ITEM 7. MANAGEMENT’S DISCUSSION ANDANALYSISOF FINANCIAL CONDITION ANDRESULTSOF OPERATIONS.
The following discussion and analysis provides information about our business, the results of operations, financial condition, liquidity and capital resources of HF Foods Group Inc. This information is intended to facilitate the understanding and assessment of significant changes and trends related to our results of operations and financial condition. This discussion and analysis should be read in conjunction with the consolidated financial statements and the accompanying notes presented elsewhere in this Annual Report on Form 10-K. Discussions of 2021 items and year-to-year comparisons between 2022 and 2021 that are not included in this Annual Report on Form 10-K can be found in “Part II – Item 7. – Management's Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the SEC on March 31, 2023.
Overview
We market and distribute Asian specialty food products, seafood, fresh produce, frozen and dry food, and non-food products primarily to Asian restaurants and other foodservice customers throughout the United States. HF Foods was formed through a merger between two complementary market leaders, HF Foods Group Inc. and B&R Global.
On December 30, 2021, HF Foods acquired a leading seafood supplier, the Great Wall Group, resulting in the addition of three distribution centers, located in Illinois and Texas (the “Great Wall Acquisition”).
On April 29, 2022, HF Foods acquired substantially all of the assets of Sealand Food, Inc. (the “Sealand Acquisition”), one of the largest frozen seafood suppliers servicing the Asian/Chinese restaurant market along the eastern seaboard, from Massachusetts to Florida, as well as Pennsylvania, West Virginia, Ohio, Kentucky, and Tennessee. See Note 7 - Acquisitions to the consolidated financial statements in this Annual Report on Form 10-K for additional information regarding recent acquisitions.
We have grown our distribution network to eighteen distribution centers and cross-docks servicing forty-six states and covering approximately 95% of the contiguous United States with a fleet of over 400 refrigerated vehicles. Capitalizing on our deep understanding of the Chinese culture, with over 1,000 employees and subcontractors and supported by two call centers in China, we have become a trusted partner serving approximately 15,000 Asian restaurants, providing sales and service support to customers who mainly converse in Mandarin or other Chinese dialects. We are dedicated to serving the vast array of Asian and Chinese restaurants in need of high-quality and specialized food ingredients at competitive prices.
How to Assess HF Foods’ Performance
In assessing our performance, we consider a variety of performance and financial measures, including principal growth in net revenue, gross profit, distribution, selling and administrative expenses, as well as certain non-GAAP financial measures, including EBITDA and Adjusted EBITDA. The key measures that we use to evaluate the performance of our business are set forth below:
Net Revenue
Net revenue is equal to gross sales minus sales returns, sales incentives that we offer to our customers, such as rebates and discounts that are offsets to gross sales; and certain other adjustments. Our net revenue is driven by changes in number of customers and average customer order amount, product inflation that is reflected in the pricing of our products and mix of products sold.
Gross Profit
Gross profit is equal to net revenue minus cost of revenue. Cost of revenue primarily includes inventory costs (net of supplier consideration), inbound freight, customs clearance fees and other miscellaneous expenses. Cost of revenue generally changes as we incur higher or lower costs from suppliers and as the customer and product mix changes.
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Distribution, Selling and Administrative Expenses
Distribution, selling and administrative expenses consist primarily of salaries, stock-based compensation and benefits for employees and contract laborers, trucking and fuel expenses, utilities, maintenance and repair expenses, insurance expenses, depreciation and amortization expenses, selling and marketing expenses, professional fees and other operating expenses.
EBITDA and Adjusted EBITDA
Discussion of our results includes certain non-GAAP financial measures, including EBITDA and Adjusted EBITDA, that we believe provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing our financial performance with other companies in the same industry, many of which present similar non-GAAP financial measures to investors. We present EBITDA and Adjusted EBITDA in order to provide supplemental information that we consider relevant for the readers of our consolidated financial statements included elsewhere in this report, and such information is not meant to replace or supersede GAAP measures.
Management uses EBITDA to measure operating performance, defined as net income before interest expense, interest income, income taxes, and depreciation and amortization. In addition, management uses Adjusted EBITDA, defined as net income before interest expense, interest income, income taxes, and depreciation and amortization, further adjusted to exclude certain unusual, non-cash, or non-recurring expenses. Management believes that Adjusted EBITDA is less susceptible to variances in actual performance resulting from non-recurring expenses, and other non-cash charges and is more reflective of other factors that affect our operating performance.
The definition of EBITDA and Adjusted EBITDA may not be the same as similarly titled measures used by other companies in the industry. EBITDA and Adjusted EBITDA are not defined under GAAP and are subject to important limitations as analytical tools and should not be considered in isolation or as substitutes for analysis of HF Foods’ results as reported under GAAP. For example, Adjusted EBITDA:
•excludes certain tax payments that may represent a reduction in cash available;
•does not reflect any cash capital expenditure requirements for the assets being depreciated and amortized that may have to be replaced in the future;
•does not reflect changes in, or cash requirements for, our working capital needs; and
•does not reflect the significant interest expense, or the cash requirements, necessary to service our debt.
For additional information on EBITDA and Adjusted EBITDA, see the section entitled “EBITDA and Adjusted EBITDA” below.
Financial Review
Highlights for 2023 included:
•Net revenue: Net revenue was $1,148.5 million in 2023, compared to $1,170.5 million in 2022, a decrease of $22.0 million, or 1.9%. This decrease was primarily attributable to deflationary pricing in imported frozen seafood, Asian Specialty, poultry, and, to a lesser extent, the exit of our chicken processing businesses.
•Gross profit: Gross profit was $204.0 million in 2023 compared to $205.5 million in 2022, a decrease of $1.5 million, or 0.7%. The decrease was primarily attributable to lower revenue. Gross profit margin of 17.8% for 2023 increased from 17.6% in the prior year.
•Distribution, selling and administrative expenses: Distribution, selling and administrative expenses increased by $0.1 million, or 0.1%, mainly due to settlement amounts received partially offset by an increase in payroll and related labor costs as well as insurance costs. During 2023, we received legal settlements amounts totaling $9.25 million and $1.7 million, of which we paid $0.9 million, for a net settlement totaling $10.0 million. These net settlement amounts were recorded as a reduction of distribution, selling and administrative expenses. Distribution, selling and administrative expenses as a percentage of net revenue increased to 17.0% in 2023 from 16.7% in 2022, primarily due to the costs disclosed above combined with the decrease in revenue year over year.
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•Net (loss) income attributable to HF Foods Group Inc.: Net loss attributable to HF Foods Group Inc. was $2.2 million in 2023 compared to net income of $0.5 million in 2022. The decrease of $2.6 million was primarily driven by a decrease in our income from operations of $1.6 million, an increase in interest expense of $4.0 million, a change in fair value of interest rate swap contracts of $2.4 million, and a change in other income of $0.7 million, partially offset by a favorable change in lease guarantee expense of $6.1 million.
•Exit of chicken processing businesses: During the second half of 2023, we exited both of our low margin chicken processing businesses on the east and west coast as part of our commitment to refocusing on our core business.
Results of Operations
Comparison of Year Ended December 31, 2023 to Year Ended December 31, 2022
The following table sets forth a summary of our consolidated results of operations for the years ended December 31, 2023and 2022. The historical results presented below are not necessarily indicative of the results that may be expected for any future period.
Year Ended December 31, Change
Change in fair value of interest rate swap contracts 1,580 (817) 2,397
(Loss) income before income taxes (2,621) 4 (2,625)
Income tax expense (benefit) 41 (231) 272
Net (loss) income and comprehensive (loss) income (2,662) 235 (2,897)
Less: net loss attributable to noncontrolling interests (488) (225) (263)
The following table sets forth the components of our consolidated results of operations expressed as a percentage of net revenue for the periods indicated:
Year Ended December 31,
Distribution, selling and administrative expenses 17.0 % 16.7 %
Income from operations 0.8 % 0.9 %
Interest expense 1.0 % 0.6 %
Other income (0.1) % (0.2) %
Change in fair value of interest rate swap contracts 0.1 % (0.1) %
Lease guarantee expense — % 0.5 %
(Loss) income before income taxes (0.2) % — %
Income tax expense (benefit) — % — %
Net (loss) income and comprehensive (loss) income (0.2) % — %
Less: net loss attributable to noncontrolling interests — % — %
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Net Revenue
Net revenue for the year ended December 31, 2023 decreased by $22.0 million, or 1.9%, compared to the same period in 2022. This decrease was primarily attributable to deflationary pricing product categories such as frozen seafood, poultry, Asian Specialty and packaging. The revenue decrease due to pricing was partially offset by higher volume and the Seafood revenue generated due to the Sealand Acquisition which has a full year of revenue in 2023 compared to a partial year in 2022.
Gross Profit
Gross profit was $204.0 million for the year ended December 31, 2023 compared to $205.5 million in the same period in 2022, a decrease of $1.5 million, or 0.7%. The gross profit decrease was primarily attributable to decreases in revenue from Meat and Poultry, and to a lesser extent, Packaging and Other, partially offset by the increased revenue from Asian Specialty, the additional Seafood revenue generated due to the Sealand Acquisition and the successful execution of our Seafood centralized purchasing program. During the year ended December 31, 2023, poultry pricing came down from the elevated levels we benefited from during the same period in 2022. Gross profit margin for 2023 of 17.8% increased from 17.6% in the prior year.
Distribution, Selling and Administrative Expenses
Distribution, selling and administrative expenses of $195.1 million for the year ended December 31, 2023 remained consistent with prior year expenses of $195.0 million. For 2023, there was a decrease in professional fees as a result of the net settlement amounts received totaling $10.0 million, partially offset by increases of $7.3 million in payroll and related labor costs, inclusive of the additional costs due to the Sealand Acquisition, and $2.0 million in insurance related costs. Professional fees decreased $12.9 million, or $2.9 million net of the settlement amounts received, to $13.9 million for the year ended December 31, 2023, from $26.8 million for the year ended December 31, 2022. In addition, we recognized an asset impairment of $1.2 million related to the exit of our chicken processing facility. Distribution, selling and administrative expenses as a percentage of net revenue increased to 17.0% for the year ended December 31, 2023 from 16.7% in the same period in 2022, primarily due to the costs disclosed above combined with the decrease in revenue year over year.
Interest Expense
Interest expense for the year ended December 31, 2023 increased by $4.0 million or 53.9%, compared to the year ended December 31, 2022, primarily due to a sharply higher interest-rate environment. Average floating interest rates on our floating-rate debt for the year ended December 31, 2023 increased by approximately 3.4% on the line of credit and 3.4% on the JPMorgan Chase mortgage-secured term loan, compared to the same period in 2022. Our average daily line of credit balance decreased by $10.2 million, or 18.5%, to $44.9 million for the year ended December 31, 2023 from $55.0 million for the year ended December 31, 2022, and our average daily JPMorgan Chase mortgage-secured term loan balance increased by $6.5 million, or 6.4%, to $108.6 million for the year ended December 31, 2023 from $102.1 million for the year ended December 31, 2022.
