HF Foods Group Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019; financial statements are unaudited. HF Foods distributes food and related products primarily to Asian/Chinese restaurants and foodservice customers. Unless noted otherwise, amounts are in U.S. dollars.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $75.7 million | $70.4 million | $225.2 million | $217.2 million |
| Gross profit | $12.2 million | $12.6 million | $37.4 million | $36.8 million |
| Gross margin | 16.1% | 17.9% | 16.6% | 16.9% |
| Operating income | $2.2 million | $2.2 million | $6.0 million | $5.1 million |
| Net income attributable to HF Foods | $1.35 million | $1.67 million | $4.04 million | $4.04 million |
| Basic and diluted EPS | $0.06 | $0.08 | $0.18 | $0.20 |
| Adjusted EBITDA | $2.7 million | $3.7 million | $9.9 million | $10.4 million |
- Q3 revenue grew 7.6%, but cost of revenue grew faster, at 9.9%; gross profit fell 2.9%. Management attributed the margin decline mainly to higher frozen-meat prices. Independent-restaurant gross margin fell to 17.0% from 18.7%; wholesale margin fell to 4.7% from 6.4%.
- Q3 net income attributable to HF Foods declined 19.2%; nine-month attributable income was nearly flat. Nine-month consolidated net income increased 16.5% to $4.38 million.
- Adjusted EBITDA declined 26.5% in Q3 and 5.4% for the first nine months. The measure is non-GAAP; the filing reports a $625,000 Q3 adjustment related to reversal of part of a contingency accrual.
- Nine-month cash from operations was only $0.44 million, versus approximately $8.5 million a year earlier. Inventory growth used $7.65 million of cash; management linked the increase to purchases of frozen seafood, flank steak, and poultry at advantageous prices. Capital expenditures were $5.38 million. Cash ended the period at $6.80 million.
- At September 30, current assets were $55.7 million and current liabilities $38.6 million. Lines of credit were $11.9 million; long-term debt, including current portion, was $17.1 million; capital-lease liabilities were $1.40 million. The East West Bank facility was a $25 million revolving line, with covenants reported as satisfied.
- Total assets were $83.1 million and total liabilities $56.5 million at quarter-end. Inventory was $29.8 million, up from $22.2 million at December 31, 2018.
Material changes and significant events
- Nine-month revenue increased 3.7%, primarily from independent-restaurant sales, which management said reflected slightly higher commodity prices. Wholesale revenue rose 3.3% for the nine months and 18.9% in Q3.
- Interest expense and bank charges increased 17.8% for the nine months, mainly due to higher average line-of-credit borrowings.
- On September 30, the company transferred $12.04 million of loans to companies associated with CEO Zhou Min Ni and his family to Mr. Ni in exchange for 905,115 company shares valued at $13.30 each, recorded as treasury stock. Another 298,688 shares were placed in escrow against a potential share-price shortfall. Related-party balances and transaction terms merit scrutiny.
- After quarter-end, HF Foods closed its acquisition of B&R Global Holdings on November 4, issuing 30.7 million shares. Former B&R shareholders owned approximately 58.9% of the combined company. The filing says the acquisition will be accounted for using the acquisition method; purchase-price allocation details were not yet available.
- Also on November 4, the company entered a JPMorgan credit agreement providing a $100 million asset-secured revolver and $55.4 million in mortgage-secured term loans. The agreement requires a consolidated fixed-charge coverage ratio of at least 1.10 to 1.00. Proceeds repaid prior credit-line and term-loan balances.
Outlook, risks, contingencies, and controls
- No quantified earnings or revenue guidance is provided. Management plans to pursue acquisitions to expand geographically, invest in management technology, and explore value-added products. It cautions that acquisitions depend on financing and successful integration.
- Management believed available resources and operating cash flow would cover normal working capital and debt needs for at least 12 months, but noted that weaker demand, economic conditions, competition, or reduced support from banks and suppliers could create funding shortfalls.
- A negligence-related claim had been accrued at $1.0 million; it was settled through mediation on November 11 for $0.4 million. The company reversed $0.6 million of the accrual in Q3. The filing records the accrual in distribution, selling and administrative expenses.
- The company remains guarantor of certain long-term Manhattan property leases entered into by former subsidiary AnHeart, despite transferring ownership. The filing describes security and third-party guaranty protections, but HF Foods could remain exposed if those protections prove inadequate.
- Two suppliers represented 47% and 14% of advances to suppliers outstanding at September 30. Related-party sales, purchases, receivables, payables, and loans are also disclosed.
- Management concluded disclosure controls were not effective at quarter-end because of previously reported material weaknesses in SEC financial-report preparation and documentation of customer and purchase-order controls. Additional accounting staff had been hired, but remediation was not complete.
- Risks identified include commodity and fuel cost increases, tariffs, competition, customer or supplier disruption, food-safety and regulatory compliance, employee retention, acquisition financing and integration, and debt levels. The filing reports no legal proceedings in Item 1.
Important facts for investors to verify
- Whether gross-margin pressure and weak operating cash conversion persisted, and whether inventory was sold as planned.
- The final B&R purchase accounting, integration performance, post-merger share count, and effect of the acquisition on earnings, leverage, and covenants.
- The JPMorgan facility’s borrowing availability, interest costs, collateral, and compliance with the 1.10 fixed-charge coverage covenant.
- The loan-sale valuation and escrow outcome, including the related-party governance and potential effects of the share-price protection.
- Whether internal-control weaknesses were fully remediated and whether the remaining AnHeart lease guarantees or supplier concentrations created losses.