Business context and reporting period
HF Foods Group Inc. distributes fresh, frozen and dry food, and supplies to primarily Chinese and Asian restaurants in the southeastern United States. It reported for the fiscal year ended December 31, 2018; this 10-K does not provide standalone fourth-quarter results. The company served approximately 3,200 restaurants in ten states through three distribution centers.
On August 22, 2018, Atlantic Acquisition Corp. completed its merger with HF Group Holding and changed its name to HF Foods Group Inc. The transaction was accounted for as a reverse acquisition, with HF Group treated as the accounting acquirer. The filing presents 2017 comparative results for the operating business.
Key financial metrics
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Net revenue | $291.0 million | $295.5 million | Down 1.5% |
| Gross profit / margin | $49.6 million / 17.0% | $43.9 million / 14.9% | Profit up 12.8%; margin up 2.1 percentage points |
| Operating income | $8.5 million | $11.0 million | Down 22.6% |
| Net income | $6.4 million | $10.1 million | Down 37.0% |
| Net income attributable to HF Foods | $6.3 million | $9.6 million | Down 34.8% |
| Adjusted EBITDA | $14.2 million; 4.9% of revenue | $14.0 million; 4.8% of revenue | Up 1.0% |
| Operating cash flow | $12.0 million | $15.3 million | Down $3.3 million |
| Investing / financing cash flow | $(6.4) million / $(6.2) million | $(5.5) million / $(9.7) million | Cash decreased $0.6 million in 2018 |
At year-end, cash was $5.5 million and current assets were $59.0 million against current liabilities of $33.6 million. Debt included $8.2 million in revolving credit lines and $14.6 million in long-term debt, plus $0.3 million in capital lease obligations. The two credit facilities had $8.2 million outstanding in total; the East West Bank facility, with $5.6 million drawn, was due May 27, 2019.
Material changes versus the prior comparable period
- Revenue declined despite a 17.5% increase in sales volume to independent restaurants. Management attributed lower reported sales largely to 15%–30% price declines across product categories, including lower chicken and other commodity prices. Sales to independent restaurants fell 1.2%; wholesale sales fell 6.2%.
- Gross margin improved as lower purchase costs increased the markup as a percentage of sales, alongside stronger purchasing and inventory management. Independent-restaurant margin rose from 15.5% to 17.9%; wholesale margin fell from 6.8% to 4.9%.
- Distribution, selling and administrative expenses increased 24.6% to $41.0 million. The main drivers included higher labor costs, a $1.8 million accrued Department of Labor settlement, professional fees related to the merger, and increased advertising expenses.
- Income tax expense rose to $2.5 million from $0.6 million as operating entities converted from pass-through tax status to C corporations effective January 1, 2018. The effective tax rate was 28.1%, versus 5.8% in 2017.
Outlook, risks, contingencies and unusual items
- Management plans to pursue growth through acquisitions and expansion into underserved markets, but states that execution depends on access to capital and successful integration. No specific financial guidance is provided.
- Management believed operating cash flow and other resources would cover normal working-capital needs and obligations for at least twelve months, while cautioning that demand, competition, economic conditions, and continued bank and supplier support could undermine that expectation.
- New Southern Food Distributors was not in compliance with a credit-facility covenant at December 31, 2018. The company was seeking a waiver or amendment; the bank could demand repayment if the issue were not resolved. This disclosure should be read alongside other statements that the company was in compliance with its credit covenants.
- The company made $8.5 million of related-party loans at year-end, including $8.1 million classified as current, and had $3.8 million receivable from a supplier. Subsequent agreements extended several note maturities to 2024; Zhou Min Ni personally guaranteed certain notes. Related-party purchases totaled $31.7 million and sales totaled $18.1 million in 2018.
- A March 2019 Department of Labor settlement resolved wage-practice claims for $1.831 million, including back wages, liquidated damages and penalties; it was accrued in 2018 and was due by May 15, 2019.
- HF Foods remained guarantor of AnHeart’s Manhattan leases after agreeing in February 2019 to transfer its ownership of AnHeart for $20,000. The leases have 15- and 30-year terms, escalating rent and associated building costs. The filing does not clearly quantify the company’s maximum potential exposure under the continuing guarantee.
- Management identified material weaknesses in financial reporting controls, including insufficient capacity to prepare SEC-compliant financial statements and inadequate documentation of orders and customer balances. Disclosure controls and internal controls were deemed ineffective at year-end. The auditor gave an unqualified opinion on the financial statements but did not opine on internal-control effectiveness.
- Nasdaq notified the company in January 2019 that it had not met the annual-meeting requirement. The company submitted a compliance plan and stated its intention to hold an annual meeting by July 1, 2019; no Nasdaq response had been received as of the filing date.
- Other stated risks include commodity and fuel cost volatility, tariffs on imports, food-safety and labor regulation, customer or supplier disruption, acquisition financing and integration, and the concentration of decision-making power in CEO and principal shareholder Zhou Min Ni.
Most important facts for investors to verify
- Whether New Southern Food Distributors obtained a covenant waiver or amendment, and whether any lender can accelerate repayment.
- Collection prospects, maturity extensions and guarantees for related-party and supplier notes receivable, which represent a meaningful portion of current assets.
- The company’s continuing exposure under AnHeart’s long-term leases, including landlord consent, enforceability of indemnities and guarantees, and potential rent and construction costs.
- Whether the $1.831 million Department of Labor settlement was paid and whether wage-and-hour compliance measures are operating effectively.
- Progress in remediating internal-control weaknesses and regaining Nasdaq annual-meeting compliance.
- Whether volume growth and improved gross margins can persist as commodity prices, customer pricing and operating expenses change.