Income Tax Expense (Benefit)
Income tax expense (benefit) was an income tax expense of approximately $41,000 for the year ended December 31, 2023, compared to income tax benefit of $0.2 million for the year ended December 31, 2022, primarily due to the impact of non-deductible items, change in valuation allowance, and state taxes, partially offset by the expiration of the statute of limitations in relation to unrecognized tax benefits, tax credits, and other tax adjustments during the year ended December 31, 2023.
Net (Loss) Income Attributable to HF Foods Group Inc.
Net loss attributable to HF Foods Group Inc. was $2.2 million for the year ended December 31, 2023, compared to net income of $0.5 million for the year ended December 31, 2022. The decrease of $2.6 million was primarily driven by a decrease in our income from operations of $1.6 million, an increase in interest expense of $4.0 million, a change in fair value of interest rate swap contracts of $2.4 million, and a change in other income of $0.7 million, partially offset by a favorable change in lease guarantee expense of $6.1 million.
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EBITDA and Adjusted EBITDA
The following table reconciles EBITDA and Adjusted EBITDA to the most directly comparable GAAP measure:
Year Ended December 31, Change
Income tax expense (benefit) 41 (231) 272
Change in fair value of interest rate swap contracts 1,580 (817) 2,397
Business transformation costs (1) 929 — 929
Acquisition-related costs — 1,130 (1,130)
_________________
(1) Represents non-recurring costs associated with the launch of strategic projects including supply chain management improvements and technology infrastructure initiatives.
(2) Includes contested proxy and related legal and consulting costs and facility closure costs.
Liquidity and Capital Resources
As of December 31, 2023, we had cash of approximately $15.2 million, checks issued not presented for payment of $4.5 million and access to approximately $37.6 million in additional funds through our $100.0 million line of credit, subject to a borrowing base calculation. We have funded working capital and other capital requirements primarily by cash flow from operations and bank loans. Cash is required to pay purchase costs for inventory, salaries, fuel and trucking expenses, selling expenses, rental expenses, income taxes, other operating expenses and to service debts.
We believe that our cash flow generated from operations is sufficient to meet our normal working capital needs for at least the next twelve months. However, our ability to repay our current obligations will depend on the future realization of our current assets. Management has considered the historical experience, the economy, the trends in the foodservice distribution industry to determine the expected collectability of accounts receivable and the realization of inventories as of December 31, 2023.
We are party to an amortizing interest rate swap contract with JPMorgan Chase for an initial notional amount of $120.0 million, expiring in March 2028, as a means to partially hedge our existing floating rate loans exposure. Pursuant to the agreement, we will pay the swap counterparty a fixed rate of 4.11% in exchange for floating payments based on CME Term SOFR.
Effective as of April 20, 2023, we and certain parties to the Delaware Action reached an agreement to settle the Delaware Action on the terms and conditions set forth in a binding term sheet (the “Binding Term Sheet”), which was incorporated into a long-form settlement agreement on May 5, 2023 and filed with the Court of Chancery on May 8, 2023. The Binding Term Sheet provided for, among other things, the dismissal of the Delaware Action with prejudice, thereby resolving all existing and potential liability against all named defendants in the Delaware Action, in exchange for Zhou Min Ni, a former Chairman and Chief Executive Officer of the Company, and Chan Sin Wong, a former President and Chief Operating Officer of the Company, making a payment to the Company in the sum of $9.25 million (the “Settlement Amount”). The full terms of the settlement of the Delaware Action were incorporated into the long-form settlement agreement, which was subject to approval of the Court of Chancery (as amended on November 1, 2023, the “Settlement Agreement”). On September 8, 2023, the Court of Chancery approved the proposed settlement and an application by Bishop’s counsel for an award of attorneys’ fees and expenses.
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On October 16, 2023, after approval of the settlement had become final, the Ni Defendants paid the Company $1.5 million of the Settlement Amount. On December 1, 2023, the Company received 1,997,423 shares of the Company’s common stock as consideration for the remaining $7.75 million balance due under the Settlement Agreement. All of the shares of Company common stock received as consideration for the Settlement have been placed by the Company in treasury. Please refer to Part I. Item 3. Legal Proceedings in this Annual Report on Form 10-K and Note 16 - Commitments and Contingencies to the consolidated financial statements herein for additional information.
Management believes we have sufficient funds to meet our working capital requirements and debt obligations in the next twelve months. However, there are a number of factors that could potentially arise which might result in shortfalls in anticipated cash flow, such as the demand for our products, economic conditions, competitive pricing in the foodservice distribution industry, and our bank and suppliers being able to provide continued support. If the future cash flow from operations and other capital resources is insufficient to fund our liquidity needs, we may have to resort to reducing or delaying our expected acquisition plans, liquidating assets, obtaining additional debt or equity capital, or refinancing all or a portion of our debt.
As of December 31, 2023, we have no off balance sheet arrangements that currently have or are reasonably likely to have a material effect on our consolidated financial position, changes in financial condition, results of operations, liquidity, capital expenditures or capital resources.
The following table summarizes cash flow data for the years ended December 31, 2023and 2022:
Years Ended December 31,
Net cash (used in) provided by financing activities (23,347) 28,999 (52,346)
Operating Activities
Net cash provided by operating activities consists primarily of net income adjusted for non-cash items, including depreciation and amortization, changes in deferred income taxes and others, and includes the effect of working capital changes. Net cash provided by operating activities decreased by $15.5 million, or 49%, primarily due to the timing of working capital outlays. During the year ended December 31, 2023, we implemented new enterprise accounting and finance applications, which modified our accounts receivable, accounts payable and treasury processes. As a result of this transformation, we significantly paid down our accounts payable, which negatively impacted our net cash provided by operating activities.
Investing Activities
Net cash used in investing activities decreased by $49.3 million, or 97%, primarily due to payments related to acquisitions in the year ended December 31, 2022.
Financing Activities
Net cash (used in) provided by financing activities decreased by $52.3 million to $23.3 million used in financing activities primarily due to the reduction in proceeds from long-term debt for the year ended December 31, 2023. In addition, checks issued not presented for payment decreased significantly for the year ended December 31, 2023 compared to the year ended December 31, 2022 due to the reduction in checks issued as a result of our new enterprise accounting and finance applications.
Critical Accounting Estimates
The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. These principles require management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, cash flow and related disclosure of contingent assets and liabilities. The estimates include, but are not limited to, inventory reserves, impairment of long-lived assets, impairment of goodwill, and the purchase price allocation and fair value of assets and liabilities acquired with respect to business combinations. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and the actual results, future financial statements will be affected.
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We believe that among our significant accounting policies, which are described in Note 2 - Summary of Significant Accounting Policies to the consolidated financial statements in this Annual Report on Form 10-K, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, we believe these are the most critical to fully understand and evaluate our financial condition and results of operations.
Business Combinations
We account for our business combinations using the purchase method of accounting in accordance with ASC Topic 805 (“ASC 805”), Business Combinations. The purchase method of accounting requires that the consideration transferred be allocated to the assets, including separately identifiable assets and liabilities we acquired, based on their estimated fair values. The consideration transferred in an acquisition is measured as the aggregate of the fair values at the date of exchange of the assets given, liabilities incurred, and equity instruments issued as well as the contingent considerations and all contractual contingencies as of the acquisition date. Identifiable assets, liabilities and contingent liabilities acquired or assumed are measured separately at their fair value as of the acquisition date, irrespective of the extent of any noncontrolling interests. The excess of (i) the total of cost of acquisition, fair value of the noncontrolling interests and acquisition date fair value of any previously held equity interest in the acquiree over, (ii) the fair value of the identifiable net assets of the acquiree, is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in earnings.
We estimate the fair value of assets acquired and liabilities assumed in a business combination. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, its estimates are inherently uncertain and subject to refinement. Significant estimates in valuing certain intangible assets include, but are not limited to future expected revenues and cash flows, useful lives, discount rates, and selection of comparable companies. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are based in part on historical experience and information obtained from management of the acquired companies and are inherently uncertain. During the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. On the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations and comprehensive income (loss).
Goodwill
Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. We test goodwill for impairment at least annually, as of December 31, or whenever events or changes in circumstances indicate that goodwill might be impaired. We have concluded we are one reporting unit for purposes of testing goodwill for impairment.
We review the carrying value of goodwill whenever events or changes in circumstances indicate that such carrying values may not be recoverable and annually for goodwill as required by ASC Topic 350, Intangibles — Goodwill and Other. Factors that may be considered a change in circumstances, indicating that the carrying value of our goodwill may not be recoverable, include a sustained decline in stock price and market capitalization, reduced future cash flow estimates and slower growth rates in our industry. This guidance provides the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If, based on a review of qualitative factors, it is more likely than not that the fair value of a reporting unit is less than its carrying value, we perform a quantitative analysis. If the quantitative analysis indicates the carrying value of a reporting unit exceeds its fair value, we measure any goodwill impairment losses as the amount by which the carrying amount of a reporting unit exceeds its fair value, not to exceed the total amount of goodwill allocated to that reporting unit.
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As a result of our 2023 financial performance in comparison to previous forecasts, combined with our level of stock price, we performed a quantitative impairment assessment. A quantitative goodwill impairment analysis requires valuation of the respective reporting unit, which requires complex analysis and judgment. We use a combination of discounted cash flow (“DCF”) model and market approaches, such as public company comparable analysis and comparable acquisitions analysis to determine fair value. The income approach and market approaches were weighted equally to estimate fair value. The income approach requires detailed forecasts of cash flows, including significant assumptions such as revenue growth rates, gross profit margin, and an estimate of weighted-average cost of capital which we believe approximate the assumptions from a market participant’s perspective. The market approaches are primarily impacted by an enterprise value multiple of EBITDA. These estimates incorporate many uncertain factors which could be impacted by changes in market conditions, interest rates, growth rate, tax rates, costs, customer behavior, regulatory environment and other macroeconomic changes. We categorize the fair value determination as Level 3 in the fair value hierarchy due to its use of internal projections and unobservable measurement inputs.
The results of testing as of December 31, 2023, concluded that the estimated fair value exceeded carrying value, and no impairment existed as of that date. In addition, we corroborated the reasonableness of the total fair value of the reporting unit by assessing the implied control premium based on our market capitalization. Our market capitalization is calculated using the number of common shares issued and common stock publicly traded price. We also consider the amount of headroom for the reporting unit when determining whether an impairment existed. Headroom is the difference between the fair value of a reporting unit and its carrying value. The fair value of the reporting unit exceeded the reporting unit carrying value by approximately $10%, or $45.0 million. No goodwill impairment was recorded for the year ended December 31, 2023. See Note 8 - Goodwill and Acquired Intangible Assets to the consolidated financial statements in this Annual Report on Form 10-K for additional information.
Assumptions used in impairment testing are made at a point in time and require significant judgment; therefore, they are subject to change based on the facts and circumstances present at each impairment test date.Additionally, these assumptions are generally interdependent and do not change in isolation.
