HF Foods Group Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. The filing is unaudited. HF Foods distributes Asian specialty foods and other products to restaurants and food-service customers. Results include B&R Global, acquired in November 2019, so reported year-over-year comparisons are not like-for-like.
Financial results and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $139.9 million | $75.7 million | $420.3 million | $225.2 million |
| Gross profit / margin | $25.2 million / 18.0% | $12.2 million / 16.1% | $74.8 million / 17.8% | $37.4 million / 16.6% |
| Operating income (loss) | $0.1 million | $2.2 million | $(4.8) million | $6.0 million |
| Net income (loss) attributable to HF Foods | $(0.6) million | $1.3 million | $(344.6) million | $4.0 million |
| Adjusted EBITDA | $6.0 million | $2.7 million | $13.7 million | $9.9 million |
- Margins and expenses: Gross margin improved year over year, which management attributed to product/customer mix and lower-margin buffet restaurant sales remaining depressed. Distribution, selling and administrative expenses rose 151% in Q3 to $25.1 million, reflecting B&R Global, acquired-intangible amortization and $1.9 million of legal and investigation costs, partly offset by cost reductions.
- Cash flow: Nine-month operating cash flow was $44.3 million, versus $0.4 million in 2019; investing cash outflow was $94.3 million, principally the $94.0 million real-estate acquisition payment; financing cash inflow was $44.6 million. Cash declined $5.4 million to $9.2 million.
- Debt and liquidity: At September 30, cash was $9.2 million, current assets $101.3 million and current liabilities $82.0 million. The balance sheet reported $25.2 million of lines of credit and $95.1 million of long-term debt, plus a $7.0 million related-party subordinated note. The $100 million revolving facility and mortgage term loans had $98.7 million outstanding in total; the revolver matures November 2022 and the real-estate term loans mature in 2030. The company reported compliance with credit covenants at quarter end.
- Balance sheet: Total assets were $489.9 million and total shareholders’ equity $263.1 million. Goodwill fell from $406.7 million to $68.5 million after a $338.2 million impairment charge.
Material changes versus comparable periods
- Reported Q3 revenue rose 84.8%, and nine-month revenue rose 86.6%, mainly because of the B&R Global acquisition. B&R contributed $81.5 million of Q3 revenue and $258.3 million for the nine months.
- Management said legacy HF revenue declined by $17.3 million in Q3 and $63.2 million for the nine months, largely due to COVID-19 disruption to restaurant customers. On a pro forma basis, as if B&R had been included from January 1, 2019, nine-month 2020 revenue was down 32.4% and adjusted EBITDA down 47.7% versus 2019.
- The nine-month net loss chiefly reflects the non-cash goodwill impairment. The impairment followed pandemic-related declines in restaurant demand and a March 2020 valuation analysis; management reported no additional impairment in Q3 but planned its annual test for Q4.
Outlook, risks and unusual items
- COVID-19 and outlook: Management reported weekly sales at about 70% of pre-pandemic levels from July through the filing date, with positive weekly operating cash flow at then-current sales and cost levels. It said there were no immediate liquidity concerns, while cautioning that recovery timing and the effects of renewed restrictions were uncertain. No quantified financial guidance was provided.
- Liquidity and strategy: Management expected operating cash flow to meet normal working-capital needs and obligations for at least 12 months, but noted this depended on sales, collections, economic conditions and continued bank and supplier support. Growth plans include further acquisitions, subject to financing and integration risks.
- Legal and regulatory matters: The company disclosed consolidated securities class-action litigation, related shareholder derivative suits and a formal, non-public SEC investigation concerning matters that include related-party transactions and share-float disclosures. The company disputes the allegations and is cooperating with the SEC. It could not estimate potential losses and accrued no amounts. Labor claims were also disclosed; no loss contingency was accrued for those matters.
- Governance and controls: Disclosure controls were deemed ineffective due to material weaknesses, including limited accounting and SEC-reporting expertise and deficiencies in IT general controls and process documentation. Remediation efforts were ongoing, with no assurance they would be successful.
- Other exposure: The company reported related-party purchases, sales and a $7.0 million note payable to a related party. It also remains guarantor of long-term leases of a divested subsidiary, AnHeart; the filing describes security and third-party guarantees intended to mitigate that exposure.
Important facts for investors to verify
- Whether restaurant demand and sales recover from the reported roughly 70% of pre-pandemic levels, and how that affects cash generation and covenant headroom.
- The assumptions supporting the $338.2 million goodwill impairment, the remaining goodwill balance and the results of the Q4 2020 annual impairment test.
- Debt balances, maturities, interest-rate exposure and compliance with facility covenants; approximately 79.3% of floating-rate debt was reported hedged for June 2021–June 2025.
- Developments and potential financial or governance consequences from the SEC investigation and shareholder litigation, for which no loss estimate was available.
- Progress in remediating material weaknesses and the adequacy of controls over financial reporting and related-party transactions.
- Pro forma operating trends: reported growth is acquisition-driven, while management’s pro forma comparison shows lower revenue and adjusted EBITDA.