HF Foods Group Inc. — Form 10-Q Summary
Period: Quarter and nine months ended September 30, 2018. Financial statements are unaudited. HF Foods distributes food and related products primarily to Asian/Chinese restaurants and other foodservice customers in the southeastern United States.
Business context and reporting period
On August 22, 2018, Atlantic Acquisition Corp. completed its business combination with HF Group Holding and changed its name to HF Foods Group Inc. The transaction is accounted for as a reverse business combination, with HF Group treated as the accounting acquirer. The 2017 comparison also reflects the group’s common-control reorganization on a retrospective basis.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $70.4 million | $75.6 million | $217.2 million | $225.7 million |
| Gross profit | $12.6 million | $11.1 million | $36.8 million | $31.6 million |
| Gross margin | 17.9% | 14.7% | 16.9% | 14.0% |
| Operating income | $2.2 million | $2.5 million | $5.1 million | $7.6 million |
| Net income | $1.8 million | $2.3 million | $3.8 million | $6.9 million |
| Net income attributable to HF Foods | $1.7 million | $2.0 million | $4.0 million | $6.6 million |
| EPS, basic and diluted | $0.08 | $0.10 | $0.20 | $0.33 |
- For the nine months, operating cash flow was $8.5 million, investing cash flow was negative $5.0 million, and financing cash flow was negative $1.8 million. Cash increased $1.7 million to $7.8 million.
- At September 30, cash was $7.8 million, current assets were $52.8 million and current liabilities were $38.2 million. Total liabilities were $51.9 million. Lines of credit totaled $12.5 million; long-term debt, including its current portion, totaled $14.7 million.
- Contractual obligations totaled $56.1 million, including $28.6 million of operating lease commitments. Scheduled lines of credit of $12.5 million were shown as due within one year.
- Management reported nine-month adjusted EBITDA of $10.4 million versus $9.9 million a year earlier. This non-GAAP measure includes a $2.5 million add-back for the labor dispute accrual.
Material changes versus the prior comparable period
- Nine-month revenue fell 3.8%; Q3 revenue fell 6.9%. Management attributed the decline mainly to lower commodity prices passed through to customers, with sales quantities described as consistent. Nine-month wholesale revenue also declined as the company exited sales to two low-margin customers.
- Nine-month gross profit rose 16.5%, and gross margin improved to 16.9% from 14.0%. Management cited improved supplier purchasing terms, currency effects on imported products, centralized procurement and reduced low-margin sales.
- Nine-month distribution, selling and administrative expense increased 32% to $31.7 million. The increase included a $2.5 million labor dispute accrual, higher management and driver costs, merger-related professional fees and advertising. Q3 expense rose 20.1%.
- Nine-month net income declined; the tax provision rose to $1.5 million from $0.5 million as the operating entities converted from pass-through entities to C corporations effective January 1, 2018. Management noted the federal statutory rate fell to 21% under the Tax Cuts and Jobs Act.
Outlook, risks and unusual items
- Management expects operating cash flow to cover normal working-capital needs and debt obligations for at least 12 months, but notes this depends on realization of current assets and continued support from banks and suppliers. The company may need to defer acquisitions, sell assets, or obtain or refinance debt or equity if resources fall short.
- The company intends to pursue acquisitions of distributors and wholesalers, subject to obtaining sufficient capital and successfully integrating acquired businesses. No specific financial guidance was provided.
- The Department of Labor inquiry into a subsidiary’s wage practices and records remains open. A preliminary estimate of approximately $2.5 million for back wages, damages and related costs was accrued; the final amount could differ. Management says it believes past issues have been resolved.
- Two New York City leases, with terms of 30 and 15 years, were entered into for a planned Chinese herb supplement expansion. Management later abandoned that expansion. As of November 1, it reported agreements in principle to sell AnHeart for $20,000, with landlord consent and definitive documents still pending. HF Holding had guaranteed rent and related costs, including rehabilitation costs.
- Related-party activity includes $8.5 million of related-party notes receivable and $13.4 million of related-party sales for the nine months. A separate $3.3 million note receivable was advanced to supplier Feilong Trading at 5% interest. Supplier advance balances were concentrated: one supplier represented 63% of third-party advances and one related-party supplier represented 92% of related-party advances.
- The $14.5 million East West Bank revolving facility had $9.1 million outstanding and was extended only through November 28, 2018 while renewal was under review. The company reported covenant compliance at quarter-end. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Confirm the renewal or refinancing outcome for the East West Bank credit facility and the availability of the company’s other bank facilities.
- Track the Department of Labor inquiry, the final assessed amount and any costs beyond the $2.5 million accrual.
- Verify completion of the proposed AnHeart sale, landlord consent and release or transfer of lease guarantees; assess the remaining long-term lease exposure.
- Review collectability, terms and governance of related-party receivables and supplier advances, as well as concentration in supplier advances.
- Reconcile reported figures: the MD&A describes nine-month attributable income as $3.8 million, while the income statement reports $4.0 million; it also gives operating cash flow as $8,484,258 versus $8,482,258 in the cash-flow statement. The Q3 adjusted EBITDA table and accompanying narrative also appear inconsistent. The filing text does not clearly resolve these differences.