We performed sensitivity analyses on the key inputs and assumptions used in determining the estimated fair value of our reporting unit by utilizing changes in assumptions that would reasonably likely occur. Assuming all other assumptions and inputs used in the fair value analysis are held constant, a 100 basis point increase in the discount rate assumption, a 1x decrease in the respective EBITDA multiple assumptions, a 25 basis point decrease in the gross profit margin assumption, and a 50 basis point decrease in the long-term revenue growth rate assumption would result in a decrease in the fair value of our reporting unit of approximately $14.8 million, $36.9 million, $8.4 million, and $22.6 million, respectively. These estimated changes in fair value are not necessarily representative of the actual impairment that would be recorded in the event of a fair value decline.
If, in future periods, the financial performance of the reporting unit does not meet forecasted expectations, or a prolonged decline occurs in the market price of our common stock, it may cause a change in the results of the impairment assessment and, as such, could result in an impairment of goodwill.
Impairment of Long-lived Assets
We assess our long-lived assets such as property and equipment and intangible assets subject to amortization for impairment whenever events or changes in circumstances indicate the carrying amount of an asset or asset group may not be recoverable. Factors which may indicate potential impairment include a significant underperformance related to the historical or projected future operating results or a significant negative industry or economic trend. Recoverability of these assets is measured by comparison of their carrying amounts to future undiscounted cash flows which the assets or asset groups are expected to generate. If property and equipment and intangible assets are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds their fair value.
We impaired machinery used in the operations within HF Foods Industrial, Inc. and recognized impairment expense of $1.2 million in distribution, selling and administrative expenses in the consolidated statements of operations during the year ended December 31, 2023. We impaired our acquired developed technology attributable to Syncglobal, Inc. and recognized impairment expense of $0.4 million in distribution, selling and administrative expenses in the consolidated statements of operations during the year ended December 31, 2022.
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Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements, see Note 2 - Summary of Significant Accounting Policies to the consolidated financial statements in this Annual Report on Form 10-K.
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk.
Interest Rate Risk
Our debt exposes us to risk of fluctuations in interest rates. Floating rate debt, where the interest rate fluctuates periodically, exposes us to short-term changes in market interest rates. Fixed rate debt, where the interest rate is fixed over the life of the instrument, exposes us to changes in market interest rates reflected in the fair value of the debt and to the risk that we may need to refinance maturing debt with new debt at higher rates. We manage our debt portfolio to achieve an overall desired proportion of fixed and floating rate debts and may employ interest rate swaps as a tool from time to time to achieve that position. To manage our interest rate risk exposure, we entered into four interest rate swap contracts to hedge the floating rate term loans. See Note 9 - Derivative Financial Instruments to the consolidated financial statements in this Annual Report on Form 10-K for additional information.
As of December 31, 2023, our aggregate floating rate debt’s outstanding principal balance without hedging was $60.8 million, or 35.2% of total debt, consisting primarily of our revolving line of credit (see Note 10 - Debt to the consolidated financial statements in this Annual Report on Form 10-K). Our floating rate debt interest is based on the floating 1-month SOFR plus a predetermined credit adjustment rate plus the bank spread. The remaining 64.8% of our debt is on a fixed rate or a floating rate with hedging. In a hypothetical scenario, a 1% change in the applicable rate would cause the interest expense on our floating rate debt to change by approximately $0.6 million per year.
Fuel Price Risk
We are also exposed to risks relating to fluctuations in the price and availability of diesel fuel. We require significant quantities of diesel fuel for our vehicle fleet, and the inbound delivery of the products we sell is also dependent upon shipment by diesel-fueled vehicles. Additionally, elevated fuel costs can negatively impact consumer confidence and discretionary spending and thus reduce the frequency and amount spent by consumers for food-away-from-home purchases. We currently are able to obtain adequate supplies of diesel fuel, and average prices in 2023 decreased in comparison to average prices in 2022, decreasing 15.5% on average. However, it is impossible to predict the future availability or price of diesel fuel. The price and supply of diesel fuel fluctuates based on external factors not within our control, including geopolitical developments, supply and demand for oil and gas, regional production patterns, weather conditions and environmental concerns. Increases in the cost of diesel fuel could increase our cost of goods sold and operating costs to deliver products to our customers.
We do not actively hedge the price fluctuation of diesel fuel in general. Instead, we seek to minimize fuel cost risk through delivery route optimization and fleet utilization improvement.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
HF Foods Group Inc. and Subsidiaries
Consolidated Financial Statements
Index to Consolidated Financial Statements
Page
Consolidated Financial Statements
Consolidated Balance Sheets 41
Consolidated Statements of Operations and Comprehensive Income (Loss) 42
Consolidated Statements of Cash Flows 43
Consolidated Statements of Changes in Shareholders’ Equity 45
Notes to Consolidated Financial Statements 46
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Report of Independent Registered Public Accounting Firm
Shareholders and Board of Directors
HF Foods Group Inc.
Las Vegas, Nevada
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of HF Foods Group Inc. (the “Company”) as of December 31, 2023 and 2022, the related consolidated statements of operations and comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2023, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2023 and 2022, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2023, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 26, 2024, expressed an adverse opinion thereon.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Consolidated Financial Statements - Impact of Control Environment and Information Technology General Controls
As disclosed in management’s report on internal control over financial reporting, the Company identified material weaknesses as of December 31, 2023. These material weaknesses included ineffective information technology general controls (ITGCs), and ineffective controls over certain non-routine transactions, significant management estimates, and financial reporting. The completeness and accuracy of the consolidated financial statements, including the financial condition, results of operations and cash flows, is dependent on, in part, the Company’s ability to (i) design and maintain an effective control environment, including maintaining a sufficient number of qualified resources to support and provide proper oversight and accountability over the performance of controls, (ii) design and maintain effective ITGCs for certain information systems relevant to the preparation of the financial statements, and (iii) design and maintain effective controls over financial reporting.
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We identified a critical audit matter over the completeness and accuracy of the consolidated financial statements. The ineffective control environment, including the ineffective ITGCs resulted in several material weaknesses. Designing the appropriate procedures and evaluating audit evidence to ensure the completeness and accuracy of the consolidated financial statements, including higher risk areas, with an ineffective control environment, required especially challenging and subjective auditor judgment due to the increased extent of audit effort including the need to modify the nature and extent of audit evidence obtained.
The primary procedures we performed to address this critical audit matter included:
•Performing incremental procedures over material financial statement accounts such as revenue and receivables by i) increasing the sample sizes to perform certain audit procedures and ii) lowering the testing thresholds and for journal entries by expanding the types of entries to be tested.
•Evaluating the impact of improper segregation of duties and designing incremental procedures over disbursements.
•Manually testing the completeness and accuracy of information provided by the Company and increasing the extent of our testing for items to be selected and agreed to source documents.
Goodwill Impairment – Valuation of Reporting Unit
As disclosed in Notes 2 and 8 to the consolidated financial statements, the Company’s consolidated goodwill balance was $85.1 million as of December 31, 2023. There is only one reporting unit at December 31, 2023. Goodwill is tested for impairment at the reporting unit level at least annually, or whenever events or changes in circumstances indicate that goodwill might be impaired. In the valuation of goodwill, management must make assumptions regarding estimated future cash flows to be derived from the Company’s business. A change in underlying assumptions could cause a change in the results of the impairment test and, as such, could cause fair value to be less than the carrying amount and result in an impairment of goodwill in the future. In connection with the annual impairment test completed as of December 31, 2023 using the quantitative goodwill impairment assessment, the Company determined the fair value of the reporting unit, using an average of the income approach, specifically, the discounted cash flow method, and market approaches, specifically, the comparable public company analysis and comparable acquisition analysis methods. The income approach uses a discounted cash flow model that reflects management significant assumptions that mainly related to revenue growth rates, gross profit margins and a discount rate. The comparable public company and comparable acquisition analysis methods apply a market multiple assumption to the Company’s EBITDA to calculate fair value. The fair value of the Company’s reporting unit exceeded the carrying value, and therefore the Company concluded no impairment was required to be recorded during the year ended December 31, 2023.
We identified certain assumptions used in the valuation of goodwill for the reporting unit as a critical audit matter. Management’s determination of the fair value of the reporting unit required the use of significant judgment due to the subjectivity and uncertainty of the revenue growth rates, gross profit margins and discount rate assumptions used in the income approach, and the EBITDA multiple assumption used in the comparable public company analysis and comparable acquisition analysis approaches. Auditing these elements involved especially challenging and subjective auditor judgment due to the nature and extent of audit effort required to address these matters, including the extent of specialized skill or knowledge needed.
The primary procedures we performed to address this critical audit matter included:
•Evaluating the reasonableness of the forecasted revenue and gross profit margins by: 1) evaluating the consistency of the revenue growth rates and gross profit margins with historical results, ii) evaluating the consistency of the revenue growth rates and gross profit margins with the Company’s objectives and strategies, and iii) comparing the forecasted revenue growth rates and gross profit margins with external market data and evidence obtained in other areas of the audit.
•Utilizing personnel with specialized knowledge and skill with valuation to assist in assessing the reasonableness of the discount rate incorporated in the income approach and the EBITDA multiples incorporated in the comparable company analysis and comparable acquisition analysis approaches.
/s/ BDO USA, P.C.
We have served as the Company’s auditor since 2021.
Troy, Michigan
March 26, 2024
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HF Foods Group Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share data)
ASSETS
CURRENT ASSETS:
Accounts receivable - related parties 308 213
Prepaid expenses and other current assets 10,145 8,937
Trademarks, trade names and other intangibles, net 30,625 36,343
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Checks issued not presented for payment $ 4,494 $ 21,946
Accounts payable - related parties 397 1,529
Current portion of long-term debt, net 5,450 6,266
Current portion of obligations under finance leases 1,749 2,254
Current portion of obligations under operating leases 3,706 3,676
Accrued expenses and other liabilities 17,287 19,648
Obligations under finance leases, non-current 11,229 11,441
Obligations under operating leases, non-current 9,414 10,591
COMMITMENTS AND CONTINGENCIES (Note 16)
SHAREHOLDERS’ EQUITY:
TOTAL SHAREHOLDERS’ EQUITY ATTRIBUTABLE TO HF FOODS GROUP INC. 286,661 291,813
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 596,520 $ 637,529
The accompanying notes are an integral part of these consolidated financial statements.
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HF Foods Group Inc. and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income (Loss)
(In thousands, except share and per share data)
Year Ended December 31,
Change in fair value of interest rate swap contracts 1,580 (817) (1,425)
Lease guarantee (income) expense (377) 5,744 —
NET (LOSS) INCOME AND COMPREHENSIVE (LOSS) INCOME (2,662) 235 22,821
Less: net (loss) income attributable to noncontrolling interests (488) (225) 676
(LOSS) EARNINGS PER COMMON SHARE - BASIC $ (0.04) $ 0.01 $ 0.43
(LOSS) EARNINGS PER COMMON SHARE - DILUTED $ (0.04) $ 0.01 $ 0.43
The accompanying notes are an integral part of these consolidated financial statements.
