting principles
generally accepted in
We have identified the following accounting policies as those that require us to make the most subjective or complex judgments in order to fairly present our consolidated financial position and results of operations. Actual results in these areas could differ materially from management's estimates under different assumptions and conditions.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts receivable for estimated losses
resulting from the inability of our customers to make required payments.
Consistent with industry practices, we require payment from most customers
within 30-60 days of the invoice date. We have an estimation procedure, based on
historical data and recent changes in the aging of the receivables, that we use
to record an allowance. A 20% change in our estimate at
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Refund Liability
We estimate the gross profit impact of returns and allowances for previously
recorded sales. This liability is calculated on historical and statistical
returns and allowances data and adjusted as trends in the variables change. A
20% change in our estimate at
Vendor Rebates
Some of our arrangements with our vendors entitle us to receive a rebate of a
specified amount when we achieve any of a number of measures, generally related
to the volume of purchases from the vendor. We account for such rebates as a
reduction of the prices of the vendor's products and therefore as a reduction of
inventory until we sell the product, at which time such rebates reduce cost of
sales. Throughout the year, we estimate the amount of the rebates earned based
on purchases to date relative to the total purchase levels expected to be
achieved during the rebate period. We continually revise these estimates to
reflect rebates expected to be earned based on actual purchase levels and
forecasted purchase volumes for the remainder of the rebate period. A 20% change
in our estimate of total rebates earned during 2020 would have resulted in a
change in loss before income taxes of
Inventory Reserves
Inventories are valued at the lower of cost, using the average cost method, or
net realizable value. We continually monitor our inventory levels at each of our
distribution centers. Our reserve for inventory is based on the age of the
inventory, movements of our inventory over the prior twelve months and the
experience of our purchasing and sales departments in estimating demand for the
product in the succeeding year. Our inventories are generally not susceptible to
technological obsolescence. At
Goodwill
We conduct impairment testing for goodwill annually in the fourth quarter of our fiscal year and more frequently, on an interim basis, when an event occurs or circumstances change that indicate that the fair value of a reporting unit may have declined below its carrying value. Events or circumstances which could indicate a probable impairment include, but are not limited to, financial performance, industry and market conditions, macroeconomic conditions, reporting unit-specific events, historical results of goodwill impairment testing and the timing of the last performance of a quantitative assessment.
We test goodwill at the reporting unit level, which is defined as an operating
segment or one level below an operating segment that constitutes a business for
which financial information is available and is regularly reviewed by
management. We have determined that, in 2020, we had four reporting units for
this purpose. At
The goodwill impairment test consists of assessing 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, including goodwill. We may bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the quantitative goodwill impairment test. The quantitative goodwill impairment test, used to identify both the existence of impairment and the amount of impairment loss, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.
When performing goodwill impairment testing, the fair values of reporting units are determined based on valuation techniques using the best available information. Inherent in such fair value determinations are certain judgments and estimates relating to future cash flows, including our interpretation of current economic indicators and market valuations, and assumptions about our strategic plans. In developing fair values for our reporting units, we may employ a market multiple or a discounted cash flow methodology, or a combination thereof. The market multiple methodology compares us to similar companies on the basis of risk characteristics to determine our risk profile relative to the comparable companies as a group. This analysis generally focuses on quantitative considerations, which include financial performance and other quantifiable data, and qualitative considerations, which include any factors which are expected to impact future financial performance. The most significant assumptions affecting the market multiple methodology are the market multiples and control premium. A control premium represents the value an investor would pay above non-controlling interest transaction prices in order to obtain a controlling interest in the respective unit.
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The discounted cash flow methodology establishes fair value by estimating the present value of the projected future cash flows to be generated from the reporting unit. The discount rate applied to the projected future cash flows to arrive at the present value is intended to reflect all risks of ownership and the associated risks of realizing the stream of projected future cash flows. The discounted cash flow methodology uses our projections of financial performance. The most significant assumptions used in the discounted cash flow methodology are the discount rate and expected future revenue and operating margins, which vary among reporting units. If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be exposed to future impairment losses that could be material to our results of operations.
Intangible Assets
Our intangible assets, excluding goodwill, represent tradenames and customer
relationships acquired in purchase transactions, as well as internal-use
software acquired in 2020. At
We assign useful lives to our intangible assets based on the periods over which we expect the assets to contribute directly or indirectly to our future cash flows. Customer relationships are amortized over 6 to 9 year useful lives and internal software is amortized over 3 year useful life. If events or circumstances were to indicate that any of our definite-lived intangible assets might be impaired, we would assess recoverability based on the estimated undiscounted future cash flows to be generated from the applicable intangible asset.
