Notes
to Consolidated Financial Statements
(Unaudited)
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1.
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Basis
of Presentation and Principles of Consolidation
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Houston
Wire & Cable Company (the “Company”), through its wholly owned subsidiaries, provides industrial products 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 March 31, 2019 and for the three months ended March 31, 2019 and 2018 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, 2018 filed with the SEC.
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
February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” Under the new guidance as amended, a lessee
is required to recognize a right-of-use asset and a lease liability for leases greater than 1 year, both finance and operating
leases. This update was effective for public companies for fiscal years beginning after December 15, 2018 with early adoption
permitted. Under the transition rules, an entity initially applies the new leases standard at the adoption date and recognizes
a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption and the comparative periods
presented in the financial statements continue to be in accordance with previously-existing GAAP. The Company has adopted this
ASU effective January 1, 2019. See Note 7 for detailed information.
In
June 2018, the FASB issued ASU No. 2018-07, “Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee
Share-Based Payment Accounting,” which simplifies the accounting for share-based payment arrangements with nonemployees
for goods and services. Under the ASU, the guidance on such payments to nonemployees is aligned with the accounting for share-based
payments granted to employees, including the measurement of equity-classified awards, which is fixed at the grant date under the
new guidance. The ASU superseded Subtopic 505-50, “Equity - Equity-Based Payments to Non-Employees,” and was effective
for public entities for interim and annual reporting periods beginning after December 15, 2018. The Company adopted this ASU in
the first quarter of 2019 and the adoption did not have a material impact on the Company’s consolidated financial statements.
Recent
Accounting Pronouncements
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 guidance is effective for
public companies beginning in the first quarter of 2020 and early adoption is permitted. The Company is currently assessing the
impact of this ASU on its consolidated financial statements and evaluating the timing of adoption.
In
August 2018, the FASB issued ASU 2018-14, “Disclosure Framework – Changes to the Disclosure Requirements for Defined
Benefit Plans.” The amendments in this update eliminate, add and modify certain disclosure requirements for defined benefit
pension plans. The guidance is effective for public companies beginning in the first quarter of 2020 and early adoption is permitted.
The Company is currently assessing the impact of this ASU on its consolidated financial statements and evaluating the timing of
adoption.
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 guidance is effective for public
companies beginning in the first quarter of 2020 and early adoption is permitted. The Company is currently assessing the impact
of this ASU on its consolidated financial statements.
In
June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit
Losses on Financial Instruments.” The amendments in this update amend the guidance of the impairment of financial instruments
and add an impairment model, known as the current expected credit loss (CECL) model. The CECL model is designed to capture expected
credit losses through the establishment of an allowance account, which will be presented as an offset to the amortized cost basis
of the related financial asset. The guidance is effective for interim and annual periods beginning after December 15, 2019.
The Company is currently assessing the impact of this ASU on its consolidated financial statements and evaluating the timing of
adoption.
Basic
earnings per share is calculated by dividing net income 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 per share:
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Three Months Ended
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March 31,
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2019
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2018
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Denominator:
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Weighted average common shares for basic earnings per share
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16,477,855
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16,349,902
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Effect of dilutive securities
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99,271
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73,059
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Weighted average common shares for diluted earnings per share
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16,577,126
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16,422,961
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Stock
awards to purchase 356,890 shares and 422,947 shares of common stock were not included in the diluted net income per share calculation
for the three months ended March 31, 2019 and 2018, respectively, as their inclusion would have been anti-dilutive.
On
March 12, 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 Amendment 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 of the Company’s $100
million revolving credit facility until March 12, 2024. 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 March 31, 2019, 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.”
The
Company calculates its provision for income taxes during interim reporting periods by applying the estimated annual effective
tax rate for the full fiscal year to pre-tax income or loss, excluding discrete items, for the reporting period.
Stock
Option Awards
There
were no stock option awards granted during the first three months of 2019 or 2018.
Restricted
Stock Awards and Restricted Stock Units
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 $0.3 million for each of the three months ended March 31, 2019 and 2018, respectively, and is
included in salaries and commissions for employees, and in other operating expenses for non-employee directors.
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6.
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Commitments
and Contingencies
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As
a result of unfavorable lease terms relative to market for one of the leases acquired as part of the Vertex acquisition in 2016,
there is a remaining additional liability of $0.2 million that is being amortized over the remaining term of the lease, which
was 51 months at March 31, 2019.
The
Company had outstanding under the Loan Agreement, letters of credit totaling $0.5 million to certain vendors as of March 31, 2019.
There
are no legal proceedings pending against or involving the Company that, in management’s opinion, based on the current known
facts and circumstances, are expected to have a material adverse effect on the Company’s consolidated financial position,
cash flows, or results of operations.
Effective
January 1, 2019, the Company adopted ASU No. 2016-02, “Leases (Topic 842)” and the series of related Accounting Standards
Updates that followed (collectively referred to as “Topic 842”). The most significant changes under the new guidance
include clarification of the definition of a lease, and the requirements for lessees to recognize a right-of-use (ROU) asset and
a lease liability for all qualifying leases with terms longer than twelve months in the consolidated balance sheet. In addition,
under Topic 842, additional disclosures are required to meet the objective of enabling users of financial statements to assess
the amount, timing and uncertainty of cash flows arising from leases.