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HF Foods Group Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
Year Ended December 31,
Cash flows from operating activities:
Treasury stock received via legal settlement (7,750) — —
Asset impairment charges 1,200 422 —
Gain from disposal of property and equipment (362) (1,327) (1,636)
Change in fair value of interest rate swap contracts 1,580 817 (1,425)
Lease guarantee expense (377) 5,744 —
Other non-cash expense (income) 493 (266) (85)
Changes in operating assets and liabilities (excluding effects of acquisitions):
Accounts receivable - related parties (95) 36 1,020
Advances to suppliers - related parties — — 197
Prepaid expenses and other current assets (1,069) (4,008) (944)
Accounts payable - related parties (1,132) (412) (365)
Cash flows from investing activities:
Proceeds from sale of property and equipment 2,000 7,794 3,246
Payment made for acquisition of Sealand — (34,848) —
Payment made for acquisition of Great Wall Group — (17,445) (37,841)
Payment made for acquisition of noncontrolling interests — — (5,000)
Settlement of interest rate swap contracts — — 718
Cash flows from financing activities:
Payments for tax withholding related to vested stock awards (394) — —
Proceeds from long-term debt — 45,956 —
Payment of debt financing costs — (544) —
Repayment of obligations under finance leases (2,480) (2,626) (2,135)
Repayment of promissory note payable - related party — (4,500) (2,500)
Proceeds from noncontrolling interests shareholders — 240 480
Cash distribution to shareholders (884) (187) (338)
The accompanying notes are an integral part of these consolidated financial statements.
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HF Foods Group Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
Year Ended December 31,
Supplemental disclosure of cash flow data:
Supplemental disclosure of non-cash investing and financing activities:
Property acquired in exchange for finance leases 1,763 1,272 8,947
Treasury stock received via legal settlement 7,750 — —
Acquisition of noncontrolling interests 1,652 — —
Note receivable related to property and equipment sales 300 — 257
Intangible asset acquired in exchange for noncontrolling interests — 566 —
Deferred consideration from Great Wall Acquisition — — 17,330
The accompanying notes are an integral part of these consolidated financial statements.
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HF Foods Group Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity
(In thousands, except share data)
Shares Amount Shares Amount
Capital contribution by shareholders — — — — — — — 480 480
Distribution to shareholders — — — — — — — (338) (338)
Stock-based compensation — — — — 635 — 635 — 635
Capital contribution by shareholders — — — — — — — 806 806
Distribution to shareholders — — — — — — — (186) (186)
Distribution to shareholders — — — — — — — (884) (884)
Dissolution of noncontrolling interests — — — — 1,652 — 1,652 (1,742) (90)
The accompanying notes are an integral part of these consolidated financial statements.
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HF Foods Group Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1 - Organization and Description of Business
Organization and General
HF Foods Group Inc. and subsidiaries (collectively “HF Foods”, or the “Company”) is an Asian foodservice distributor that markets and distributes fresh produce, seafood, frozen and dry food, and non-food products to primarily Asian restaurants and other foodservice customers throughout the United States. The Company's business consists of one operating segment, which is also its one reportable segment: HF Foods, which operates solely in the United States. The Company's customer base consists primarily of Chinese and Asian restaurants, and it provides sales and service support to customers who mainly converse in Mandarin or Chinese dialects.
On December 30, 2021, the Company completed the acquisition of Great Wall Seafood Supply, Inc., Great Wall Restaurant Supplier, Inc., and First Mart Inc. (collectively the “Great Wall Group”), and substantially all of the operating assets of the Great Wall Group’s seafood and restaurant products sales, marketing, and distribution businesses (the “Great Wall Acquisition”). The acquisition was completed as part of the Company’s strategy to develop a national footprint through expansion into the Midwest, Southwest and Southern regions of the United States.
On April 29, 2022, the Company completed the acquisition of substantially all of the operating assets of Sealand Food, Inc. ("Sealand") including equipment, machinery and vehicles. The acquisition was completed to expand the Company's territory along the East Coast, from Massachusetts to Florida, as well as Pennsylvania, West Virginia, Ohio, Kentucky, and Tennessee.
See Note 7 - Acquisitions for additional information on the Great Wall Group and Sealand acquisitions.
Note 2 - Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). All adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.
The accompanying consolidated financial statements for 2023 include the accounts of HF Foods, and for 2022 and 2021, the accounts of HF Foods and certain variable interest entities for which the Company was the primary beneficiary. All significant intercompany balances and transactions have been eliminated in consolidation. For consolidated entities where we own or are exposed to less than 100% of the economics, the Company records net income (loss) attributable to noncontrolling interest in its consolidated statements of operations and comprehensive income (loss) equal to the percentage of the economic or ownership interest retained in such entity by the respective noncontrolling party.
Variable Interest Entities
GAAP provides guidance on the identification of a variable interest entity (“VIE”) and financial reporting for an entity over which control is achieved through means other than voting interests. The Company evaluates each of its interests in an entity to determine whether or not the investee is a VIE and, if so, whether the Company is the primary beneficiary of such VIE. In determining whether the Company is the primary beneficiary, the Company considers if the Company (1) has power to direct the activities that most significantly affect the economic performance of the VIE, and (2) has the obligation to absorb losses or the right to receive the economic benefits of the VIE that could be potentially significant to the VIE. If deemed the primary beneficiary, the Company consolidates the VIE.
As of and for the year ended December 31, 2023, the Company has one VIE, AnHeart, Inc. (“AnHeart”), for which the Company is not the primary beneficiary and therefore does not consolidate. The Company did not incur expenses from VIEs and did not have any sales to or income from any VIEs during the years ended December 31, 2023 and 2022. See Note 16 - Commitments and Contingencies for additional information on AnHeart.
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For the years ended December 31, 2022 and 2021, the Company had both VIEs for which it was not the primary beneficiary and therefore did not consolidate, and VIEs for which it was the primary beneficiary and did consolidate. The VIEs are summarized as follows:
•Consolidated VIEs (collectively "Consolidated VIEs"):
•FUSO Trucking LLC (“FUSO”) – Dissolved in 2022
•8 staffing agencies (collectively, the “Staffing Agencies”) – Suppliers of staffing services through 2021:
◦Anfu, Inc.
◦Anshun, Inc.
◦Inchoi, Inc.
◦Malways, Inc.
◦Rousafe
◦S&P
◦SNP
◦Suntone
•Unconsolidated VIEs (collectively "Unconsolidated VIEs"):
•Revolution Industry, LLC (“Revolution Industry”) – Supplier of goods (until March 2021)
•UGO USA, Inc. (“UGO”) – Supplier of online goods, customer, and lessee (until April 2021)
•AnHeart, Inc. (“AnHeart”)
Consolidated VIEs
FUSO
FUSO was established solely to provide exclusive trucking services to the Company and was dissolved in 2022. The entity lacked sufficient equity to finance its activities without additional subordinated financial support from the Company, and the Company had the power to direct the VIEs’ activities. In addition, the Company received economic benefits from the entity and concluded that the Company was the primary beneficiary. The carrying amounts of the assets, liabilities, the results of operations and cash flows of the VIE included in the Company’s consolidated balance sheets, statements of operations and comprehensive income (loss) and statements of cash flows were immaterial.
Staffing Agencies
The Staffing Agencies were set up by an employee of the Company, or their relatives, and provided temporary labor services exclusively to the Company at the direction of the Company. There were no other substantive business activities of the Staffing Agencies. There were immaterial assets held, or liabilities owed by the Staffing Agencies and immaterial equity. The Company determined it was the primary beneficiary for the Staffing Agencies through 2021 as it controlled how and when the labor force would be utilized. The Company consolidated the Staffing Agencies, recognizing compensation expense within distribution, selling, and administrative expenses in the consolidated statements of operations and comprehensive income (loss), and the related accrued expenses in the consolidated balance sheets. The Company did not have any guarantees, commitments or other forms of financing to the Staffing Agencies. As of December 31, 2021, the Company no longer had involvement with any of the Staffing Agencies and therefore was no longer considered a VIE and was no longer consolidated.
Unconsolidated VIEs
Revolution Industry and UGO
Revolution Industry was established to produce egg roll mix for the Company. UGO was originally designed to be an online marketplace for various Asian goods. Revolution Industry and UGO were thinly capitalized and were not able to finance their activities without additional subordinated support. The former Co-CEO's (Mr. Ni) son, as sole equity holder of Revolution Industry, had unilateral control over the ongoing activities of Revolution Industry and significantly benefited from their operations. Therefore, the Company was not the primary beneficiary for Revolution Industry. The former Co-CEO (Mr. Ni) and his niece, as equity holders, had unilateral control over the ongoing activities of UGO and significantly benefited from its operations. Therefore, the Company was not the primary beneficiary for UGO.
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Revolution Industry and UGO are also related parties and were generally the Company’s suppliers or customers and the Company did not have other involvement with these entities. Therefore, the Company’s exposure to loss due to its involvement with these entities was limited to amounts due from these entities, which was included in Accounts receivable – related parties. The Company did not have any guarantees, commitments, or other forms of financing with these entities. All transactions with Revolution Industry and UGO ceased in 2021. Related party transactions with Revolution Industry and UGO are disclosed in Note 13 - Related Party Transactions.
AnHeart
AnHeart was previously a subsidiary of the Company designed to sell traditional Chinese medicine, sold to a third-party in February 2019. As discussed in Note 6 - Leases, after the sale, the Company continued to provide a guarantee for all rent and related costs associated with two leases of AnHeart in Manhattan, New York. The Company has determined that AnHeart is a VIE as a result of the guarantee. However, the Company concluded it is not the primary beneficiary of AnHeart because it does not have the power to direct the activities of AnHeart that most significantly impact AnHeart's economic performance. Please refer to Note 6 - Leases for additional information regarding the Company's maximum exposure to loss related to AnHeart.
The Company did not have any sales to or rental income from any of the other VIEs during the three years ended December 31, 2023.
Noncontrolling Interests
GAAP requires that noncontrolling interests in subsidiaries and affiliates be reported in the equity section of the Company’s consolidated balance sheets. In addition, the amounts attributable to the net income (loss) of those noncontrolling interests are reported separately in the consolidated statements of operations and comprehensive income (loss).
As of December 31, 2023 and December 31, 2022, noncontrolling interest equity consisted of the following:
HF Foods Industrial, LLC ("HFFI") (a) 45.00% $ (759) $ 204
Ocean West Food Services, LLC (b) —% — 1,986
Syncglobal Inc. (c) —% — 90
_________________
(a)During the year ended December 31, 2023, the Company exited HFFI operations. Accordingly, the machinery used in HFFI operations was impaired and subsequently sold. See Note 4 - Balance Sheet Components for additional information.
(b)Effective June 30, 2023, Ocean West Food Services, LLC (“Ocean West”) became a wholly-owned subsidiary of the Company. In accordance with ASC Topic 810 (“ASC 810”), Consolidation, changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary shall be accounted for as equity transactions. No gain or loss was recognized. As a result of this transaction, noncontrolling interests of $1.7 million was reclassified to additional paid-in capital on the consolidated balance sheets.
(c)During the year ended December 31, 2023 the Company ceased operations of Syncglobal Inc. and dissolved the entity.
Uses of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during each reporting period. Actual results could differ from those estimates. Significant accounting estimates reflected in the Company’s consolidated financial statements include, but are not limited to, inventory reserves, impairment of long-lived assets, impairment of goodwill, and the purchase price allocation and fair value of assets and liabilities acquired with respect to business combinations.
