HF Foods Group Inc. 10-Q

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations of HF Foods Group Inc. This discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this report. The following discussion contains forward-looking statements that involve numerous risks and uncertainties. Our actual results could differ materially from the forward-looking statements as a result of these risks and uncertainties. See “ Cautionary Note About Forward-Looking Statements” for additional cautionary information. Company Background and Overview HF Foods Group Inc. (“HF Group” or the “Company”) markets and distributes fresh produce, frozen and dry food, and non- food products to primarily Asian restaurants and other food service customers throughout the Southeast, Pacific and Mountain West regions region of the United States. The Company was originally incorporated in Delaware on May 19, 2016 as a special purpose acquisition company under the name Atlantic Acquisition Corp. (“Atlantic”) in order to acquire, through a merger, share exchange, asset acquisition, share purchase, recapitalization, reorganization or similar business combination, one or more businesses or entities. Effective August 22, 2018, Atlantic consummated the transactions contemplated by a merger agreement (the “Atlantic Merger Agreement”), dated as of March 28, 2018, by and among Atlantic, HF Group Merger Sub Inc., a Delaware subsidiary formed by Atlantic, HF Group Holding Corporation, a North Carolina corporation (“HF Holding”), the stockholders of HF Holding, and Zhou Min Ni, as representative of the stockholders of HF Holding. Pursuant to the Atlantic Merger Agreement, HF Holding merged with HF Merger Sub and HF Holding became the surviving entity (the “Atlantic Merger”) and a wholly-owned subsidiary of Atlantic (the “Atlantic Acquisition”). Additionally, upon the closing of the transactions contemplated by the Atlantic Merger Agreement (the “Atlantic Closing”), (i) the stockholders of HF Holding became the holders of a majority of the shares of common stock of Atlantic, and (ii) Atlantic changed its name to HF Foods Group Inc. (collectively, these transactions are referred to as the “Atlantic Transactions”). Effective November 4, 2019, HF Group consummated the transactions contemplated by a merger agreement (the “B&R Global Merger Agreement”), dated as of June 21, 2019, by and among the Company, B&R Global Merger Sub Inc., a Delaware corporation (“Merger Sub”), B&R Global, the stockholders of B&R Global (the ”B&R Global Stockholders”), and Xiao Mou Zhang, as representative of the B&R Global Stockholders (the “Business Combination”). Upon the closing of the transactions contemplated by the B&R Global Merger Agreement (the “Closing”), Merger Sub merged with and into B&R Global, resulting in B&R Global becoming a wholly owned subsidiary of HF Group. HF Group acquired 100% of the controlling interest of B&R Global, in exchange for 30,700,000 shares of HF Group Common Stock. The aggregate fair value of the consideration paid by HF Group in the business combination was approximately $576,699,494, based on the closing share price at the date of Closing. On January 17, 2020, B&R Global acquired all equity membership interests in the BRGR Subsidiaries (as defined in Note 1 to the financial statements), which own warehouse facilities that were being leased by the Company for its operations in California, Arizona, Utah, Colorado, Washington, and Montana. Co-CEO of the Company, Xiao Mou Zhang, managed and owned an 8.91% interest in BRGR. The total purchase price for the acquisition was $101,269,706, which was based on independent fair market value appraisals of the properties owned by the BRGR Subsidiaries. The Company notes that substantially all of the fair value of the gross assets acquired is concentrated in a group of similar assets (land and buildings used for warehousing and distribution purposes). As such, the acquisition of BRGR Subsidiaries would not be deemed a business combination under ASC 805 but as an asset acquisition. The total purchase price is allocated on a relative fair value basis to the net assets acquired. Due to the acquisition of B&R Global, the financial information of the Company for the three and six month periods ended June 30, 2020 is not comparable to the same period of 2019. As such, the Company has presented our results of operations for the three and six month periods ended June 30, 2020 and 2019, as well as the unaudited pro forma combined results of operations for the three and six month periods ended June 30, 2020 and 2019. For more information, see section titled “Supplemental Unaudited Pro Forma Combined Financial Information”. Outlook The Company plans to continue to expand our business through acquisition of other distributors and wholesalers, which depends on access to sufficient capital. If the Company is unable to obtain equity or debt financing, or borrowings from bank 35 Table of Contents loans, the Company may not be able to execute its plan to acquire other distributors and wholesalers. Even if the Company is able to make such acquisitions, the Company may not be able to successfully integrate any acquired businesses or improve their profitability, which could have a material adverse effect on our financial condition and future operating performance. Financial Overview Our net revenue for the six months ended June 30, 2020 was $280.4 million, an increase of $130.8 million, or 87.5%, from $149.5 million for the six months ended June 30, 2019, as a result of the business combination with B&R Global on November 4, 2019. Net loss attributable to HF Group’s stockholders for the the six months ended June 30, 2020 was $343.9 million, a decrease of $346.6 million, or 12,858.9%, from net income attributable to HF Group’s stockholders of $2.7 million for the six months ended June 30, 2019, due to the significant impairment of goodwill ($338.2 million - see Note 9 to our financial statements for additional information) prompted by the impact of the COVID-19 pandemic and an increase in other non-cash charges, such as amortization of intangible assets. Adjusted EBITDA for the six months ended June 30, 2020 was $7.8 million, an increase of $0.6 million, or 9.0%, from $7.1 million for the six months ended June 30, 2019. For additional information on Adjusted EBITDA, see the section entitled “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS— Adjusted EBITDA” below. On a pro-forma basis, assuming that the Business Combination took place on January 1, 2019, our net revenue for the six months ended June 30, 2020 would have been $280.4 million, a decrease of $136.6 million, or 32.8% from $417.0 million for the six months ended June 30, 2019. Net loss attributable to HF Group’s