When performing quantitative assessments for impairment, we use various assumptions in determining the current fair value of these indefinite-lived intangible assets, including future expected cash flows and discount rates under the relief from royalty method, as well as other fair value measures. If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be exposed to future impairment charges that could be material to our results of operations.
Income Taxes
We determine deferred tax assets and liabilities based on differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and measure them using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
Estimates, judgments and assumptions are required in determining whether deferred tax assets will be fully or partially realized. We establish a valuation allowance to reduce the deferred tax assets when it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized. In evaluating the ability to realize deferred tax assets, we consider all available positive and negative evidence, in determining whether, based on the weight of that evidence, a valuation allowance is needed for part or all of the deferred tax assets. In determining the need for a valuation allowance on our deferred tax assets, we place greater weight on recent and objectively verifiable current information, as compared to more forward-looking information that is used in valuing other assets on the consolidated balance sheet. We have considered taxable income in prior carryback years, future reversals of existing taxable temporary differences, future taxable income, and tax planning strategies in assessing the need for the valuation allowance.
We establish liabilities for estimated tax issues, and the provisions and benefits resulting from changes to those liabilities are included in our annual tax provision along with related interest. We recognize interest on any tax issue as a component of interest expense and any related penalties in other operating expenses.
Impact of the COVID-19 Pandemic
The COVID-19 pandemic has spread throughout
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The rapid development and uncertainty of the COVID-19 pandemic precludes any prediction as to the ultimate effect of the COVID-19 outbreak on our business. However, the outbreak has had an adverse impact on our business, including reductions in the demand for our products, especially from the oil and gas market. In response, we applied for and received funds under the Paycheck Protection Program and have implemented several cost savings measures which included furloughing employees, reducing headcount, temporary payroll reductions, and other actions to decrease corporate and non-critical expenses. These cost savings measures, which began to have an impact in the latter part of the second quarter, resulted in additional savings for the balance of the year. While we cannot reasonably estimate the length or severity of this pandemic, we currently anticipate an adverse impact on our consolidated financial position, consolidated results of operations, and consolidated cash flows at least through the first quarter of 2021.
Sales
Our primary source of revenue is the sale of industrial products based upon purchase orders or contracts with customers, as well as billing for freight charges. Revenue is recognized at a point in time once we have determined that the customer has obtained control over the product. Control is typically deemed to have been transferred to the customer when the product is shipped or delivered (either by customer pickup or through common carrier). Sales incentives earned by customers are accrued in the same month as the shipment is invoiced and are accounted for as a reduction in sales.
Cost of Sales
Cost of sales consists primarily of the average cost of the industrial products that we sell. We also incur shipping and handling costs in the normal course of business. Cost of sales also reflects cash discounts for prompt payment to vendors and vendor rebates generally related to annual purchase targets, as well as inventory obsolescence charges.
Operating Expenses
Operating expenses include all expenses, excluding freight, incurred to receive, sell and ship product and administer the operations of the Company.
Salaries and Commissions. Salary expense includes the base compensation, and any overtime earned by hourly personnel, for all sales, administrative and warehouse employees and stock compensation expense for options and restricted stock granted to employees. Commission expense is earned by inside sales personnel based on gross profit dollars generated, by field sales personnel from generating sales and meeting various objectives, by sales, national and marketing managers for driving the sales process, by region managers based on the profitability of their branches and by corporate managers based primarily on our profitability and also on other operating metrics.
Other Operating Expenses. Other operating expenses include all payroll taxes, health insurance, travel expenses, public company expenses, advertising, management information system expenses, facility rent and all distribution expenses such as packaging, reels, and repair and maintenance of equipment and facilities.
Depreciation and Amortization. We incur depreciation expense on costs related to capitalized property and equipment on a straight-line basis over the estimated useful lives of the assets, which range from three to thirty years. We incur amortization expense on leasehold improvements and finance leases over the shorter of the lease term or the life of the related asset and on intangible assets over the estimated life of the asset.
Interest Expense
Interest expense consists primarily of interest we incur on our debt.
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Results of Operations
The following discussion compares our results of operations for the years ended
The following table shows, for the periods indicated, information derived from
our consolidated statements of operations, expressed as a percentage of sales
for the period presented.