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Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an original maturity of three months or shorter as cash equivalents. As of December 31, 2023 and December 31, 2022, the Company had no cash equivalents. Accounts at banks with an aggregate excess of the amount of outstanding checks over the cash balances are included in checks issued not presented for payment in current liabilities in the consolidated balance sheets.
Accounts Receivable, net
Accounts receivable represent amounts due from customers in the ordinary course of business and are recorded at the invoiced amount and do not bear interest. Receivables are presented net of the allowance for expected credit losses in the accompanying consolidated balance sheets. The Company evaluates the collectability of its accounts receivable and determines the appropriate allowance for expected credit losses based on a combination of factors. The Company maintains an allowance for expected credit losses based on historic collection trends, write-offs and the aging of receivables. The Company uses specific criteria to determine uncollectible receivables to be written off, including, bankruptcy filings, the referral of customer accounts to outside parties for collection, and the length that accounts remain past due. As of December 31, 2023 and December 31, 2022, allowances for expected credit losses were $2.1 million and $1.4 million, respectively.
Inventories
The Company’s inventories, consisting mainly of food and other foodservice-related products, are considered finished goods. Inventory costs, including the purchase price of the product and freight charges to deliver it to the Company’s warehouses, are net of certain cash consideration received from vendors, primarily in the form of rebates. The Company adjusts its inventory balance for slow-moving, excess and obsolete inventories to the net recoverable value of such goods based upon inventory category, inventory age, specifically identified items, and overall economic conditions. Inventories are stated at the lower of cost or net realizable value using the first-in, first-out (FIFO) method.
Property and Equipment, net
Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Following are the estimated useful lives of the Company’s property and equipment:
Estimated Useful Lives
Automobiles 3 to 7 years
Buildings and improvements 7 to 39 years
Furniture and fixtures 4 to 10 years
Machinery and equipment 3 to 10 years
Leasehold improvements are amortized over the shorter of the useful life of those leasehold improvements and the remaining lease term.
Repair and maintenance costs are charged to expense as incurred, whereas the cost of renewals and betterment that extends the useful lives of property and equipment are capitalized as additions to the related assets. Retirements, sales and disposals of assets are recorded by removing the cost and accumulated depreciation from the asset and accumulated depreciation accounts with any resulting gain or loss reflected in the consolidated statements of operations and comprehensive income (loss) in distribution, selling and administrative expenses.
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Software Costs
In accordance with ASC 350-40, Internal-Use Software, the Company capitalizes certain computer software licenses and software implementation costs related to developing or obtaining computer software for internal use. Subsequent additions, modifications or upgrades to internal-use software are capitalized only to the extent that they allow the software to perform a task that it previously did not perform. Internal use software is amortized on a straight-line basis over a three to five year period. Capitalized costs include direct acquisitions as well as software and software development acquired under capitalized leases and internal labor where appropriate. Capitalized software purchases and related development costs, net of accumulated amortization, were $5.1 million as of December 31, 2023 and zero as of December 31, 2022, and are included in other long-term assets on the consolidated balance sheets.
Business Combinations
The Company accounts for its business combinations using the purchase method of accounting in accordance with ASC Topic 805, Business Combinations. The purchase method of accounting requires that the consideration transferred be allocated to the assets, including separately identifiable assets and liabilities the Company acquired, based on their estimated fair values. The consideration transferred in an acquisition is measured as the aggregate of the fair values at the date of exchange of the assets given, liabilities incurred, and equity instruments issued as well as the contingent considerations and all contractual contingencies as of the acquisition date. Identifiable assets, liabilities and contingent liabilities acquired or assumed are measured separately at their fair value as of the acquisition date, irrespective of the extent of any noncontrolling interests. The excess of (i) the total of cost of acquisition, fair value of the noncontrolling interests and acquisition date fair value of any previously held equity interest in the acquiree over, (ii) the fair value of the identifiable net assets of the acquiree, is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in earnings.
The Company estimates the fair value of assets acquired and liabilities assumed in a business combination. While the Company uses its best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, its estimates are inherently uncertain and subject to refinement. Significant estimates in valuing certain intangible assets include, but are not limited to future expected revenues and cash flows, useful lives, discount rates, and selection of comparable companies. Although the Company believes the assumptions and estimates it has made in the past have been reasonable and appropriate, they are based in part on historical experience and information obtained from management of the acquired companies and are inherently uncertain. During the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. On the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the Company’s consolidated statements of operations and comprehensive income (loss).
Transaction costs associated with business combinations are expensed as incurred, and are included in distribution, selling and administrative expenses in the Company’s consolidated statements of operations and comprehensive income (loss). The results of operations of the businesses that the Company acquired are included in the Company’s consolidated financial statements from the date of acquisition.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. The Company tests goodwill for impairment at least annually, as of December 31, or whenever events or changes in circumstances indicate that goodwill might be impaired.
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The Company's policy is to test goodwill for impairment annually on the last day of the fourth quarter, or more frequently if certain triggering events or circumstances indicate it could be impaired. Potential impairment indicators include (but are not limited to) macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, other relevant entity-specific events, specific events affecting the reporting unit, or sustained decrease in share price. This guidance provides the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If, based on a review of qualitative factors, it is more likely than not that the fair value of a reporting unit is less than its carrying value, or at management’s discretion, the Company performs a quantitative analysis. If the quantitative analysis indicates the carrying value of a reporting unit exceeds its fair value, the Company measures any goodwill impairment losses as the amount by which the carrying amount of a reporting unit exceeds its fair value, not to exceed the total amount of goodwill allocated to that reporting unit. As of December 31, 2023 and December 31, 2022, the Company has one reporting unit for purposes of testing goodwill for impairment. See Note 8 - Goodwill and Acquired Intangible Assets for additional information.
Determining the fair value of a reporting unit requires the application of judgment and involves the use of significant estimates and assumptions including, projections of future cash flows, which include forecasted revenue, discount rate, and other factors which can be affected by changes in business climate, economic conditions, the competitive environment and other factors. The Company also considers the use of market approaches, such as the comparable public company analysis and comparable acquisitions analysis, to estimate the fair value of the reporting unit. The Company bases these fair value estimates on assumptions management believes to be reasonable but which are unpredictable and inherently uncertain. A change in underlying assumptions would cause a change in the results of the tests and, as such, could cause fair value to be less than the carrying amount and result in an impairment of goodwill in the future. Additionally, if actual results are not consistent with the estimates and assumptions or if there are significant changes to the Company’s planned strategy, it may cause the fair value of the reporting unit to be less than its carrying amount and result in an impairment of goodwill in the future. The Company corroborates the reasonableness of the total fair value of the reporting unit by assessing the implied control premium based on the Company’s market capitalization. The Company’s market capitalization is calculated using the relevant shares outstanding and stock price of the Company’s publicly traded shares. In the event of a goodwill impairment, the Company would be required to record an impairment, which would impact earnings and reduce the carrying amounts of goodwill on the consolidated balance sheet.
Intangible Assets, net
Intangible assets are amortized on a straight-line basis over their estimated useful lives. The Company determines the appropriate useful life of its intangible assets by measuring the expected cash flows of acquired assets. The estimated useful lives of intangible assets are as follows:
Estimated Useful Lives
Non-competition agreement 3 years
Tradenames 10 years
Customer relationships 10 to 20 years
Long-term Investments
The Company’s investments in unconsolidated entities consist of an equity investment and an investment without readily determinable fair value.
The Company follows ASC Topic 321 (“ASC 321”), Investments – Equity Securities, using the measurement alternative to measure investments in investees that do not have readily determinable fair value and over which the Company does not have significant influence at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer, if any. The Company makes a qualitative assessment of whether the investment is impaired at each reporting date. If a qualitative assessment indicates that the investment is impaired, the Company has to estimate the investment’s fair value in accordance with the principles of ASC Topic 820 (“ASC 820”), Fair Value Measurements and Disclosures. If the fair value is less than the investment’s carrying value, the entity has to recognize an impairment loss in earnings equal to the difference between the carrying value and fair value.
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Investments in entities in which the Company can exercise significant influence but does not own a majority equity interest or control are accounted for using the equity method of accounting in accordance with ASC Topic 323 (“ASC 323”), Investments-Equity Method and Joint Ventures. Under the equity method, the Company initially records its investment at cost, which is included in the equity method investment on the consolidated balance sheets. The Company subsequently adjusts the carrying amount of the investment to recognize the Company’s proportionate share of each equity investee’s net income or loss into earnings after the date of investment. The Company evaluates the equity method investments for impairment under ASC 323. An impairment loss on the equity method investments is recognized in earnings when the decline in value is determined to be other-than-temporary.
The Company did not record any impairment loss on its long-term investments during the years ended December 31, 2023, 2022 and 2021.
Impairment of Long-lived Assets
The Company assesses its long-lived assets such as property and equipment and intangible assets subject to amortization for impairment whenever events or changes in circumstances indicate the carrying amount of an asset or asset group may not be recoverable. Factors which may indicate potential impairment include a significant underperformance related to the historical or projected future operating results or a significant negative industry or economic trend. Recoverability of an asset or asset group is measured by comparison of its carrying amount to future undiscounted cash flows the asset or asset group is expected to generate. If property and equipment, and intangible assets are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the asset or asset group exceeds its fair value.
The Company impaired machinery related to HFFI and recognized impairment expense of $1.2 million in distribution, selling and administrative expenses in the consolidated statements of operations during the year ended December 31, 2023. The Company fully impaired its acquired developed technology associated with the Syncglobal joint venture and recognized impairment expense of $0.4 million in distribution, selling and administrative expenses in the consolidated statements of operations during the year ended December 31, 2022. Fair value was determined using Level 3 inputs at the time of impairment. The Company did not record any impairment loss on its long-lived assets during the year ended December 31, 2021.
Insurance and Claim Costs
The Company maintains workers compensation and general liability insurance with licensed insurance carriers. Beginning in April 2020, the Company is self-insured for auto claims less than $100,000 per claim. Insurance and claims expense represent premiums the Company paid and the accruals made for claims within the Company’s self-insured retention amounts. A liability is recognized for the estimated cost of all self-insured claims including an estimate of incurred but not reported claims based on historical experience and for claims expected to exceed the Company's policy limits.
The Company establishes reserves for anticipated losses and expenses related to auto liability claims. The reserves consist of specific reserves for all known claims and an estimate for claims incurred but not reported, and losses arising from known claims ultimately settling in excess of insurance coverage using loss development factors based upon industry data and past experience. In determining the liability, the Company specifically reviews all known claims and records a liability based upon the Company’s best estimate of the amount to be paid. In making the estimate, the Company considers the amount and validity of the claim, as well as the Company’s past experience with similar claims. In establishing the reserve for claims incurred but not reported, the Company considers its past claims history, including the length of time it takes for claims to be reported to the Company. These reserves are periodically reviewed and adjusted to reflect the Company’s experience and updated information relating to specific claims. As of December 31, 2023 and December 31, 2022, the Company has recorded a self-insurance liability of $1.7 million and $1.3 million, respectively, which is included in accrued expenses and other liabilities on the consolidated balance sheets.