stockholders for the six months ended June 30, 2020 would have been $343.9 million, a decrease of $348.0 million, or 8,594.4%, from net income attributable to HF Group’s stockholder of $4.0 million for the six months ended June 30, 2019. Adjusted EBITDA for the six months ended June 30, 2020 would have been $7.8 million, a decrease of $11.2 million, or 59.0%, from $19.0 million for the six months ended June 30, 2019. For additional information on our pro-forma results, see the section entitled “SUPPLEMENTAL UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION” below. COVID-19 Impact For the first two months of 2020, the outbreak of COVID-19 did not have a significant impact on our business. However, we began to experience a gradual decline in sales towards the end of February and the impact began to intensify in March, especially in the final two weeks of the month. By late March, almost all states across the country had issued some form of stay-at-home orders. As such, the operations of our restaurant customers were severely disrupted due to the “cliff-like” decline in consumer demand for food away from home. The government mandates forced many of our restaurant customers to temporarily close or convert to take-out or delivery-only operations. As a result, the last two weeks of March led to a significant decline in net sales, negatively impacting our overall net income and adjusted EBITDA in the first quarter ended March 31, 2020. Our net sales during the last two weeks of the first quarter decreased approximately 67% compared to pro-forma sales in the same period ended March 31, 2019. The impact of COVID-19 continued to worsen in April 2020, resulting in as much as a 75% decrease in net sales compared to pro-forma sales in the comparable prior year period and resulting in the Company making the decision to temporarily shut down the operation of a few distribution centers in North Carolina, Georgia and Florida. In response to the COVID-19 pandemic, beginning in late March 2020, we swiftly pivoted our business strategy and cost structure to reduce operating costs, strengthen our liquidity position, and secure new revenue sources. Some of the notable actions include: • actively managing our variable costs to better align with prevailing sales volumes by instituting temporary furloughs, reducing our delivery schedules and temporarily shutting down the operation of several distribution centers, resulting in approximately 40% overall cost reduction since April 2020 as compared to pre-COVID-19 levels; • improving working capital by focusing on receivables collection efforts while working with our vendors on temporarily extended terms; • suspending capital expenditures and limiting maintenance and information technology projects; • developing our proprietary e-commerce platform (www.rongchengmarkets.com) with very minimal investment to cater to consumers and meet the increasing demand for online grocery shopping in larger quantities at wholesale prices; and • securing new partnerships with other online grocery retailers. The above decisive actions have resulted in an overall improvement of our available line of credit that would enable the Company to confidently navigate through this unprecedented “crisis”. The Company reopened the distribution centers that were temporarily closed on April 27, 2020 and has since begun to experience a steady recovery of business volume as the COVID-19 infection curve began to flatten and fear among consumers began to subside. Weekly sales have since recovered to over 50% and 60% of pre-COVID-19 levels in the months of May and June, respectively. The recovery trend continued into the month of 36 Table of Contents July and, at the time of this report, we are now experiencing a relatively stabilized sales volume of nearly 65% of pre-COVID-19 levels on an aggregate basis. At current sales volumes and adjusted cost structures, the company is able to generate positive operating cash flows and does not have immediate liquidity concerns, especially if sales volume continues to remain stable or improve further. The impact of the COVID-19 pandemic continues to evolve and, therefore, we cannot currently predict the full extent to which our business, results of operations, or financial condition, will ultimately be impacted. We do not expect economic and operating conditions for our business to recover to pre-COVID-19 levels until consumers are once again willing and able to resume consumption of food away from home on a regular basis. This may not occur until well after the pandemic abates and the broader economy begins to improve. The recent resurfacing of the COVID-19 pandemic may adversely impact our sales and liquidity position. We remain optimistic about the long-term prospects for our business. Although the timetable for returning to normalcy is unknown, we believe that our current level of sales volumes will increase over time as the effects of the COVID-19 pandemic slowly dissipate and consumer demand for food prepared away from home increases. As the market leader in servicing the Asian/Chinese restaurant sector, we believe we are well-positioned for long-term success. The fragmented nature of the Asian/Chinese food service industry and the current environment create opportunities for a company like HF Group, which has the necessary expertise and deep understanding of our unique customer base. We believe we are differentiated from our competitors given our extensive footprint, strong vendor and customer relationships, and value-added service offerings, all of which have allowed us to continue to serve our customers in these unprecedented conditions. How to Assess HF Group’s Performance In assessing our performance, the Company considers a variety of performance and financial measures, including principal growth in net revenue, gross profit, distribution, general and administrative expenses, and adjusted EBITDA. The key measures that the Company uses 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 the Company offers to our customers, such as rebates and discounts that are offsets to gross sales; and certain other adjustments. Our net sales are 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 sales minus cost of revenue. Cost of revenue primarily includes inventory costs (net of supplier consideration), inbound freight, custom clearance fees and other miscellaneous expenses. Cost of revenue generally changes as the Company incurs higher or lower costs from suppliers and as the customer and product mix changes. Distribution, Selling and Administrative Expenses Distribution, selling and administrative expenses primarily consist of salaries 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. Adjusted EBITDA The Company