HF Foods Group Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. HF Foods distributes fresh, frozen and dry food and related products, primarily to Asian restaurants in the southeastern United States. Comparisons are with the corresponding 2018 periods.
Financial performance
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $74.7 million, up 3.4% | $149.5 million, up 1.8% |
| Gross profit / margin | $12.5 million / 16.7%, versus $12.1 million / 16.8% | $25.2 million / 16.9%, versus $24.2 million / 16.5% |
| Operating income | $1.4 million, up 65.7% | $3.8 million, up 30.2% |
| Net income | $1.1 million, versus $0.6 million | $2.9 million, versus $2.0 million |
| Net income attributable to HF Foods | $1.02 million, down 0.2% | $2.70 million, up 13.6% |
| Adjusted EBITDA | $3.64 million, down 6.7%; 4.9% of revenue | $7.12 million, up 6.5%; 4.8% of revenue |
Quarterly revenue growth came primarily from independent-restaurant sales, which increased 4.2%; wholesale revenue fell 8.4%. Management attributed growth largely to slightly higher commodity prices. Wholesale sales were affected in part by reduced Chinese imports and increased tariffs. For the six-month period, independent-restaurant gross margin improved to 17.7% from 17.2%, while wholesale gross margin declined to 3.8% from 6.5%. The company’s non-GAAP Adjusted EBITDA includes a $1.0 million 2019 negligence-claim accrual; 2018 included $2.2 million of labor-dispute expenses.
Cash flow, liquidity and debt
- Cash was $6.9 million at June 30, 2019, versus $5.5 million at December 31, 2018. Current assets were $54.4 million and current liabilities $39.2 million, yielding working capital of approximately $15.2 million.
- Six-month operating cash flow was $2.1 million, down from $6.1 million, primarily reflecting working-capital changes, including higher inventory. Investing cash outflow was $4.8 million, including $5.2 million of property and equipment purchases. Financing provided $4.2 million; cash increased $1.45 million.
- The company had $11.4 million outstanding on its $25 million East West Bank revolving facility, maturing August 2021. Total long-term debt was $15.9 million, including $1.8 million current; capital-lease liabilities were $1.47 million. Management reported compliance with applicable financial covenants.
- Management believed operating cash flow would meet normal working-capital and debt needs for at least 12 months, while noting that liquidity depends on operating cash flow, asset realization, and continued bank and supplier support.
Material developments, outlook and risks
- On June 21, 2019, HF Foods agreed to acquire B&R Global Holdings, a distributor serving Asian restaurants in the western United States. Closing was subject to conditions including HF Foods shareholder approval. Management expected a stock-based transaction and anticipated increased working capital for the combined businesses; no formal financial guidance was provided.
- The company accrued $1 million for potential negligence-related claims. Management, after consulting counsel, said any additional liability was not expected to be material. The filing’s legal-proceedings section reports none.
- HF Foods transferred its ownership of AnHeart in May 2019 but remains guarantor of AnHeart’s long-term Manhattan lease obligations. AnHeart provided security and a lease-assignment covenant, and a third party provided an unconditional guaranty; HF Foods could still face exposure if AnHeart defaults.
- Related-party activity is significant: six-month purchases from related parties were $17.5 million; related-party notes receivable totaled $8.4 million, largely extended to 2024. The CEO and family members have interests in counterparties. Three suppliers represented 42%, 22% and 12% of supplier advances outstanding.
- Disclosure controls were deemed ineffective at June 30 because previously reported material weaknesses remained. These included insufficient SEC-reporting expertise and deficient documentation of customer orders, purchase orders and customer acknowledgments. HF Foods hired additional finance personnel, but remediation was ongoing.
- Risks cited include competition, fuel and commodity costs, tariffs on imports from China, customer or supplier disruption, acquisition execution and financing, food-safety and regulatory compliance, staffing, and the CEO’s control of the company.
Important facts for investors to verify
- Progress, approval status, financing and integration terms for the B&R transaction.
- Cash conversion and working-capital trends, particularly inventory growth and the decline in operating cash flow.
- Performance of wholesale margins amid tariffs and reduced imports, and whether independent-restaurant growth reflects volume or mainly commodity-price increases.
- Debt maturities, borrowing availability and continued covenant compliance.
- Recoverability and terms of related-party receivables, supplier advances, and the company’s ongoing related-party transactions.
- Potential exposure under the AnHeart lease guarantees and the outcome of the negligence claims.
- Whether management remediates the identified internal-control weaknesses and demonstrates their effectiveness.