Year Ended December 31,
2020 2019 2018
Sales 100.00 % 100.0 % 100.0 %
Cost of sales 78.0 % 76.4 % 76.1 %
Gross profit 22.0 % 23.6 % 23.9 %
Operating expenses:
Salaries and commissions 11.5 % 11.0 % 10.7 %
Other operating expenses 10.1 % 9.8 % 8.7 %
Depreciation and amortization 1.2 % 0.7 % 0.6 %
Impairment charge 0.1 % n/m n/m
Loss on divestiture/HFS classification 3.1 % - -
Total operating expenses 26.0 % 21.6 % 20.0 %
Operating income (loss) (4.0 )% 2.0 % 3.9 %
Interest income (expense) (0.7 )% (0.9 )% (0.8 )%
Income (loss) before income taxes (4.6 )% 1.1 % 3.1 %
Income tax (expense) benefit 0.2 % (0.4 )% (0.7 )%
Net income (loss) (4.4 )% 0.8 % 2.4 %
Note: Due to rounding, percentages may not add up to total operating expenses, operating income (loss), income (loss) before income taxes or net income (loss).
Comparison of Years Ended
Sales
Year Ended
December 31,
(Dollars in millions) 2020 2019 Change
Sales $ 286.0 $ 338.3 $ (52.3 ) (15.5 )%
Our sales in 2020 decreased
Gross Profit
Year Ended
December 31,
(Dollars in millions) 2020 2019 Change
Gross profit $ 63.0 $ 79.9 $ (16.9 ) (21.1 )%Gross profit as a percent of sales 22.0 % 23.6 %
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Gross profit decreased $16.9 million or 21.1% from 2019. The decrease in gross
profit was primarily due to decreased sales from the decline in the oil and gas
market caused by the COVID-19 pandemic. Gross margin (gross profit as a
percentage of sales) decreased from 23.6% in 2019 to 22.0% in 2020 due to the
$0.6 million inventory returned under a one-time agreement with a vendor in the
second quarter of 2020, as well as lower rebates from vendors and reduced prompt
pay discounts.
Operating Expenses
Year Ended
December 31,
(Dollars in millions) 2020 2019 Change
Operating expenses:
Salaries and commissions $ 33.0 $ 37.2 $ (4.2 ) (11.2 )%
Other operating expenses 28.9 33.2 (4.3 ) (13.1 )%
Depreciation and amortization 3.4 2.5 0.9 35.0 %
Impairment charge 0.4 0.1 0.3 210.8 %Loss on divestiture/HFS classification 8.7 0.0 8.7 n/m Total operating expenses
$ 74.4 $ 73.0 $ 1.3 1.8 %
Operating expenses as a percent of sales 26.0 % 21.6 %
Note: Due to rounding, numbers may not add up to total operating expenses.
Salaries and Commissions. Salaries and commissions decreased
Other Operating Expenses. Other operating expenses decreased
Depreciation and Amortization. Depreciation and amortization increased to$3.4
million in 2020 from
Impairment Charge. We recorded non-cash impairment charges in 2020 and 2019 with respect to tradenames at our Southwest and Vertex reporting units. (See Note 4 to our Consolidated Financial Statements)
Loss on divestiture/HFS classification. In
Interest Expense
Interest expense decreased 38.3% from
Income Tax
The income tax benefit of
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Comparison of Years Ended
Sales
Year Ended
December 31,
(Dollars in millions) 2019 2018 Change
Sales $ 338.3 $ 356.9 $ (18.6 ) (5.2 )%
Our sales in 2019 decreased
Gross Profit
Year Ended
December 31,
(Dollars in millions) 2019 2018 Change
Gross profit $ 79.9 $ 85.2 $ (5.3 ) (6.2 )%Gross profit as a percent of sales 23.6 % 23.9 %
Gross profit decreased
Operating Expenses
Year Ended
December 31,
(Dollars in millions) 2019 2018 Change
Operating expenses:
Salaries and commissions $ 37.2 $ 38.1 $ (0.9 ) (2.4 )%
Other operating expenses 33.2 31.0 2.3 7.4 %
Depreciation and amortization 2.5 2.2 0.3 14.9 %
Impairment charge 0.1 0.1 0.1 0.0 %
Total operating expenses $ 73.0 $ 71.3 $ 1.7 2.4 %
Operating expenses as a percent of sales 21.6 % 20.0 %
Note: Due to rounding, numbers may not add up to total operating expenses.