believes that Adjusted EBITDA is a useful performance measure and can be used to facilitate a comparison of the Company’s operating performance on a consistent basis from period to period and to provide for a more complete understanding of factors and trends affecting our business than U.S. GAAP measures alone can provide. Our management believes that Adjusted EBITDA is less susceptible to variances in actual performance resulting from non-recurring expenses, extraordinary charges, depreciation, amortization and other non-cash charges and more reflective of other factors that affect our operating performance. Our management believes that the use of these non-GAAP financial measures 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 37 Table of Contents which present similar non-GAAP financial measures to investors. The Company presents Adjusted EBITDA in order to provide supplemental information that the Company considers relevant for the readers of our consolidated financial statements included elsewhere in this report, and such information is not meant to replace or supersede U.S. GAAP measures. The Company defines Adjusted EBITDA as net income (loss) before interest expense, income taxes, and depreciation and amortization, further adjusted to exclude certain unusual, non-cash, non-recurring, cost reduction, and other adjustment items. The definition of Adjusted EBITDA may not be the same as similarly titled measures used by other companies in the industry. Adjusted EBITDA is not defined under U.S. GAAP and is subject to important limitations as analytical tools and you should not consider them in isolation or as substitutes for analysis of HF Group’s results as reported under U.S. GAAP. For example, Adjusted EBITDA: • excludes certain tax payments that may represent a reduction in cash available to the Company; • 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 Adjusted EBITDA, see the section entitled “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Adjusted EBITDA” below. Results of Operations for the Three Months Ended June 30, 2020 and 2019 The following table sets forth a summary of our consolidated results of operations for the three month periods ended June 30, 2020 and 2019. The historical results presented below are not necessarily indicative of the results that may be expected for any future period. For the Three Months Ended June 30, Changes 2020 2019 Amount % Net revenue $ 104,560,096 $ 74,718,206 $ 29,841,890 39.9 % Cost of revenue 83,947,312 62,206,053 21,741,259 35.0 % Gross profit 20,612,784 12,512,153 8,100,631 64.7 % Distribution, selling and administrative expenses 25,092,568 11,094,041 13,998,527 126.2 % Income (loss) from operations (4,479,784) 1,418,112 (2,773,232) (195.6) % Interest income 132 152,518 (152,386) (99.9) % Interest expenses (324,319) (388,160) 63,841 (16.4) % Other income, net 264,730 338,995 (74,265) (21.9) % Change in fair value of interest rate swap contracts (1,264,254) — (1,264,254) (100.0) % Income (loss) before income tax provision (5,803,495) 1,521,465 (7,324,960) (481.4) % Provision (benefit) for income taxes (1,489,305) 460,751 (1,950,056) (423.2) % Net income (loss) (4,314,190) 1,060,714 (5,374,904) (506.7) % Less: net income (loss) attributable to noncontrolling interest (255,287) 37,819 (293,106) (775.0) % Net income (loss) attributable to HF Foods Group Inc. $ (4,058,903) $ 1,022,895 $ (5,081,798) (496.8) % Net Revenue Net revenue was mainly derived from sales to independent restaurants (Chinese/Asian restaurants) and wholesale sales to smaller distributors. 38 Table of Contents The following table sets forth the breakdown of net revenue: For the Three Months Ended June 30, 2020 2019 Change Amount % Amount % Amount % Net revenue Sales to independent restaurants $ 98,620,662 94.3 % $ 70,460,722 94.3 % $ 28,159,940 40.0 % Wholesale 5,939,434 5.7 % 4,257,484 5.7 % 1,681,950 39.5 % Total $ 104,560,096 100.0 % $ 74,718,206 100.0 % $ 29,841,890 39.9 % Net revenue increased by $29.8 million, or 39.9%, during the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. This was attributable primarily to the acquisition of B&R Global, which contributed $2.4 million in sales to wholesale customers and $61.5 million in sales to independent restaurants. The increase was offset by a decrease in revenue of $33.3 million in sales to independent restaurants of HF and $0.7 million of sales to wholesale customers. This decrease was due to lower sales as a result of the COVID-19 pandemic. The negative impact of the COVID-19 pandemic on our restaurant customers led to a significant decline in the net revenue for both HF and B&R Global for the three months ended June 30, 2020. For pro forma financial information, see the section entitled “SUPPLEMENTAL UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION” below. We conduct wholesale operations as a supplemental business to our food service distribution to restaurants by purchasing full truckloads of product from suppliers and redistributing to smaller distributors who are typically not large enough to order truckload quantities, or do not want to keep inventory for long periods. These larger purchases can improve overall bargaining power with suppliers by increasing total order quantity. Net revenue from wholesale for the three months ended June 30, 2020 increased by $1.7 million, or 39.5%, as compared to the three months ended June 30, 2019, due to the acquisition of B&R Global. Cost of Sales and Gross Profit The following tables set forth the calculation of gross profit and gross margin for sales to independent restaurants, wholesale and total net revenue: For the Three Months Ended June 30, Changes 2020 2019 Amount % Sales to independent restaurants Net revenue $ 98,620,662 $ 70,460,722 $ 28,159,940 40.0 % Cost of revenue 78,415,142 58,140,065 20,275,077 34.9 % Gross profit $ 20,205,520 $ 12,320,657 $ 7,884,863 64.0 % Gross Margin 20.5 % 17.5 % 3.0 % 17.1 % Wholesale Net revenue $ 5,939,434 $ 4,257,484 $ 1,681,950 39.5 % Cost of revenue 5,532,170 4,065,988 1,466,182 36.1 % Gross profit $ 407,264 $ 191,496 $ 215,768 112.7 % Gross Margin 6.9 % 4.5 % 2.4 % 53.3 % Total sales Net revenue $ 104,560,096 $ 74,718,206 $ 29,841,890 39.9 % Cost of revenue 83,947,312 62,206,053 21,741,259 35.0 % Gross profit $ 20,612,784 $ 12,512,153 $ 8,100,631 64.7 % Gross Margin 19.7 % 16.7 % 3.0 % 18.0 % Cost of revenue was $83.9 million for the three months ended June 30, 2020, an increase of $21.7 million, or 35.0%, from $62.2 million for the three months ended June 30, 2019. The increase was mainly attributable to the acquisition of B&R Global, 39 Table of Contents with $50.2 million and $2.2 million in cost of revenue for sales to independent restaurants and wholesale