Revenue Recognition
The Company recognizes revenue from the sale of products when control of each product passes to the customer and the customer accepts the goods, which occurs at delivery. The majority of customer orders are fulfilled within a day and customer payment terms are typically thirty days or less from invoice date. Our 100% satisfaction guarantee permits our customers to reject part of the order or the entire order within twenty-four hours of receipt without any penalty. Sales taxes invoiced to customers and remitted to government authorities are excluded from net sales.
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The Company follows ASC Topic 606, Revenue from Contracts with Customers. The Company recognizes revenue that represents the transfer of goods and services to customers in an amount that reflects the consideration to which the Company expects to be entitled in such exchange. This requires the Company to identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time, based on when control of goods and services transfer to a customer. The Company’s contracts contain performance obligations which are satisfied when customers have physical possession of each product. The Company’s revenue streams are recognized at a specific point in time.
Cost of Revenue
Cost of revenue primarily includes inventory costs (net of vendor consideration, primarily in the form of rebates), inbound freight, customs clearance fees and other miscellaneous expenses.
Distribution, Selling and Administrative Expenses
Distribution, selling and administrative expenses consist primarily of salaries and benefits for employees and contract laborers, trucking and fuel expenses for deliveries, utilities, maintenance and repair expenses, insurance expenses, depreciation and amortization expenses, selling and marketing expenses, professional fees and other operating expenses.
Shipping and Handling Costs
Shipping and handling costs, which include costs related to the selection of products and their delivery to customers, are included in distribution, selling and administrative expenses. Shipping and handling costs were $76.0 million, $83.7 million and $58.3 million for the years ended December 31, 2023, 2022 and 2021, respectively, and includes estimates for labor associated with shipping and handling activities.
Income Taxes
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, the Company determines deferred tax assets and liabilities based on the differences between the financial statement and tax basis of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
The Company recognizes deferred tax assets to the extent that it believes that these assets are more likely than not to be realized. In making such a determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. A valuation allowance is provided when it is more likely than not that some portion or all of the net deferred tax assets will not be realized.
Based on our assessment, it is more likely than not that most of the net deferred tax assets will be realized through future taxable income. Management has established a valuation allowance against certain deferred taxes attributable to the Company's subsidiary, HFFI. Management believes the realization of these deferred tax assets will be limited as the Company exited HFFI operations during the year ended December 31, 2023. As such, the Company has recorded a valuation allowance of $0.7 million on the deferred tax assets of HFFI. The Company will continue to assess the need for a valuation allowance in the future by evaluating both positive and negative evidence that may exist.
The Company records uncertain tax positions in accordance with ASC Topic 740, Income Taxes (“ASC 740”), on the basis of a two-step process in which (1) the Company determines whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, the Company recognizes the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. See Note 12 - Income Taxes for additional information.
The Company adopted ASU 2019-12 (“ASU 2019-12”), Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, on January 1, 2021. ASU 2019-12 is intended to simplify various aspects related to managerial accounting for income taxes. The adoption had no material impact on the Company's consolidated financial statements.
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In 2021, the Organization for Economic Co-operation and Development (“OECD”) published the Tax Challenges Arising from the Global Anti-Base Erosion Model Rules (“Pillar Two”), also referred to as the GloBE Rules or Pillar Two. The rules are designed to ensure large multinational enterprises (“MNEs”) pay a minimum level of tax (15%) on income of each jurisdiction and are expected to be effective for the first time in January 2024. The legislation applies to MNEs with annual consolidated group revenues of at least €750 million if at least one jurisdiction in which the MNE operates has enacted tax laws in accordance with the Pillar Two framework. The Company continues to monitor the effects of Pillar Two but does not believe it will have a material impact on the financial statements provided that the Company currently has no foreign operations that would be expected to result in the application of Pillar Two.
Leases
The Company accounts for leases following ASC Topic 842, Leases ("ASC 842"). The Company determines if an arrangement is a lease at inception and also considers classification of leases as operating or finance. Operating leases are included in operating lease ROU assets, current portion of obligations under operating leases, and obligations under operating leases, non-current on the Company’s consolidated balance sheets. Finance leases are included in property and equipment, net, current portion of obligations under finance leases, and obligations under finance leases, non-current on the consolidated balance sheets.
Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. The operating lease ROU asset also includes any lease payments made and initial direct costs incurred and excludes lease incentives. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term. Variable rent payments related to both operating and finance leases are expensed as incurred. The Company's variable lease payments primarily consist of real estate, maintenance and usage charges.
The Company has elected to exclude short-term leases from the recognition requirements of ASC 842. A lease is short-term if, at the commencement date, it has a term of less than or equal to one year. Lease expense related to short-term leases is recognized on a straight-line basis over the lease term. The Company has also elected to combine lease and non-lease components when measuring lease liabilities for vehicle and equipment leases.
Derivative Financial Instruments
In accordance with the guidance in ASC Topic 815, Derivatives and Hedging ("ASC 815"), derivative financial instruments are recognized as assets or liabilities on the consolidated balance sheets at fair value. The Company has not designated its interest rate swap ("IRS") contracts as hedges for accounting treatment. Pursuant to GAAP, income or loss from fair value changes for derivatives that are not designated as hedges by management are reflected as income or loss on the consolidated statements of operations and comprehensive income (loss). Net amounts received or paid under the interest rate swap contracts are recognized as an increase or decrease to interest expense when such amounts are incurred. The Company is exposed to credit loss in the event of nonperformance by the counterparty.
Concentrations and Credit Risk
Credit risk
Accounts receivable are typically unsecured and derived from revenue earned from customers, and thereby exposed to credit risk. The risk is mitigated by the Company’s assessment of its customers’ creditworthiness and its ongoing monitoring of outstanding balances.
The Company maintains cash balances with banks which at times exceed federally insured limits. The Company has not experienced any losses in such accounts.
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Segment Reporting
ASC Topic 280, Segment Reporting, establishes standards for reporting information about operating segments on a basis consistent with the Company’s internal organizational structure as well as information about geographical areas, business segments and major customers in financial statements for details on the Company’s business segments. The Company uses the “management approach” in determining reportable operating segments. The management approach considers the internal organization and reporting used by the Company’s operating decision makers for making operational decisions and assessing performance as the source for determining the Company’s reportable segments. In 2021, former co-CEO Zhou Min Ni resigned, and Xiao Mou Zhang assumed the role of sole CEO and sole Chief Operating Decision Maker ("CODM"). The CODM, reviews operating results and makes resource allocations on a consolidated basis and thus the Company has concluded it has one operating and reportable segment.
Recent Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13, Measurement of Credit Losses on Financial Instruments (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 requires companies to measure credit losses utilizing a methodology that reflects expected credit losses and requires a consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 was further amended in November 2019 in “Codification Improvements to Topic 326, Financial Instruments-Credit Losses.” The Company adopted this ASU within the annual reporting period ending as of December 31, 2022. The adoption of this guidance resulted in an adjustment to retained earnings of $0.7 million as of January 1, 2022 as evidenced in the Company’s consolidated statements of changes in shareholders’ equity.
In November 2023, the FASB issued Accounting Standards Update (ASU) 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures, which requires enhanced disclosures about segment expenses on an annual and interim basis. This standard is effective for the Company’s consolidated financial statements for the year ending December 31, 2024 and for interim periods beginning in 2025. The impact of the adoption of this ASU is not expected to have a material effect on the Company’s financial position, or operations, however, the Company is currently evaluating the impact of this standard on its disclosures to the consolidated financial statements.
In December 2023, the FASB issued ASU 2023-09, Income Taxes (ASC 740): Improvement to Income Tax Disclosures, which requires (1) disclosure of specific categories in the rate reconciliation and (2) additional information for reconciling items that meet a quantitative threshold. Additionally, the amendment requires disclosure of certain disaggregated information about income taxes paid, income from continuing operations before income tax expense (benefit) and income tax expense (benefit). The standard is effective for the Company’s consolidated financial statements for the year ending December 31, 2025. The Company is currently evaluating the impact of this standard on its consolidated financial statements.
Note 3 - Revenue
The following table presents the Company's net revenue disaggregated by principal product categories:
Year Ended December 31,
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Note 4 - Balance Sheet Components
Accounts receivable, net consisted of the following:
Less: allowance for expected credit losses (2,119) (1,442)
Movement of allowance for expected credit losses was as follows:
Year Ended December 31,
Adjustment for adoption of the CECL standard — 690 —
Bad debt (write-offs) recoveries (24) (170) 364
Prepaid expenses and other current assets consisted of the following:
Prepaid expenses and other current assets $ 10,145 $ 8,937
Property and equipment, net consisted of the following:
Depreciation expense was $9.6 million, $9.2 million and $8.1 million for the years ended December 31, 2023, 2022 and 2021, respectively. During the year ended December 31, 2023, the Company impaired machinery and recognized impairment expense of $1.2 million in distribution, selling and administrative expense in the consolidated statements of operations and comprehensive income (loss). See Note 2 - Summary of Significant Accounting Policies for additional information regarding the Company’s operations at HFFI.
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Long-term investments consisted of the following:
Asahi Food, Inc. ("Asahi") 49% $ 588 $ 879
Pt. Tamron Akuatik Produk Industri ("Tamron") 12% 1,800 1,800
Total long-term investments $ 2,388 $ 2,679
The investment in Tamron is accounted for using the measurement alternative under Accounting Standards Codification (“ASC”) Topic 321 Investments—Equity Securities, which is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments, if any. The investment in Asahi is accounted for under the equity method due to the fact that the Company has significant influence but does not exercise control over this investee. The Company determined there was no impairment for the years ended December 31, 2023, 2022 and 2021 for these investments.
Accrued expenses and other liabilities consisted of the following:
Total accrued expenses and other liabilities $ 17,287 $ 19,648
Note 5 - Fair Value Measurements
The following table presents the Company's hierarchy for its assets and liabilities measured at fair value on a recurring basis as of the dates indicated:
Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total
(In thousands)
Assets:
Liabilities:
Interest rate swaps $ — $ (1,601) $ — $ (1,601) $ — $ — $ — $ —
The Company follows the provisions of ASC Topic 820 Fair Value Measurement which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:
•Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.
•Level 2 - Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data.
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•Level 3 - Inputs are unobservable inputs which reflect the reporting entity’s own assumptions about what assumptions market participants would use in pricing the asset or liability based on the best available information.
Any transfers of assets or liabilities between Level 1, Level 2, and Level 3 of the fair value hierarchy will be recognized at the end of the reporting period in which the transfer occurs. There were no transfers between fair value levels in any of the periods presented herein.
The carrying amounts reported in the consolidated balance sheets for cash, accounts receivable, other current assets, accounts payable, checks issued not presented for payment and accrued expenses and other liabilities approximate their fair value based on the short-term maturity of these instruments.
Please refer to Note 9 - Derivative Financial Instruments for additional information regarding the Company’s interest rate swaps.
Carrying Value and Estimated Fair Value of Outstanding Debt - The following table presents the carrying value and estimated fair value of the Company’s outstanding debt as described in Note 10 - Debt of the Notes to the Consolidated Financial Statements, including the current portion, as of the dates indicated:
Fair Value Measurements
(In thousands) Level 1 Level 2 Level 3 Carrying Value
Fixed rate debt:
Bank of America $ — $ — $ 151 $ 169
Other finance institutions — — 43 45
Variable rate debt:
Fixed rate debt:
Other finance institutions — — 186 197
Variable rate debt:
The carrying value of the variable rate debt approximates its fair value because of the variability of interest rates associated with these instruments. For the Company's fixed rate debt, the fair values were estimated using discounted cash flow analyses, based on the current incremental borrowing rates for similar types of borrowing arrangements.
