HF Foods Group Inc. 10-Q

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS AND RISK FACTOR SUMMARY This Quarterly Report on Form 10-Q for HF Foods Group Inc. (“HF Foods”, the “Company,” “we,” “us,” or “our”) contains certain statements that are, or may deemed to be, “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, regarding our expectations, beliefs, plans, objectives, intentions, assumptions and other statements that are not historical facts. Words or phrases such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “project,” “will” or similar words or phrases, or the negatives of those words or phrases, may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking. We derive many of our forward-looking statements from our operating budgets and forecasts, which are based on many detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expected. Important factors that could cause actual results to differ materially from our expectations, or cautionary statements, include without limitation: • Low margins in the foodservice distribution industry and periods of significant or prolonged inflation or deflation; • Qualified labor shortages; • Unfavorable macroeconomic conditions in the United States; • Competition in the foodservice distribution industry particularly the entry of new competitors into the Chinese/Asian restaurant supply market niche; • Increases in fuel costs; • Disruption of relationships with vendors and increases in product prices; • Dependency on the timely delivery of products from vendors, particularly the prolonged diminution of global supply chains; • The effects of the COVID-19 pandemic or other pandemics; • The steps taken by the governments where our suppliers are located, including the People’s Republic of China, to address the COVID-19 pandemic or other pandemics; • Disruption of relationships with or loss of customers; • Changes in consumer eating and dining out habits; • Related party transactions and possible conflicts of interests; • Related parties and variable interest entities consolidation; • Failure to protect our intellectual property rights; • Our ability to renew or replace our current warehouse leases on favorable terms, or terminations prior to expiration of stated terms; • Failure to retain our senior management and other key personnel, particularly our interim CEO, President and COO, CFO and General Counsel and CCO; • Our ability to attract, train and retain employees; • Changes in and enforcement of immigration laws; • Failure to comply with various federal, state and local rules and regulations regarding food safety, sanitation, transportation, minimum wage, overtime and other health and safety laws; • Product recalls, voluntary recalls or withdrawals if any of the products we distribute are alleged to have caused illness, been mislabeled, misbranded or adulterated or to otherwise have violated applicable government regulations; • Costs to comply with environmental laws and regulations; • Litigation, regulatory investigations and potential enforcement actions; • Increases in commodity prices; • U.S. government tariffs on products imported into the United States, particularly from China; • Severe weather, natural disasters and adverse climate change; • Unfavorable geopolitical conditions; • Any cyber security incident, other technology disruption or delay in implementing our information technology systems; • Current indebtedness affecting our liquidity and ability of future financing; • Failure to acquire other distributors or wholesalers and enlarge our customer base; • Scarcity of and competition for acquisition opportunities; • Our ability to obtain acquisition financing; • The impact of non-cash charges relating to the amortization of intangible assets related to material acquisitions; • Our ability to identify acquisition candidates; • Increases in debt in order to successfully implement our acquisition strategy; 20 • Difficulties in integrating operations, personnel, and assets of acquired businesses that may disrupt our business, dilute stockholder value, and adversely affect our operating results; • The impact on the price and demand for our common stock resulting from the relative illiquidity of the market for our common stock; • Significant stockholders’ ability to significantly influence the Company; and • The impact of state anti-takeover laws and related provisions in our governance documents. We caution you that the foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q. All written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements as well as other cautionary statements that are made from time to time in our other filings with the Securities and Exchange Commission (the "SEC") and public communications. We caution you that the important factors referenced above may not contain all of the risks, uncertainties (some of which are beyond our control) or other assumptions that are important to you. These risks and uncertainties include, but are not limited to, those factors described under Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2023, filed with the SEC. In addition, we cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our operations in the way we expect. The forward-looking statements included in this Quarterly Report on Form 10-Q are made only as of the date hereof. Except as otherwise required by law, we undertake no obligation to update or revise any forward-looking statement as a result of new information, future events or otherwise. 