customers, respectively. This increase was offset by a decrease of $30.7 million cost of revenue due to reduced sales resulting from the COVID-19 pandemic. Gross profit was $20.6 million for the three months ended June 30, 2020, an increase of $8.1 million, or 64.7%, from $12.5 million for the three months ended June 30, 2019. The increase was attributable primarily to the acquisition of B&R Global, with $11.3 million and $0.2 million in gross profit derived from sales to independent restaurants and wholesale customers, respectively. This increase was offset by a decrease of $3.4 million cost of revenue for the sales to independent restaurants of HF resulting from the decrease in sales. Gross margin increased from 16.7% for the three months ended June 30, 2019 to 19.7% for the three months ended June 30, 2020, attributable mainly to a margin increase in second quarter of 2020 due primarily to two factors: (1) elimination of lower margin sales to the buffet restaurants still severely impacted by the outbreak of COVID-19, a segment of our customers on the West Coast region which typically have higher sales volume but at lower margin; and (2) sell-through of existing lower cost inventories at a higher gross margin in second quarter of 2020 in line with the general increase in food prices. Distribution, Selling and Administrative Expenses Distribution, selling and administrative expenses were $25.1 million and $11.1 million for the three months ended June 30, 2020 and June 30, 2019, respectively, representing a $14.0 million, or 126.2%, increase. The increase was mainly attributable to the Business Combination with B&R Global, which contributed $11.7 million, amortization expense of $2.7 million relating to the intangible assets acquired from the Business Combination, $1.4 million non-recurring legal expenses associated with the defense of the securities class action lawsuit (See Note 18) and special internal investigation, and $1.9 million attributed to special accounts receivable reserve accrual. The overall increase was offset by a decrease of $3.7 million cost reduction in deliveries charges as a result of the outbreak of COVID-19. Interest Expenses Interest expenses are primarily derived from lines of credit, finance leases, and long-term debts. Interest expenses were $0.3 million for the three months ended June 30, 2020, a decrease of $0.1 million, or 16.4%, compared with $0.4 million for the three months ended June 30, 2019. The decrease was mainly attributable to an overall reduction in line of credit utilization, lower interest rates, and the reclassification of fair value of interest rate swaps from interest expense to change in fair value of interest rate swap contracts of $0.6 million. The decrease was offset by additional interest expense of $0.8 million resulting from the Business Combination with B&R Global and the Realty Acquisition. Other Income Other income consists primarily of non-operating income and rental income. Other income was $0.3 million for the three months ended June 30, 2020 and 2019. Change in Fair Value of Interest Rate Swap Contracts Change in fair value of interest rate swap contracts stemmed from mark to market fair value change of four interest rate swap contracts. See Note 10 for more details. Income Tax Provision (Benefit) Provision for income taxes decreased by $2.0 million of 423.2%, from $0.5 million for the three months ended June 30, 2019 to a tax benefit of $1.5 million for the three months ended June 30, 2020, as a result of the decrease in income before income tax provision. Net Income (Loss) Attributable to Noncontrolling interest Net income (loss) attributable to noncontrolling interest was derived from four minority owned subsidiaries and decreased by $0.3 million, or 775.0%, from net income of $0.04 million for the three months ended June 30, 2019 to a net loss of $0.3 million for the three months ended June 30, 2020. The decrease was mainly due to net loss attributable to noncontrolling interest of $0.2 million brought in by B&R Global for the three months ended June 30, 2020. Net Income (Loss) Attributable to Our Stockholders 40 Table of Contents As a result of all analysis above, net income attributable to our stockholders was $1.0 million and net loss attributable to our stockholders was $4.1 million for the three months ended June 30, 2019 and for the three months ended June 30, 2020, respectively. Adjusted EBITDA The following table sets forth of the calculation of adjusted EBITDA and reconciliation to net income (loss), the closest U.S. GAAP measure: For the three months ended June 30, Change 2020 2019 Amount % Net income (loss) $ (4,314,190) $ 1,060,714 $ (5,374,904) (506.7) % Interest expenses 324,319 388,160 (63,841) (16.4) % Income tax provision (benefit) (1,489,305) 460,751 (1,950,056) (423.2) % Depreciation and amortization 4,335,932 727,423 3,608,509 496.1 % Change in fair value of interest rate swap contracts 1,264,254 — 1,264,254 100.0 % COVID-19 bad debt reserve 1,886,781 — 1,886,781 100.0 % Non-recurring expenses* 1,405,671 1,000,000 405,671 40.6 % Adjusted EBITDA $ 3,413,462 $ 3,637,048 $ (223,586) (6.1) % Percentage of revenue 3.3 % 4.9 % (1.6) % (32.7) % * For the three months ended June 30, 2019, non-recurring expenses represented the amount accrued for potential loss contingency relating to a negligence claim for damages. The claim was subsequently settled in November 2019 in the amount of $0.4 million. For the three months ended June 30, 2020, non-recurring expenses comprised of $1.4 million for legal fees related to the defense of class action lawsuit and internal investigation stemming from the lawsuit (see Note 18 for additional information). Adjusted EBITDA was $3.4 million for the three months ended June 30, 2020, an decrease of $0.2 million, or 6.1%, compared to $3.6 million for the three months ended June 30, 2019, resulting mainly from the $5.4 million decrease in net income partially offset by $3.6 million more in depreciation and amortization from intangible and fixed assets associated with the acquisition of B&R Global and BRGR Subsidiaries and increase in non-recurring expenses associated with the legal defense of the class action lawsuit, cost for the internal investigation, and a special reserve for doubtful accounts receivable due to COVID-19 pandemic's disruption on the payment schedules of customers. Results of Operations for the Six Months Ended June 30, 2020 and 2019 The following table sets forth a summary of our consolidated results of operations for the six months ended June 30, 2020 and 2019. The historical results presented below are not necessarily indicative of the results that may be expected for any future period. 