Please refer to Note 10 - Debt for additional information regarding the Company's debt.
Nonrecurring Fair Values
The Company measures fair value of certain assets on a nonrecurring basis when events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Adjustments to fair value resulted from the write-down of asset values due to impairment.
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During the year ended December 31, 2023, the Company partially impaired machinery related to the operations of HFFI and recognized impairment expense of $1.2 million in distribution, selling and administrative expense in the consolidated statements of operations and comprehensive income (loss). The machinery was sold during the year ended December 31, 2023. The impairment was based on sales prices of similar equipment listed by third-party sellers and considered a Level 3 fair value measurement.
During the year ended December 31, 2022, the Company fully impaired its acquired developed technology associated with the Syncglobal, Inc. joint venture and recognized impairment expense of $0.4 million in distribution, selling and administrative expenses in the consolidated statements of operations and comprehensive income (loss) during the year ended December 31, 2022.
Note 6 - Leases
The Company leases office space, warehouses and vacant land under non-cancelable operating leases, with terms typically ranging from one to thirty years, as well as operating and finance leases for vehicles and delivery trucks, forklifts and computer equipment with various expiration dates through 2051. The Company determines whether an arrangement is or includes an embedded lease at contract inception.
Operating and finance lease assets and lease liabilities are recognized at commencement date and initially measured based on the present value of lease payments over the defined lease term. Operating lease expense is recognized on a straight-line basis over the lease term. The Company also recognizes finance lease assets and finance lease liabilities at inception, with lease expense recognized as interest expense and amortization of the lease payment. Variable lease costs were insignificant in the years ended December 31, 2023, 2022 and 2021.
As of December 31, 2023, the balances for operating lease right-of-use ("ROU") assets and liabilities were $12.7 million and $13.1 million, respectively. As of December 31, 2022, the balances for operating lease ROU assets and liabilities were $14.2 million and $14.3 million, respectively.
Operating Leases
The components of operating lease expense were as follows:
Year Ended December 31,
Weighted average remaining lease term (months) 42 47 56
Weighted average discount rate 4.5% 3.8% 3.9%
Year Ended December 31,
Operating cash flows from operating leases $ 4,234 $ 4,005 $ 822
Finance Leases
The components of lease expense were as follows:
Year Ended December 31,
Finance leases cost:
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Supplemental cash flow information related to finance leases was as follows:
Year Ended December 31,
Operating cash flows from finance leases $ 657 $ 670 $ 701
Supplemental balance sheet information related to finance leases was as follows:
Weighted average remaining lease term (months) 219 215
Weighted average discount rate 5.7 % 5.7 %
Maturities of lease liabilities are as follows:
Operating Leases
(In thousands) Related Party(1) Third Party Total FinanceLeases
Year Ended December 31,
_______________
(1) See Note 13 - Related Party Transactions
As of December 31, 2023, the Company had additional leases that had not yet commenced which totaled $7.0 million in future minimum lease payments and were excluded from the table above. These leases comprise vehicle leases expected to commence during the year ended December 31, 2024 with lease terms of 4 to 7 years. Subsequent to December 31, 2023, the Company entered into additional vehicle leases which total $15.5 million in future minimum lease payments, with lease terms of 4 to 6 years and were excluded from the table above.
Note 7 - Acquisitions
Acquisition of Sealand
On April 29, 2022, the Company completed the acquisition of substantially all of the operating assets of Sealand, including equipment, machinery and vehicles. The acquisition was completed to expand the Company's territory along the East Coast, from Massachusetts to Florida, as well as Pennsylvania, West Virginia, Ohio, Kentucky, and Tennessee.
The price for the purchased assets was $20.0 million paid in cash at closing. In addition to the closing cash payment, the Company separately acquired all of the sellers' saleable product inventory, for approximately $14.4 million and additional fixed assets for approximately $0.5 million.
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The Company accounted for this transaction under ASC 805 Business Combinations, by applying the acquisition method of accounting and established a new basis of accounting on the date of acquisition. The assets acquired by the Company were measured at their estimated fair values as of the date of acquisition. Goodwill is calculated as the excess of the purchase price over the net assets recognized and represent synergies and benefits expected as a result from combining operations with an emerging national presence. The transaction costs for the acquisition for the year ended December 31, 2022 totaled approximately $0.7 million and were reflected in distribution, selling and administrative expenses in the consolidated statement of operations and comprehensive income.
The information included herein was prepared based on the allocation of the purchase price using estimates of the fair value of assets acquired and liabilities assumed which were determined using a combination of quoted market prices, discounted cash flows, and other estimates made by management.
Purchase Price Allocation
The total consideration paid to acquire the assets and liabilities of Sealand, as set forth below:
(In thousands) Amount
Property plant, and equipment 1,424
Right-of-use assets 127
Total assets acquired 30,114
Obligations under operating leases 127
Total liabilities assumed 127
Total consideration $ 34,848
The Company recorded acquired intangible assets of $14.7 million, which were measured at fair value using Level 3 inputs. These intangible assets include tradenames and trademarks of $4.4 million, customer relationships of $8.9 million and non-competition agreements of $1.4 million. The fair value of customer relationships was determined by applying the income approach utilizing the excess earnings methodology and Level 3 inputs including a discount rate. The fair value of tradenames and trademarks was determined by applying the income approach utilizing the relief from royalty methodology and Level 3 inputs including a royalty rate of 1% and a discount rate. The fair value of non-competition agreements was determined by applying the income approach and Level 3 inputs including a discount rate. Discount rates used in determining fair values for customer relationships, tradenames and trademarks, and non-competition agreements ranged from 17.5% to 18.0%. The useful lives of the tradenames and trademarks are ten years, customer relationships are ten years and non-competition agreements are three years, with a weighted average amortization period of approximately nine years. The associated goodwill is deductible for tax purposes.
Acquisition of Great Wall Group
On December 30, 2021, the Company executed an Asset Purchase Agreement with Great Wall Group to purchase substantially all of the operating assets of the Great Wall Group’s seafood and restaurant products sales, marketing, and distribution businesses. The acquisition was completed as part of the Company’s strategy to develop a national footprint through expansion into the Midwest, Southwest and Southern regions of the United States.
The final aggregate price for the purchased assets was $43.7 million with $30.8 million paid in cash at closing and the issuance of 1,792,981 shares of common stock of the Company (based on a 60-day VWAP of $7.36), with a fair value of $12.9 million based on the share price of $8.11 per share at closing and an 11.5% discount due to a lock-up restriction. In addition to the closing cash payment, the Company separately acquired all of the sellers’ saleable product inventory, for approximately $24.3 million of which approximately $6.8 million was paid during the year ended December 31, 2021 and $17.4 million was recorded in accounts payable on the consolidated balance sheets as of December 31, 2021. The Company also acquired additional vehicles for approximately $0.2 million. As such, the total acquisition price for all operating assets and inventory was approximately $68.2 million.
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The Company accounted for this transaction under ASC 805, Business Combinations, by applying the acquisition method of accounting and established a new basis of accounting on the date of acquisition. The assets acquired by the Company were measured at their estimated fair values as of the date of acquisition. Goodwill is calculated as the excess of the purchase price over the net assets recognized and represent synergies and benefits expected as a result from combining operations with an emerging national presence. For the year ended December 31, 2021, transaction costs for the acquisition totaled $0.9 million and were reflected in distribution, selling and administrative expenses in the consolidated statement of operations and comprehensive income (loss).
The information included herein has been prepared based on the allocation of the purchase price using estimates of the fair value of assets acquired and liabilities assumed which were determined using a combination of quoted market prices, discounted cash flow, and other estimates made by management.
Purchase Price Allocation
The following table presents the allocation of the total consideration paid to acquire the assets and liabilities of the Great Wall Group:
(In thousands) Amount
Property plant, and equipment 1,537
Total assets acquired 56,410
Total consideration $ 68,155
The Company recorded acquired intangible assets of $30.1 million, which included tradenames and trademarks of $10.5 million, customer relationships of $17.2 million and non-competition agreements of $2.4 million. The fair value of customer relationships was determined by applying the income approach utilizing the excess earnings methodology using Level 3 inputs including a discount rate. The fair value of tradenames and trademarks was determined by applying the income approach utilizing the relief from royalty methodology and Level 3 inputs including a royalty rate of 1% and a discount rate.The fair value of non-competition agreements was determined by applying the income approach using Level 3 inputs including a discount rate. Discount rates used in determining fair values for customer relationships, tradenames and trademarks, and non-competition agreements ranged from 11.5% to 14.0%. The useful lives of the tradenames and trademarks are ten years, customer relationships are ten years and non-compete agreements are three years, with a weighted average amortization period of approximately nine years. The associated goodwill is deductible for tax purposes. See Note 8 - Goodwill and Acquired Intangible Assets for additional information on acquired intangibles in the Great Wall Acquisition.
Since the Great Wall Acquisition occurred on December 30, 2021, the amounts of revenue and earnings of the Great Wall Group included in the Company’s consolidated statement of operations and comprehensive income (loss) from the acquisition date to December 31, 2021 were immaterial.
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Unaudited Supplemental Pro Forma Financial Information
The following table presents the Company’s unaudited pro forma results for the years ended December 31, 2022, as if the Great Wall Acquisition and the Sealand Acquisition had been consummated on January 1, 2021. The unaudited pro forma financial information presented includes the effects of adjustments related to the amortization of acquired intangible assets and excludes other non-recurring transaction costs directly associated with the acquisition such as legal and other professional service fees. Statutory rates were used to calculate income taxes.
(In thousands, except share and per share data) Year Ended December 31,
Pro forma net income attributable to HF Foods $ 35 $ 33,724
Pro forma earnings per common share—basic $ — $ 0.65
Pro forma earnings per common share—diluted $ — $ 0.65
Note 8 - Goodwill and Acquired Intangible Assets
Goodwill
The changes in the carrying amount of goodwill are presented below:
(In thousands) Amount
Acquisition of Sealand Food, Inc. 4,861
No Goodwill activity —
Accumulated impairment for goodwill is $338.2 million as of December 31, 2023, 2022 and 2021. The accumulated impairment resulted from an impairment during the year ended December 31, 2020.
There is only one reporting unit at December 31, 2023 and 2022. As a result of the Company’s results of operations compared to previous forecasts, combined with the level of the Company’s stock price, the Company performed a quantitative goodwill impairment assessment as of December 31, 2023 and 2022. The fair value was determined using an average of the income approach, comparable public company analysis, and comparable acquisitions analysis. The fair value of the reporting unit exceeded the carrying value, and therefore the Company concluded no impairment was required to be recorded during the year ended December 31, 2023 and December 31, 2022. For the year ended December 31, 2021, the Company performed a qualitative goodwill impairment assessment and concluded no impairment was required to be recorded during the year ended December 31, 2021.