Salaries and Commissions. Salaries and commissions decreased
Other Operating Expenses. Other operating expenses increased
Depreciation and Amortization. Depreciation and amortization increased slightly
to
Impairment Charge. We recorded non-cash impairment charges in 2019 and 2018 with respect to tradenames at our Southwest reporting unit. (See Note 4 to our Consolidated Financial Statements)
Operating expenses as a percentage of sales increased to 21.6% in 2019 from 20.0% in 2018, as operating expenses increased combined with a reduction in sales.
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Interest Expense
Interest expense increased 5.2% to
Income Tax
Income tax expense decreased 45.9% to
Impact of Inflation and Commodity Prices
Our results of operations are affected by changes in the inflation rate and commodity prices. Moreover, because copper, steel, aluminum, nickel and petrochemical products are components of the industrial products we sell, fluctuations in the costs of these and other commodities have historically affected our operating results. To the extent commodity prices decline, the net realizable value of our existing inventory could also decline, and our gross profit can be adversely affected because of either reduced selling prices or lower of cost or net realizable value adjustments in the carrying value of our inventory. If we turn our inventory approximately three times a year, the impact of changes in commodity prices in any particular quarter would primarily affect the results of the succeeding two calendar quarters. If we are unable to pass on to our customers future cost increases due to inflation or rising commodity prices, our operating results could be adversely affected.
Liquidity and Capital Resources
Our primary capital needs are for working capital obligations, capital expenditures, and other general corporate purposes, including acquisitions. Our primary sources of working capital are cash from operations supplemented by bank borrowings.
Liquidity is defined as the ability to generate adequate amounts of cash to meet the current need for cash. We assess our liquidity in terms of our ability to generate cash to fund our operating activities. Significant factors which could affect liquidity include the following:
• the adequacy of available bank lines of credit; • cash flows generated from operating activities; • capital expenditures; • acquisitions; and • the ability to attract long-term capital with satisfactory terms
Comparison of Years Ended
Our net cash provided by operating activities was
Changes in our operating assets and liabilities resulted in cash provided by
operating activities of
Net cash provided by investing activities was
Net cash used in financing activities was
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Comparison of Years Ended
Our net cash used in operating activities was
Changes in our operating assets and liabilities resulted in cash used in
operating activities of
Net cash used in investing activities was
Net cash provided by financing activities was
Indebtedness
Our principal source of liquidity at
We believe that we will have adequate availability of capital to fund our present operations, meet our commitments on our existing debt, and fund anticipated growth over the next twelve months, including expansion in existing and targeted market areas. We continually seek potential acquisitions and from time to time hold discussions with acquisition candidates. If suitable acquisition opportunities or working capital needs arise that would require additional financing, we believe that our financial position and earnings history provide a solid base for obtaining additional financing resources at competitive rates and terms. Additionally, based on market conditions, we may decide to issue additional shares of common or preferred stock to raise funds.
Loan and Security Agreement
Covenants in the Loan Agreement require us to maintain a specified minimum fixed
charge coverage ratio, unless certain availability levels exist. Repaid amounts
can be re-borrowed subject to the borrowing base. As of
On
Capital Expenditures
We made capital expenditures of
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Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Financial Derivatives
We have no financial derivatives.
Climate Risk
Our operations are subject to inclement weather conditions, which could potentially be related to climate change, including hurricanes, earthquakes and abnormal weather events. Our previous experience from these events has had a minimal effect on our operations.
Factors Affecting Future Results
This Annual Report on Form 10-K contains statements that may be considered forward-looking. These statements can be identified by the fact that they do not relate strictly to historical or current facts. They use words such as "aim," "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "plan," "project," "should," "will be," "will continue," "will likely result," "would" and other words and terms of similar meaning in conjunction with a discussion of future operating or financial performance. You should read statements that contain these words carefully, because they discuss our future expectations, contain projections of our future results of operations or of our financial position or state other "forward-looking" information. Actual results could differ materially from the results indicated by these statements, because the realization of those results is subject to many risks and uncertainties. Some of these risks and uncertainties are discussed in greater detail under Item 1A, "Risk Factors."
All forward-looking statements are based on current management expectations and
speak only as of the date of this filing. Except as required under federal
securities laws and the rules and regulations of the
ITEM 7A. - Not applicable and has been omitted.
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