41 Table of Contents For the Six Months Ended June 30, Changes 2020 2019 Amount % Net revenue $ 280,363,432 $ 149,519,228 $ 130,844,204 87.5 % Cost of revenue 230,775,603 124,300,219 106,475,384 85.7 % Gross profit 49,587,829 25,219,009 24,368,820 96.6 % Distribution, selling and administrative expenses 54,499,161 21,459,213 33,039,948 154.0 % Income (loss) from operations (4,911,332) 3,759,796 (8,671,128) (230.6) % Interest income 263 304,467 (304,204) (99.9) % Interest expenses (2,275,888) (725,118) (1,550,770) 213.9 % Goodwill impairment loss (338,191,407) — (338,191,407) (100.0) % Other income, net 670,380 623,530 46,850 7.5 % Change in fair value of interest rate swap contracts (1,264,254) — (1,264,254) (100.0) % Income (loss) before income tax provision (345,972,238) 3,962,675 (349,934,913) (8,830.8) % Provision (benefit) for income taxes (1,971,516) 1,108,390 (3,079,906) (277.9) % Net income (loss) (344,000,722) 2,854,285 (346,855,007) (12,152.1) % Less: net income (loss) attributable to noncontrolling interest (57,877) 158,577 (216,454) (136.5) % Net income (loss) attributable to HF Foods Group Inc. $ (343,942,845) $ 2,695,708 $ (346,638,553) (12,858.9) % Net Revenue Net revenue was mainly derived from sales to independent restaurants (Chinese/Asian restaurants) and wholesale sales to smaller distributors. The following table sets forth the breakdown of net revenue: For the six months ended June 30, 2020 2019 Change Amount % Amount % Amount % Net revenue Sales to independent restaurants $ 265,892,979 94.8 % $ 140,583,856 94.0 % $ 125,309,123 89.1 % Wholesale 14,470,453 5.2 % 8,935,372 6.0 % 5,535,081 61.9 % Total $ 280,363,432 100.0 % $ 149,519,228 100.0 % $ 130,844,204 87.5 % Net revenue increased by $130.8 million, or 87.5%, during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019. This was attributable primarily to the acquisition of B&R Global, which contributed $6.6 million in sales to wholesale customers and $170.2 million in sales to independent restaurants. The increase was offset by a decrease in revenue of $44.9 million in sales to independent restaurants of HF and $1.0 million of sales to wholesale customers. This decrease was due to lower sales as a result of the COVID-19 pandemic. The negative impact of the COVID-19 pandemic on our restaurant customers starting the last two weeks of March 2020 through the end of June 2020 led to a significant decline in the net revenue for both HF and B&R Global for the six months ended June 30, 2020. See the section entitled “SUPPLEMENTAL UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION” below. We conduct wholesale operations as a supplemental business to our food service distribution to restaurants by purchasing full truckloads of product from suppliers and redistributing to smaller distributors who are typically not large enough to order truckload quantities, or do not want to keep inventory for long periods. These larger purchases can improve overall bargaining power with suppliers by increasing total order quantity. Net revenue from wholesale for the six months ended June 30, 2020 increased by $5.5 million, or 61.9%, as compared to the six months ended June 30, 2019, due to the acquisition of B&R Global. Cost of Sales and Gross Profit 42 Table of Contents The following tables set forth the calculation of gross profit and gross margin for sales to independent restaurants, wholesale and total net revenue: For the Six Months Ended June 30, Changes 2020 2019 Amount % Sales to independent restaurants Net revenue $ 265,892,979 $ 140,583,856 $ 125,309,123 89.1 % Cost of revenue 217,144,426 115,700,311 101,444,115 87.7 % Gross profit $ 48,748,552 $ 24,883,545 $ 23,865,007 95.9 % Gross Margin 18.3 % 17.7 % 0.6 % 3.4 % Wholesale Net revenue $ 14,470,453 $ 8,935,372 $ 5,535,081 61.9 % Cost of revenue 13,631,177 8,599,908 5,031,269 58.5 % Gross profit $ 839,277 $ 335,464 $ 503,813 150.2 % Gross Margin 5.8 % 3.8 % 2.0 % 52.6 % Total sales Net revenue $ 280,363,432 $ 149,519,228 $ 130,844,204 87.5 % Cost of revenue 230,775,603 124,300,219 106,475,384 85.7 % Gross profit $ 49,587,829 $ 25,219,009 $ 24,368,820 96.6 % Gross Margin 17.7 % 16.9 % 0.8 % 4.7 % Cost of revenue was $230.8 million for the six months ended June 30, 2020, an increase of $106.5 million, or 85.7%, from $124.3 million for the six months ended June 30, 2019. The increase was mainly attributable to the acquisition of B&R Global, with $141.8 million and $6.1 million in cost of revenue for sales to independent restaurants and wholesale customers, respectively. This increase was offset by a decrease of $41.4 million cost of revenue due to reduced sales resulting from the COVID-19 pandemic. Gross profit was $49.6 million for the six months ended June 30, 2020, an increase of $24.4 million, or 96.6%, from $25.2 million for the six months ended June 30, 2019. The increase was attributable primarily to B&R Global, with $28.5 million and $0.5 million in gross profit derived from sales to independent restaurants and wholesale customers, respectively. This increase was offset by a decrease $4.6 million cost of revenue for the sales to independent restaurants of HF resulting from the decrease in sales. Gross margin increased from 16.9% for the six months ended June 30, 2019 to 17.7% for the six months ended June 30, 2020, attributable mainly to a margin increase in the second quarter of 2020 primarily due to two factors: (1) elimination of lower margin sales to the buffet restaurants still impacted by the outbreak of COVID-19, a segment of our customers on the West Coast region which typically have higher sales volume but at lower margin; and (2) sell-through of existing lower cost inventories at a higher gross margin in the second quarter of 2020 in line with the general increase in food prices. Distribution, Selling and Administrative Expenses Distribution, selling and administrative expenses were $54.5 million and $21.5 million for the six months ended June 30, 2020 and the six months ended June 30, 2019, respectively, representing a $33.0 million, or 154.0%, increase. The increase was mainly attributable to the Business Combination with B&R Global, which contributed $28.2 million, and the amortization expense of $5.5 million relating to the intangible assets acquired from the Business Combination, $1.4 million non-recurring legal expenses associated with the defense of the securities class action lawsuit (See Note 18) and special internal investigation, and $1.9 million attributed to special accounts receivable reserve accrual. The overall increase was offset by a decrease of $3.7 million cost reduction in deliveries charges as a result of the outbreak of COVID-19. Interest Expense 43 Table of Contents Interest expense are primarily generated from lines of credit, capital leases, and long-term