The 2023 impairment test resulted in an estimated fair value that exceeded carrying value by approximately 10% at December 31, 2023. The most critical assumptions in determining fair value using the income approach were projections of future cash flows such as forecasted revenue growth rates, gross profit margins, and the discount rate. The market approaches were primarily impacted by an enterprise value multiple of EBITDA. A significant change in these assumptions or a sustained decline in the Company’s stock price could result in an interim impairment test and/or potential goodwill impairment in the future.
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Acquired Intangible Assets
In connection with the Sealand acquisition, the Company acquired $14.7 million of intangible assets, primarily representing trademarks and trade names of $4.4 million, customer relationships of $8.9 million and non-compete agreements of $1.4 million. The useful lives of trademarks and trade names are ten years, customer relationships are ten years and non-compete agreements are three years, with a weighted average amortization period of approximately nine years. The associated goodwill is deductible for tax purposes.
In connection with the Great Wall Group acquisition, HF Foods acquired $30.1 million of intangible assets, primarily representing a non-competition agreement, trademarks and trade names and customer relationships, which have an estimated amortization period of approximately 3 years, 10 years, and 10 years, respectively.
In connection with the acquisition of B&R Global in 2019, HF Foods acquired $188.5 million of intangible assets, primarily representing trademarks and trade names and customer relationships which have an estimated amortization period of 10 and 20 years, respectively.
The Company evaluated possible triggering events that would indicate long-lived asset impairment assessment. The Company impaired its acquired developed technology and recognized impairment expense of $0.4 million in distribution, selling and administrative expenses in the consolidated statements of operations during the year ended December 31, 2022. There were no triggering events identified for the remaining acquired intangible assets at December 31, 2022. No impairment was recorded against acquired intangible assets for the years ended December 31, 2023 and 2021.
HF Foods’ amortization expense for acquired intangible assets was $16.3 million, $15.7 million and $10.9 million for the years ended December 31, 2023, 2022 and 2021, respectively.
The estimated future amortization expense for intangible assets is presented below:
(In thousands) Amount
Year ending December 31,
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Note 9 - Derivative Financial Instruments
Derivative Instruments
The Company utilizes interest rate swaps ("IRS") for the sole purpose of mitigating interest rate fluctuation risk associated with floating rate debt instruments (as defined in Note 10 - Debt). The Company does not use any other derivative financial instruments for trading or speculative purposes.
On August 20, 2019, HF Foods entered into two IRS contracts with East West Bank (the "EWB IRS") for initial notional amounts of $1.1 million and $2.6 million, respectively. On April 20, 2023, the Company amended the corresponding mortgage term loans, which pegged the two mortgage term loans to 1-month Term SOFR (Secured Overnight Financing Rate) + 2.29% per annum for the remaining duration of the term loans. The amended EWB IRS contracts fixed the two term loans at 4.23% per annum until maturity in September 2029.
On December 19, 2019, HF Foods entered into an IRS contract with Bank of America (the "BOA IRS") for an initial notional amount of $2.7 million in conjunction with a newly contracted mortgage term loan of corresponding amount. On December 19, 2021, the Company entered into the Second Amendment to Loan Agreement, which pegged the mortgage term loan to Term SOFR + 2.5%. The BOA IRS was modified accordingly to fix the SOFR based loan to approximately 4.50%. The term loan and corresponding BOA IRS contract mature in December 2029.
On March 15, 2023, the Company entered into an amortizing IRS contract with JPMorgan Chase for an initial notional amount of $120.0 million, effective from March 1, 2023 and expiring in March 2028, as a means to partially hedge its existing floating rate loans exposure. Pursuant to the agreement, the Company will pay the swap counterparty a fixed rate of 4.11% in exchange for floating payments based on Term SOFR.
The Company evaluated the aforementioned IRS contracts currently in place and did not designate those as cash flow hedges. Hence, the fair value change on these IRS contracts are accounted for and recognized as a change in fair value of IRS contracts in the consolidated statements of operations and comprehensive income (loss).
As of December 31, 2023, the Company determined that the fair values of the IRS contracts were $0.4 million in an asset position and $1.6 million in a liability position. As of December 31, 2022, the fair values of the IRS contracts were $0.5 million in an asset position. The Company includes these in other long-term assets and other long-term liabilities, respectively, on the consolidated balance sheets. In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible, as well as consider counterparty credit risk in its assessment of fair value. The inputs used to determine the fair value of the IRS are classified as Level 2 on the fair value hierarchy.
Note 10 - Debt
Long-term debt at December 31, 2023 and December 31, 2022 is summarized as follows:
($ in thousands)
Less: debt issuance costs (258) (302)
_______________
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(a)Loan balance consists of real estate term loan and equipment term loan, collateralized by one real property and specific equipment. The real estate term loan is pegged to TERM SOFR + 2.5%.
(b)Real estate term loans with East West Bank are collateralized by three real properties. Balloon payments of $1.8 million and $2.9 million are due at maturity in 2027 and 2029, respectively.
(c)Real estate term loan with a principal balance of $106.3 million as of December 31, 2023 and $111.4 million as of December 31, 2022 is secured by assets held by the Company and has a maturity date of January 2030. Equipment term loan with a principal balance of $0.02 million as of December 31, 2023 and $0.3 million as of December 31, 2022 is secured by specific vehicles and equipment as defined in loan agreements. Equipment term loan matured in December 2023 and retired after December 31, 2023 with the final payment of remaining outstanding principal.
(d)Secured by vehicles.
The terms of the various loan agreements related to long-term bank borrowings require the Company to comply with certain financial covenants, including, but not limited to, a fixed charge coverage ratio and effective tangible net worth. As of December 31, 2023, the Company was in compliance with its covenants.
On March 31, 2022, the Company amended the JPM Credit Agreement, defined below, extending the Real Estate Term Loan for five years. The amendment provides for an increase in the Real Estate Term Loan from $69.0 million to $115.0 million with a 1-month SOFR plus a credit adjustment of 0.1% plus 1.875% per annum.
The future maturities of long-term debt as of December 31, 2023 are as follows:
(In thousands) Amount
Year ending December 31,
Credit Facility
On November 4, 2019, the Company entered into a credit agreement with JPMorgan Chase (the “JPM Credit Agreement”). The JPM Credit Agreement provided for a $100.0 million asset-secured revolving credit facility maturing on November 4, 2022, with an option to renew at the bank’s discretion. On January 17, 2020, the Company and certain of the wholly-owned subsidiaries and affiliates of the Company as borrowers, and certain material subsidiaries of the Company as guarantors, entered into the Second Amended Credit Agreement (“Second Amended Credit Agreement”). On December 30, 2021, the Company entered into the Consent, Waiver, Joinder and Amendment No. 3 to the Second Amended Credit Agreement with JPMorgan Chase, as Administrative Agent, and certain lender parties thereto, including Comerica Bank. The Second Amended Credit Agreement, as amended, provided for (i) a $100.0 million asset-secured revolving credit facility maturing on November 4, 2022 (the “Revolving Facility”), (ii) mortgage-secured term loan of $75.6 million, (the “Term Loan”), and (iii) amendment in the referenced interest rate from 1-month LIBOR to 1-month Secured Overnight Financing Rate ("SOFR") plus a credit adjustment of 0.1% (difference between LIBOR and SOFR plus 1.375% per annum).
The existing revolving credit facility balance under the Second Amended Credit Agreement, was rolled over to the Revolving Facility on December 30, 2021. On the same day, the Company utilized an additional $33.3 million drawdown from the Revolving Facility to fund the Great Wall Acquisition. The Second Amended Credit Agreement, as amended, contains certain financial covenants, including, but not limited to, a fixed charge coverage ratio.
On March 31, 2022, the Company amended the JPM Credit Agreement extending the Revolver Facility for five years, with a maturity date of November 4, 2027. The amendment provides for a $100.0 million asset-secured revolving credit facility with a one-month SOFR plus a credit adjustment of 0.1% plus 1.375% per annum. As of December 31, 2023, the Company was in compliance with its covenants. The outstanding principal balance on the line of credit as of December 31, 2023 was $58.6 million and outstanding letters of credit amounted to $3.8 million leaving access to approximately $37.6 million in additional funds through our $100.0 million line of credit, subject to a borrowing base calculation.
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Subsequent to December 31, 2023, on February 6, 2024, the Company amended the JPM Credit Agreement to (i) remove a cap on permitted indebtedness in respect of capital lease obligations, subject to certain enumerated conditions; (ii) create a reserve on the borrowing base, which will be reduced on a dollar-for-dollar basis once the Company has made expenditures in excess of such amount relating to the development and construction of certain real property, and which amounts shall be excluded from certain financial covenants under the JPM Credit Agreement and; (iii) remove certain sublease income from various financial covenants.
Note 11 - Earnings (Loss) Per Share
The Company computes earnings per share (“EPS”) in accordance with ASC Topic 260 (“ASC 260”), Earnings per Share. ASC 260 requires companies with complex capital structures to present basic and diluted EPS. Basic EPS is measured as net income divided by the weighted average common shares outstanding for the period. Diluted EPS is similar to basic EPS, but presents the dilutive effect on a per share basis of potential common shares (e.g., convertible securities, options, warrants and restricted stock) as if they had been converted at the beginning of the periods presented, or issuance date, if later. Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS. There were 862,182, 348,610 and 130,668 potential common shares related to performance-based restricted stock units and restricted stock units that were excluded from the calculation of diluted EPS for the years ended December 31, 2023, 2022 and 2021, respectively, because their effect would have been anti-dilutive.
The following table sets forth the computation of basic and diluted EPS:
Year Ended December 31,
($ in thousands, except share and per share data) 2023 2022 2021
Numerator:
Net (loss) income attributable to HF Foods Group Inc. $ (2,174) $ 460 $ 22,145
Denominator:
Earnings (Loss) per common share:
Note 12 - Income Taxes
The provision (benefit) for income taxes of the Company for the years ended December 31, 2023, 2022 and 2021 consists of the following:
Year Ended December 31,
Current:
Deferred income benefit:
Total income tax expense (benefit) $ 41 $ (231) $ 4,503
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The Company's effective income tax rates for the years ended December 31, 2023, 2022 and 2021 were (1.6)%, (5,148.7)% and 16.6%, respectively. The determination of the Company’s overall effective income tax rate requires the use of estimates. The effective income tax rate reflects the income earned and taxed in U.S. federal and various state jurisdictions based on enacted tax law, permanent differences between book and tax items, change in valuation allowance, tax credits and the Company’s change in relative income in each jurisdiction. Changes in tax laws and rates may affect recorded deferred tax assets and liabilities and the Company’s effective income tax rate in the future. The Company has no operations outside the U.S., as such, no foreign income tax was recorded.
Reconciliations of the statutory income tax rate to the effective income tax rate are as follows:
Year Ended December 31,
U.S permanent differences (8.7) % 207.1 % 1.9 %
Noncontrolling interests 5.5 % 3,164.6 % — %
Officers’ compensation (12.5) % — % — %
Return to provision 21.6 % — % — %
Change in valuation allowance (35.9) % — % — %
Tax credits 6.7 % — % — %
Stock compensation (6.6) % — % — %