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. In 2022, HF Foods acquired two frozen seafood suppliers, expanding its distribution network in Illinois, Texas and along the eastern seaboard, from Massachusetts to Florida, as well as Pennsylvania, West Virginia, Ohio, Kentucky, and Tennessee. We aim to supply the increasing demand for Asian American restaurant cuisine, leveraging our nationwide network of distribution centers and our strong relations with growers and suppliers of fresh, high-quality specialty restaurant food products and supplies in the US, South America, and China. Capitalizing on our deep understanding of the Chinese culture, we have become a trusted partner serving Asian restaurants and other foodservice customers throughout the United States, 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 restaurants in need of high-quality and specialized food ingredients at competitive prices. Transformation Plan To position the business for long-term success, we have initiated a comprehensive, operational transformation plan in an effort to drive growth and cost savings. Our transformation is focused on four key areas, each of which we expect will positively impact future growth or cost savings. The components of our transformation are as follows: • Centralized Purchasing: We began the roll out of our centralized purchasing program with seafood products and have yielded positive results with respect to margin expansion for the product category. We are now focusing on expanding the program to other categories. • Fleet and Transportation: We have established a national fleet maintenance program. Within this, we have defined new truck specifications, initiated a replacement program for 50% of our current fleet, implemented a national fuel savings program to maximize efficiency, and plan to outsource domestic inbound freight logistics to a third-party partner to adopt a cohesive national approach to our supply chain. This is expected to deliver substantial improvements to our transportation system. • Digital Transformation: We will be implementing a modern ERP solution across all of our distribution centers. This is expected to deliver enhanced operational efficiency and responsiveness, streamlined processes, and greater data driven decision-making. • Facility Upgrades: We will be reorganizing and upgrading our facilities and distribution centers to efficiently streamline costs, and to capitalize on cross-selling opportunities with both new and existing customers. 21 Financial Overview Three Months Ended September 30, Nine Months Ended September 30, ($ in thousands) 2024 2023 Change 2024 2023 Change Net revenue $ 298,389 $ 281,453 $ 16,936 $ 896,385 $ 867,620 $ 28,765 Net (loss) income $ (3,837) $ 1,974 $ (5,811) $ (4,161) $ (5,383) $ 1,222 Adjusted EBITDA $ 8,305 $ 10,097 $ (1,792) $ 27,568 $ 24,203 $ 3,365 For additional information on our non-GAAP financial measures, EBITDA and Adjusted EBITDA, see the section entitled “EBITDA and Adjusted EBITDA” below. 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. 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 condensed 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. 22 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 and a reconciliation to their most directly comparable U.S. GAAP financial measures, see “ Results of Operations — EBITDA and Adjusted EBITDA ” below. Results of Operations Comparison of Three Months Ended September 30, 2024 to Three Months Ended September 30, 2023 The following table sets forth a summary of our consolidated results of operations for the three months ended September 30, 2024 and 2023 . The historical results presented below are not necessarily indicative of the results that may be expected for any future period. Three Months Ended September 30, ($ in thousands) 2024 2023 Change Net revenue $ 298,389 $ 281,453 $ 16,936 Cost of revenue 248,226 230,528 17,698 Gross profit 50,163 50,925 (762) Distribution, selling and administrative expenses 49,652 48,841 811 Income from operations 511 2,084 (1,573) Interest expense 2,644 2,715 (71) Other expense (income), net (332) (490) 158 Change in fair value of interest rate swap contracts 3,290 (1,984) 5,274 Lease guarantee income — (95) 95 (Loss) income before income taxes (5,091) 1,938 (7,029) Income tax benefit (1,254) (36) (1,218) Net (loss) income and comprehensive (loss) income (3,837) 1,974 (5,811) Less: net income attributable to noncontrolling interests 103 90 13 Net (loss) income and comprehensive (loss) income attributable to HF Foods Group Inc. $ (3,940) $ 1,884 $ (5,824) 23 The following table sets forth the components of our consolidated results of operations expressed as a percentage of net revenue for the periods indicated: Three Months Ended September 30, 2024 2023 Net revenue 100.0 % 100.0 % Cost of revenue 83.2 % 81.9 % Gross profit 16.8 % 18.1 % Distribution, selling and administrative expenses 16.6 % 17.4 % Income from operations 0.2 % 0.7 % Interest expense 0.8 % 1.0 % Other expense (income), net (0.1) % (0.2) % Change in fair value of interest rate swap contracts 1.1 % (0.7) % Lease guarantee income — % — % (Loss) income before income taxes (1.7) % 