debt. Interest expenses was $2.3 million for the six months ended June 30, 2020, an increase of $1.6 million, or 213.9%, compared with $0.7 million for the six months ended June 30, 2019. The increase was mainly attributable to increased lines of credit usage after the business combination with B&R Global and additional long-term debt with B&R Realty Subsidiaries, with total interest expenses of $1.8 million for the six months ended June 30, 2020. Goodwill Impairment Loss Goodwill impairment loss was $338.2 million for the six months ended June 30, 2020 and nil for the six months ended June 30, 2019. See Note 9 to our financial statements for additional information. Other Income Other income consists primarily of non-operating income and rental income. Other income was $0.7 million for the six months ended June 30, 2020, an increase of $0.1 million, or 7.5%, compared with $0.6 million for the six months ended June 30, 2019. Change in Fair Value of Interest Rate Swap Contracts Change in fair value of interest rate swap contracts stemmed from mark to market fair value change of four interest rate swap contracts. See note 10 for more detail. Income Tax Provision (Benefit) Provision for income taxes decreased by $3.1 million, or 277.9%, from $1.1 million for the six months ended June 30, 2019 to a tax benefit of $2.0 million for the six months ended June 30, 2020, as a result of the decrease in income before income tax provision. Net Income (Loss) Attributable to Noncontrolling interest Net income attributable to noncontrolling interest was derived from four minority owned subsidiaries and decreased by $0.22 million, or 136.5%, from 0.16 million for the six months ended June 30, 2019 to net loss attributable to noncontrolling interest of $(0.06) million for the six months ended June 30, 2020. The decrease was mainly due to the Business Combination with B&R Global, net loss attributable to noncontrolling interest of $0.14 million for the six months ended June 30, 2020. Net Income (Loss) Attributable to Our Stockholders As a result of all analysis above, net income attributable to our stockholders was $2.7 million and net loss attributable to our stockholders was $343.9 million for the six months ended June 30, 2019 and for the six months ended June 30, 2020, respectively. Adjusted EBITDA The following table sets forth of the calculation of adjusted EBITDA and reconciliation to net income (loss), the closest U.S. GAAP measure: 44 Table of Contents For the Six Months Ended June 30, Changes 2020 2019 Amount % Net income (loss) $ (344,000,722) $ 2,854,285 $ (346,855,007) (12,152.1) % Interest expense 2,275,888 725,118 1,550,770 213.9 % Income tax provision (benefit) (1,971,516) 1,108,390 (3,079,906) (277.9) % Depreciation and amortization 8,710,012 1,434,819 7,275,193 507.0 % Goodwill impairment loss 338,191,407 — 338,191,407 100.0 % Change in fair value of interest rate swap contracts 1,264,254 — 1,264,254 100.0 % COVID-19 bad debt reserve 1,886,781 — 1,886,781 100.0 % Non-recurring expenses* 1,405,671 1,000,000 405,671 40.6 % Adjusted EBITDA $ 7,761,775 $ 7,122,612 $ 639,163 9.0 % Percentage of revenue 2.8 % 4.8 % (2.0) % (41.7) % * For the six months ended June 30, 2019, non-recurring expenses represented a non-recurring expense accrued for potential loss contingency relating to negligence claim(s) for damages. This claim was settled in November 2019 in the amount of $0.4 million. For the six months ended June 30, 2020, non-recurring expenses comprised of $1.4 million of legal fee related to the defense of the class action lawsuit and internal investigation stemming from the lawsuit (see Note 18 for additional information). Adjusted EBITDA was $7.8 million for the six months ended June 30, 2020, an increase of $0.6 million, or 9.0%, compared to $7.1 million for the six months ended June 30, 2019, resulting mainly from the $8.7 million decrease in net income (excluding goodwill impairment loss), partially offset by a $1.6 million increase in interest expense due to an increased line of credit and long-term debt, and an additional $7.3 million depreciation and amortization from intangible and fixed assets associated with acquisition of B&R Global and B&R Realty Subsidiaries. Supplemental Unaudited Pro Forma Combined Financial Information As described above, the Company completed the Business Combination with B&R Global on November 4, 2019. For comparative purposes, the Company is presenting supplemental unaudited pro forma combined statements of operations for the three and six month periods ended June 30, 2020 and 2019. The unaudited pro forma combined statements of operations for these periods present our consolidated results of operations giving pro forma effect to the Business Combination as if it had occurred on January 1, 2019. The pro forma combined adjustments give effect to the items identified in the unaudited pro forma combined tables below in connection with the Business Combination. The unaudited pro forma combined adjustments are based on available information and upon assumptions that our management believes are reasonable in order to reflect, on a pro forma combined basis, the impact of the Business Combination on our historical financial information, as applicable. The B&R Global Financial Statements and our financial statements have been adjusted in the pro forma financial information to give effect to events that are (1) directly attributable to the Business Combination, (2) factually supportable, and (3) expected to have a continuing impact on the combined company. The unaudited pro forma combined financial information has been prepared for informational purposes only and is not necessarily indicative of or intended to represent what the combined company’s financial position or results of operations actually would have been had the Business Combination occurred as of the dates indicated. In addition, the unaudited pro forma combined financial information does not purport to project the future financial position or operating results of the combined company. The unaudited pro forma adjustments are based on information available at the time of the preparation of the unaudited pro forma combined financial information. The unaudited pro forma combined financial information does not reflect cost savings, synergies or revenue enhancements that the Company may achieve with respect to combining the companies or costs to integrate the B&R Global business or the impact of any non-recurring activity and any one-time transaction related costs. Synergies and integration costs have been excluded from consideration because they do not meet the criteria for unaudited pro forma adjustments. 