The
Company elected the practical expedient available under ASU 2018-11 “Leases: Targeted Improvements” which allows the
Company to apply the transition provision for Topic 842 at the Company’s adoption date instead of at the earliest comparative
period presented in the Company’s financial statements. Therefore, the Company recognized and measured leases existing at
January 1, 2019 but without retrospective application. The Company also elected all other available practical expedients except
the hindsight practical expedient. In electing the practical expedients, the Company utilized the transition practical expedient
package whereby the Company did not reassess (i) whether any of the Company’s expired or existing contracts contain a lease,
(ii) the classification for any expired or existing leases and (iii) initial direct costs for any existing leases.
The impact of Topic
842 on the Company’s consolidated balance sheet as of January 1, 2019 was the recognition of ROU assets and lease liabilities
for operating leases, while the Company’s accounting for finance leases remained substantially unchanged. The Company’s
finance leases were immaterial prior to the adoption of Topic 842, and no change was made to the classification for these leases.
As a result of the adoption of Topic 842, beginning retained earnings was impacted by $0.1 million and there was no impact to the
income statement.
The
Company leases property including warehouse space, offices, vehicles and office equipment. The Company determines if an arrangement
is a lease at inception. As part of the transition to the new standard, the Company reviewed agreements with suppliers, vendors,
customers, and other outside parties to determine if any agreements met the definition of an embedded lease. Based on the nature
of the contracts reviewed, and various factors, including identified assets included in the agreement to which the Company has
exclusive rights of control as described by Topic 842, were considered. The Company concluded that these are not material agreements
with parties that would constitute an embedded lease. For purposes of calculating operating lease liabilities, lease terms may
be deemed to include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that
option.
Beginning
January 1, 2019, operating ROU assets and operating lease liabilities are recognized based on the present value of lease payments
over the lease term at commencement date. Operating leases in effect prior to January 1, 2019 were recognized at the present value
of the remaining lease payments over the remaining lease term as of January 1, 2019. The Company is required to determine a discount
rate in order to calculate the present value of lease payments. If the rate is not included in the lease or cannot be readily
determined, the Company uses its incremental secured borrowing rate based on lease term information available at the commencement
date of the lease in determining the present value of lease payments. The Company recognizes lease components and non-lease components
together and not as separate parts of a lease for all leases. The Company will exercise this practical expedient in the future
by asset class.
The
expenses generated by the lease activity of the Company as lessee for the three months ended March 31, 2019 were as follows:
Lease Type
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Income Statement Classification
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Amount
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(Dollars in thousands)
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Consolidated operating lease expense
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Operating expenses
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$
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986
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Consolidated financing lease amortization
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Operating expenses
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17
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Consolidated financing lease interest
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Interest expense
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2
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Consolidating financing lease expense
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19
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Net lease cost
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Operating expenses
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$
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1,005
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The
value of the net assets and liabilities generated by the leasing activity of the Company as lessee as of March 31, 2019 were as
follows:
Lease Type
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Balance Sheet Classification
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Amount
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(Dollars in thousands)
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Total ROU operating lease assets
(1)
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Operating lease right-of-use assets, net
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$
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11,954
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Total ROU financing lease assets
(2)
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Property and equipment, net
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220
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Total lease assets
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$
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12,174
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Total current operating lease obligation
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Operating lease liabilities
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$
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3,082
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Total current financing lease obligation
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Accrued and other current liabilities
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70
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Total current lease obligation
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$
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3,152
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Total long term operating lease obligation
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Operating lease long term liabilities
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$
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9,280
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Total long term financing lease obligation
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Other long term liabilities
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159
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Total long term lease obligation
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$
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9,439
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(1)
Operating lease assets are recorded net of accumulated amortization of $0.8 million as of March 31, 2019
(2)
Financing lease assets are recorded net of accumulated amortization of $0.1 million as of March 31, 2019
The
future minimum lease payments for finance and operating lease liabilities of the Company as lessee as of March 31, 2019 were as
follows:
Maturity Date of Lease Liabilities
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Operating Leases
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Financing Leases
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Total
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(Dollars in thousands)
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Year one
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$
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3,665
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$
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77
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$
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3,742
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Year two
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2,831
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72
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2,903
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Year three
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2,680
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61
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2,741
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Year four
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2,322
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32
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2,354
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Year five
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1,081
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1
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1,082
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Subsequent years
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1,462
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—
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1,462
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Total lease payments
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14,041
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243
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14,284
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Less: Interest
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1,679
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14
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1,693
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Present value of lease liabilities
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$
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12,362
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$
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229
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$
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12,591
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The weighted average remaining lease terms and discount rates of the leases held by the Company as of March 31, 2019 were as follows:
Lease Type
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Weighted Average
Term in Years
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Weighted Average Interest Rate
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Operating leases
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4.7
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5.5
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Financing leases
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3.3
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3.6
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The
cash outflows of the leasing activity of the Company as lessee for the three months ended March 31, 2019 were as follows:
Cash Flow Source
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Classification
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Amount
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(Dollars in thousands)
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Operating cash outflows from operating leases
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Operating activities
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$
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980
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Operating cash outflows from financing leases
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Operating activities
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2
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Financing cash outflows from financing leases
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Financing activities
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17
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Any leases, new or modified,
for the three months ended March 31, 2019 are not material.
Following the Annual Meeting of Stockholders on May 7, 2019, the Company approved
the award of 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 vests 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.