HF Foods Group Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. The filing is dated May 18, 2020. HF Foods distributes fresh, frozen and dry food and related products primarily to Asian restaurants and other foodservice customers. Results include B&R Global, acquired November 4, 2019; accordingly, reported year-over-year comparisons are not like-for-like.
Financial results and liquidity
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Net revenue | $175.8 million | $74.8 million |
| Gross profit / gross margin | $29.0 million / 16.5% | $12.7 million / 17.0% |
| Operating income (loss) | $(0.4) million | $2.3 million |
| Net income (loss) attributable to HF Foods | $(339.9) million | $1.7 million |
| Adjusted EBITDA (non-GAAP) | $4.3 million; 2.5% of revenue | $3.5 million; 4.7% of revenue |
| Operating cash flow | $18.6 million | $2.5 million |
| Cash at period end | $12.7 million | $6.9 million |
- Revenue rose 135.0%, primarily due to the B&R Global acquisition. On a pro forma basis as if the acquisition had occurred at the start of 2019, Q1 2020 revenue declined 15.9% from $209.0 million to $175.8 million. Management attributed the decline to COVID-19 disruption.
- Gross margin fell 0.5 percentage points, principally because B&R Global had a lower margin. Distribution, selling and administrative expenses increased 183.7% to $29.4 million, including $2.7 million of acquired-intangible amortization. Interest expense and bank charges increased to $2.0 million.
- The $339.9 million attributable net loss chiefly reflects a $338.2 million non-cash goodwill impairment. Excluding this charge, Adjusted EBITDA increased 24.8% year over year on the reported comparison, but declined 56.8% on a pro forma comparison.
- Operating cash flow was $18.6 million; investing cash outflow was $94.1 million, primarily for the real-estate acquisition; financing cash inflow was $73.6 million, principally reflecting new mortgage-backed term loans and revolving-credit activity. Cash declined $1.8 million during the quarter.
- At March 31, current assets were $125.3 million and current liabilities $103.5 million. Debt included $43.1 million drawn on a $100 million revolving facility, $97.1 million of long-term debt (including current portion), and a $7.0 million related-party note. The company reported compliance with its credit covenants.
Material developments, outlook and risks
- On January 17, 2020, B&R Global acquired warehouse properties previously leased for its operations for $101.3 million. Funding included $75.6 million of mortgage-backed term loans, a $7.0 million subordinated note to the seller, and revolving-credit borrowings. The seller was related to a co-CEO, who held an 8.91% interest in the seller.
- COVID-19 sharply affected restaurant customers late in the quarter. Sales in the final two weeks of March were approximately 67% below comparable pro forma sales; April sales fell as much as 75% below the comparable prior-year period. Management said early-May weekly sales had recovered to over 50% of pre-COVID levels and expected recovery to continue into June, while warning that Q2 impact would exceed Q1 and that timing and extent of recovery remained uncertain.
- Management described cost reductions, temporary furloughs, reduced delivery schedules, temporary distribution-center closures, vendor-term extensions, receivables collection efforts, suspended capital spending, and development of consumer online-sales channels. It reported at least a 40% overall cost reduction in April and said available credit had improved. Management believed cash from operations would cover normal working-capital needs for at least 12 months, but cautioned that this depended on demand, collections, economic conditions, and continued bank and supplier support.
- The company recorded goodwill impairment after COVID-19-related business declines reduced the estimated fair value of B&R Global. The remaining goodwill was $68.5 million. Management warned that further impairment could occur if forecasts or market assumptions deteriorate; finite-lived intangible assets passed the interim recoverability test.
- Two putative securities class actions filed in March and April 2020 allege misleading statements and undisclosed related-party matters, among other claims. Damages are unspecified; the company disputes the allegations and said it could not estimate a potential loss. Employment-related lawsuits also remain pending; no loss accrual was recorded.
- Disclosure controls were deemed ineffective as of March 31, 2020 because of material weaknesses involving accounting and SEC-reporting expertise, IT general controls, and documentation of management reviews. Management said remediation efforts were ongoing.
- Other identified risks include fuel and commodity costs, customer and vendor concentration, acquisition integration and financing, floating-rate debt, and COVID-19 effects. The company reported no off-balance-sheet arrangements expected to have a material effect.
Most important facts for investors to verify
- Whether restaurant demand and sales recover as management expected, and the resulting effects on margins, cash flow, receivables and liquidity.
- How the $338.2 million goodwill impairment was determined, whether further impairment is required, and the sensitivity of valuation assumptions.
- Debt availability, covenant headroom, refinancing needs and capacity to service floating-rate obligations amid weaker operations.
- Progress in remediating material weaknesses in financial reporting and IT controls.
- Developments in the securities and employment litigation, and the financial and governance implications of related-party transactions, including the warehouse purchase.