45 Table of Contents Unaudited Pro Forma Results of Operations The pro forma adjustments are based on our preliminary estimates and assumptions that are subject to change. The following adjustments have been reflected in the unaudited pro forma financial statements: For the Three Months Ended June 30, 2019 HF B&R Global Adjustments Pro Forma Combined Net revenue $ 74,718,206 $ 133,315,246 $ — $ 208,033,452 Net income $ 1,060,714 $ 3,322,280 $ (2,722,575) (1) $ 1,660,419 NetiIncome attributable to HF Foods Group Inc. $ 1,022,895 $ 3,070,355 $ (2,722,575) $ 1,370,675 (1) Includes intangibles asset amortization expense of $2,722,575 for the three months ended June 30, 2019. For the Six Months Ended June 30, 2019 HF B&R Global Adjustments Pro Forma Combined Net revenue $ 149,519,228 $ 267,469,590 $ — $ 416,988,818 Net income $ 2,854,285 $ 7,175,659 $ (5,445,150) (1) $ 4,584,794 Net income attributable to HF Foods Group Inc. $ 2,695,708 $ 6,798,476 $ (5,445,150) $ 4,049,034 (1) Includes intangibles asset amortization expense of $5,445,150 for the six months ended June 30, 2019. Liquidity and Capital Resources As of June 30, 2020, we had cash of approximately $8.6 million. We have funded working capital and other capital requirements primarily by equity contributions from shareholders, 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 repay debts. On April 18, 2019, we and our operating subsidiaries Han Feng, New Southern Food Distributors and Kirnland entered into a credit agreement with East West Bank, which replaced our prior credit agreement with East West Bank. The credit agreement provides a $25,000,000 revolving credit facility which was due August 18, 2021, accrued interest based on the prime rate less 0.375%, or 2.20% above LIBOR, but in no event less than 4.214% per annum, and was secured by virtually all assets of the Company and our domestic subsidiaries. On November 4, 2019, the East West Bank revolving credit facility loan was paid off from borrowings under the Amended and Restated Credit Agreement entered into in connection with the merger with B&R, as described below. On November 4, 2019, we entered into an Amended and Restated Credit Agreement with JP Morgan (the "First Amended Credit Agreement"). The First Amended Credit Agreement provided for (a) a $100 million asset-secured revolving credit facility maturing on November 4, 2022, and (b) mortgage-secured term loans of $55.4 million. On January 17, 2020, the Company, B&R Global, and the Borrowers, and certain material subsidiaries of the Company as guarantors, entered into a Second Amended and Restated Credit Agreement (the “Second Amended Credit Agreement”) by and among JPMorgan, as Administrative Agent, and certain lender parties thereto, including Comerica Bank. The Second Amended Credit Agreement provided for (a) a $100 million asset-secured revolving credit facility maturing on November 4, 2022 (the “Facility”), and (b) mortgage-secured Term Loans of $75.6 million. The Second Amended Credit Agreement amended and restated the existing $55.0 million of real estate term loans under the First Amended Credit Agreement. As of January 17, 2020, the existing balance of revolving debt under the First Amended Credit Agreement in the amount of $41.2 million was rolled over and an additional $18.7 million available to the Company under the Facility was drawn. The Company used the $75.6 million in mortgage-secured term loans and $18.7 million drawn from the revolving credit facility to fund in part the Acquisition of the B&R Realty Subsidiaries, as noted above. Borrowings under the Second Amended Credit Agreement may be used for, among other things, working capital and other general corporate purposes of the Company and its subsidiaries 46 Table of Contents (including permitted acquisitions). As of June 30, 2020, $101.2 million was outstanding under the Second Amended Credit Agreement. Borrowings under the Facility bear interest at a floating rate, which will be, at the Borrowers’ option, either LIBOR plus 1.375%, or a base rate of prime rate minus 1.125%. The mortgage-secured Term Loans bear interest at a floating rate which will be, at the Borrowers’ option, either LIBOR plus 1.875%, or a base rate of prime rate minus 0.625%. A commitment fee of 0.15% is payable monthly in arrears based on the daily amount of the undrawn portion of each lender’s revolving credit commitments under the Facility. The Borrowers are obligated to pay monthly installments on the mortgage-secured Term Loans in the amount of $252,000.00, with a final installment of the remaining principal balance of the Term Loans due on January 17, 2030, the Term Loan Maturity Date. Although management believes that the cash generated from operations will be sufficient to meet our normal working capital needs for at least the next twelve months, 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, trends in the food service distribution industry, the expected collectability of accounts receivable and the realization of the inventories as of June 30, 2020. Based on the above considerations, management is of the opinion that we have sufficient funds to meet our working capital requirements and debt obligations as they become due. However, there is no assurance that management will be successful in our plan. There are a number of factors that could potentially arise which might result in shortfalls to what is anticipated, such as the demand for our products, economic conditions, the competitive pricing in the food service 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 be forced to reduce or delay our expected acquisition plan, sell assets, obtain additional debt or equity capital, or refinance all or a portion of our debt. We, however, make no assurance that we will be able to raise any additional capital in the future on satisfactory terms or at all. Our continued access to sources of liquidity depends on multiple factors, including economic conditions, the condition of financial markets, the availability of sufficient amounts of financing, our operating performance and our credit ratings. In addition, the effect of COVID-19 on the capital markets could significantly impact our cost of borrowing and the availability of capital to us. The following table sets forth cash flow data for the six months ended June 30, 2020 and 2019: For the Six Months Ended June 30, 2020 2019 Net cash provided by operating activities $ 32,417,651 $ 2,070,308 Net cash used in investing activities (94,123,153) (4,744,301) Net cash provided by financing activities 55,732,235 4,156,578 Net increase (decrease) in cash and cash equivalents $ (5,973,267) $ 1,482,585 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 adjusted for the effect of working capital changes. Net cash provided by operating activities was approximately $32.4 million for the six months ended June 30, 2020, an increase of $30.3 million, or 1,466%, compared to net cash provided by operating activities of $2.1 million for the six months ended June 30, 2019. The increase was primarily the result of newly acquired B&R Global with total net cash provided by operating activities of $16.2 million. The remaining increase is a combined result of an increase of $20.4 million from changes in working capital items mainly resulting from changes in net income, gain from disposal of equipment, loss from derivative instruments, accounts receivable, advances to suppliers – related parties, other current assets, advances from customers – related parties, inventories, accrued expenses and depreciation and amortization expense which were offset by a decrease of $6.3 million in deferred tax benefit, other long term assets, accounts payable, and accounts payable - related parties and income tax payable. Investing Activities Net cash used in investing activities was approximately $94.1 million for the six months ended June 30, 2020, an increase of $89.4 million, or 1,883.9%, compared to $4.7 million net cash used in investing activities for the six months ended June 30, 2019. The increase was primarily due to payment made to acquire B&R Realty Subsidiaries of $94.1 million. The increase was offset by a combined result of decreased cash paid for the purchase of property and equipment of $5.1 million, decrease in cash received from notes receivable to third parties and related parties of $0.1 million, offset by a decrease in cash proceeds from the disposal of equipment of $0.2 million. 47 Table of Contents Financing Activities Net cash provided by financing activities was approximately $55.7 million for the six months ended June 30, 2020, an increase of $51.6 million, or 1,240.8%, compared with $4.2 million of net cash used in financing activities for the six months ended June 30, 2019. The increase was due primarily as a result of the newly acquired $75.6 million in mortgage-backed term loans to fund B&R Realty Acquisition. The increase was offset by an increased utilization of our line of credit from $260.8 million to $274.2 million, and increased repayment of $1.8 million of long term debt and an increase of $7.4 million in repayment of bank overdrafts. Commitments and Contractual Obligations The following table presents the company’s material contractual obligations as of June 30, 2020: Contractual Obligations Total Less than 1 year 1-3 years 3-5 years More than 5 years Line of credit $ 31,953,659 $ 31,953,659 $ — $ — $ — Long-term debt 96,531,591 7,802,869 10,410,214 7,529,022 70,789,486 Promissory note payable - related party 7,000,000 — — — 7,000,000 Finance lease obligations 1,424,053 373,715 676,502 373,836 — Operating lease obligations 896,606 355,148 521,762 19,696 — Total $ 137,805,909 $ 40,485,391 $ 11,608,478 $ 7,922,554 $ 77,789,486 On July 2, 2018, AnHeart Inc., a wholly-owned subsidiary of HF Holding ("AnHeart"), entered into two separate leases for two properties located in Manhattan, New York, at 273 Fifth Avenue and 275 Fifth Avenue, for 30 years and 15 years, respectively. The leases were on triple net basis, meaning AnHeart is required to pay all costs associated with the properties, including taxes, insurance, utilities, maintenance and repairs. HF Holding provided a guaranty for all rent and related costs of the leases, including costs associated with the planned construction of a two-story structure at 273 Fifth Avenue and rehabilitation of the building at 275 Fifth Avenue. Under the lease for 273 Fifth Avenue, the fixed rent costs over 30 years commence at $325,000 for the first year and escalate every year during the term to $1,047,000 in year 30. Under the lease for 275 Fifth Avenue, the fixed rent costs over 15 years commence at $462,000 for the first year and escalate every year during the term to approximately $760,878 in year 15. The 275 Fifth Avenue lease includes an option to extend the term for an additional 10 years. Under the leases, HF Holding delivered two letters of credit in favor of the Landlord, one in the amount of $213,000 as security for AnHeart’s obligations under the lease at 273 Fifth Avenue, and the second in the amount of $115,500 with respect to 275 Fifth Avenue. The Company entered into the leases with the planned purpose of expanding its product lines to include Chinese herb supplements and to use the sites to develop into a hub for such products. The Company has since determined to cease this business expansion. On February 23, 2019, the Company executed an agreement to divest all of the ownership interest in AnHeart to Ms. Jianping An, a resident of New York, for the sum of $20,000. The transfer of ownership was disclosed and landlord consent was obtained. However, the divestment of ownership did not release HF Holding’s guaranty of AnHeart’s obligations or liabilities under the original lease agreements. Under the terms of the sale of AnHeart stock to Ms. An, and in consideration of the Company’s ongoing guaranty of AnHeart’s performance of the lease obligations, AnHeart executed a security agreement which grants us a security interest in AnHeart assets and contains a covenant to assign the leases to HF Group if AnHeart defaults on the original lease agreements. Further, Ms. An has tendered an unconditional guaranty of all liabilities arising under the leases, in favor of the Company, executed by Minsheng Pharmaceutical Group Company, Ltd., a Chinese manufacturer and distributor of herbal medicines. Off-Balance Sheet Arrangements 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. Critical Accounting Policies and Estimates 48 Table of Contents We have prepared the financial information in this Quarterly Report in accordance with U.S. GAAP. Preparing the Company's consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during these reporting periods. We base our estimates and judgments on historical experience and other factors we believe are reasonable under the circumstances. These assumptions form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Part II, Item 7—“Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the 2019 Annual Report includes a summary of the critical accounting policies we believe are the most important to aid in understanding our financial results. There have been no changes to those critical accounting policies that have had a material impact on our reported amounts of assets, liabilities, revenue, or expenses during the three and six month periods ended June 30, 2020. Recent Accounting Pronouncements For a discussion of recent accounting pronouncements, see Note 2, Recent Accounting Pronouncements, in our consolidated financial statements. 49 Table of Contents