0.7 % Income tax (benefit) expense (0.4) % — % Net (loss) income and comprehensive (loss) income (1.3) % 0.7 % Less: net income attributable to noncontrolling interests — % — % Net (loss) income and comprehensive (loss) income attributable to HF Foods Group Inc. (1.3) % 0.7 % Net Revenue Net revenue for the three months ended September 30, 2024 increased by $16.9 million, or 6.0%, compared to the same period in 2023. This increase was primarily attributable to product cost inflation and volume increases which improved pricing in certain categories, such as chicken and seafood, partially offset by deflation in commodities, such as cooking oils, and the $2.7 million loss in revenue resulting from the exit of our chicken processing businesses in 2023. Gross Profit Gross profit was $50.2 million for three months ended September 30, 2024 compared to $50.9 million in the same period in 2023 , a decrease of $0.8 million, or 1.5%. The decrease was primarily attributable to a decrease in margins on meat and poultry during the quarter. Gross profit margin for the three months ended September 30, 2024 decreased to 16.8% compared to 18.1% in the same period in 2023 . Distribution, Selling and Administrative Expenses Distribution, selling and administrative expenses increased by $0.8 million, or 1.7%, for the three months ended September 30, 2024 primarily due to increases of $1.0 million each in both auto expenses and insurance costs, partially offset by a decrease of $1.6 million in professional fees. Distribution, selling and administrative expenses as a percentage of net revenue decreased to 16.6% for the three months ended September 30, 2024 from 17.4% in the same period in 2023, primarily due to increased net revenue and lower professional fees, partially offset by increased rental expenses and insurance costs. Interest Expense Interest expense for the three months ended September 30, 2024 of $2.6 million remained consistent compared to the three months ended September 30, 2023, having decreased slightly from $2.7 million. Average floating interest rates on our floating-rate debt for the three months ended September 30, 2024 remained consistent on our line of credit and the JPMorgan Chase mortgage-secured term loan, compared to the same period in 2023. Our average daily line of credit balance increased by $22.3 million, or 56.6%, to $61.7 million for the three months ended September 30, 2024 from $39.4 million for the three months ended September 30, 2023, and our average daily JPMorgan Chase mortgage-secured term loan balance decreased by $5 million, or 4.7%, to $103.0 million for the three months ended September 30, 2024 from $108.0 million for the three months ended September 30, 2023. 24 Income Tax Expense (Benefit) Income tax benefit was $1.3 million for the three months ended September 30, 2024, compared to an income tax benefit of $36 thousand for the three months ended September 30, 2023, primarily due to an increase in loss before income taxes. Net Income (Loss) Attributable to HF Foods Group Inc. Net loss attributable to HF Foods Group Inc. was $3.9 million for the three months ended September 30, 2024 , compared to net income of $1.9 million for the three months ended September 30, 2023. The loss was primarily driven by the change related to the fair value of interest rate swap contracts of $5.3 million and increases of $1.0 million each in both auto expenses and insurance costs partially offset by the increase of income tax benefit of $1.2 million. EBITDA and Adjusted EBITDA The following table reconciles EBITDA and Adjusted EBITDA to the most directly comparable GAAP measure: Three Months Ended September 30, ($ in thousands) 2024 2023 Change Net (loss) income $ (3,837) $ 1,974 $ (5,811) Interest expense 2,644 2,715 (71) Income tax benefit (1,254) (36) (1,218) Depreciation and amortization 6,666 6,422 244 EBITDA 4,219 11,075 (6,856) Lease guarantee income — (95) 95 Change in fair value of interest rate swap contracts 3,290 (1,984) 5,274 Stock-based compensation expense 701 757 (56) Business transformation costs (1) 77 198 (121) Other non-routine expense (2) 18 146 (128) Adjusted EBITDA $ 8,305 $ 10,097 $ (1,792) _________________ (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. 25 Results of Operations Comparison of Nine Months Ended September 30, 2024 to Nine Months Ended September 30, 2023 The following table sets forth a summary of our consolidated results of operations for the nine months ended September 30, 2024 and 2023 . The historical results presented below are not necessarily indicative of the results that may be expected for any future period. Nine Months Ended September 30, ($ in thousands) 2024 2023 Change Net revenue $ 896,385 $ 867,620 $ 28,765 Cost of revenue 743,346 715,857 27,489 Gross profit 153,039 151,763 1,276 Distribution, selling and administrative expenses 149,988 154,013 (4,025) Income (loss) from operations 3,051 (2,250) 5,301 Interest expense 8,597 8,430 167 Other expense (income), net 3,040 (845) 3,885 Change in fair value of interest rate swap contracts 959 (2,094) 3,053 Lease guarantee income (5,548) (305) (5,243) Loss before income taxes (3,997) (7,436) 3,439 Income tax expense (benefit) 164 (2,053) 2,217 Net loss and comprehensive loss (4,161) (5,383) 1,222 Less: net income (loss) attributable to noncontrolling interests 456 (484) 940 Net loss and comprehensive loss attributable to HF Foods Group Inc. $ (4,617) $ (4,899) $ 282 The following table sets forth the components of our consolidated results of operations expressed as a percentage of net revenue for the periods indicated: Nine Months Ended September 30, 2024 2023 Net revenue 100.0 % 100.0 % Cost of revenue 82.9 % 82.5 % Gross profit 17.1 % 17.5 % Distribution, selling and administrative expenses 16.7 % 17.8 % Income (loss) from operations 0.4 % (0.3) % Interest expense 1.0 % 1.0 % Other expense (income), net 0.3 % (0.1) % Change in fair value of interest rate swap contracts 0.1 % (0.2) % Lease guarantee income (0.6) % — % Loss before income taxes (0.4) % (1.0) % Income tax expense (benefit) — % (0.2) % Net loss and comprehensive loss (0.4) % (0.8) % Less: net income (loss) attributable to noncontrolling interests 0.1 % — % Net loss and comprehensive loss attributable to HF Foods Group Inc. (0.5) % (0.8) % 26 Net Revenue Net revenue for the nine months ended September 30, 2024 increased by $28.8 million, or 3.3%, compared to the same period in 2023. This increase was primarily attributable to product cost inflation and improved pricing in certain categories, partially offset by the $13.3 million loss in revenue resulting from the exit of our chicken processing businesses in 2023. Gross Profit Gross profit was $153.0 million for the nine months ended September 30, 2024 compared to $151.8 million in the same period in 2023 , an increase of $1.3 million, or 0.8% . The gross profit increase was primarily attributable to increased net revenue partially offset by increased costs. Gross profit margin for the nine months ended September 30, 2024 decreased to 17.1% compared to 17.5% in the same period in 2023. Distribution, Selling and Administrative Expenses Distribution, selling and administrative expenses of $150.0 million for the nine months ended September 30, 2024 decreased compared to prior year expenses of $154.0 million primarily due to a decrease of $10.0 million in professional fees, partially offset by an increase of $3.6 million in payroll and related labor costs and an increase of $2.0 million in insurance costs. Distribution, selling and administrative expenses as a percentage of net revenue decreased to 16.7% for the nine months ended September 30, 2024 from 17.8% in the same period in 2023, primarily due to lower professional fees and increased net revenue, partially offset by increased payroll and related labor costs and insurance costs. Interest Expense Interest expense for the nine months ended September 30, 2024 increased by $0.2 million or 2.0% , compared to the nine months ended September 30, 2023, primarily due to an increase in our average daily line of credit balance of $13.1 million combined with a slightly higher interest-rate environment, partially offset by a decrease in our average daily JPMorgan Chase mortgage-secured term loan balance of $5.1 million . Average floating interest rates on our floating-rate debt for the nine months ended September 30, 2024 increased by approximately 0.4% on the line of credit and 0.4% on the JPMorgan Chase mortgage-secured term loan, compared to the same period in 2023. Our average daily line of credit balance increased by $13.1 million, or 31.9%, to $54.3 million for the nine months ended September 30, 2024 from $41.2 million for the nine months ended September 30, 2023, and our average daily JPMorgan Chase mortgage-secured term loan balance decreased by $5.1 million, or 4.6%, to $104.2 million for the nine months ended September 30, 2024 from $109.3 million for the nine months ended September 30, 2023. Income Tax Expense (Benefit) Income tax expense was $0.2 million for the nine months ended September 30, 2024, compared to an income tax benefit of $2.1 million for the nine months ended September 30, 2023, primarily due to a decrease in loss before income taxes and discrete tax items related to the previously-disclosed settlement agreement with the SEC and stock-based compensation shortfalls impacting the tax provision for the current period. Net Loss Attributable to HF Foods Group Inc. Net loss attributable to HF Foods Group Inc. was $4.6 million for the nine months ended September 30, 2024 , compared to net loss of $4.9 million for the nine months ended September 30, 2023. The decrease in net loss of $0.3 million was primarily driven by the increase in our income from operations of $5.3 million and the $5.2 million reversal of our lease guarantee liability, partially offset by the previously-disclosed settlement with the SEC of $3.9 million, the increase of income tax expense of $2.2 million and the loss of $3.1 million resulting from the change in fair value of interest rate swap contracts. 27 EBITDA and Adjusted EBITDA The following table reconciles EBITDA and Adjusted EBITDA to the most directly comparable GAAP measure: Nine Months Ended September 30, ($ in thousands) 2024 2023 Change Net loss $ (4,161) $ (5,383) $ 1,222 Interest expense 8,597 8,430 167 Income tax expense (benefit) 164 (2,053) 2,217 Depreciation and amortization 19,932 19,551 381 EBITDA 24,532 20,545 3,987 Lease guarantee income (5,548) (305) (5,243) Change in fair value of interest rate swap contracts 959 (2,094) 3,053 Stock-based compensation expense 1,961 2,605 (644) SEC settlement 3,900 — 3,900 Asset impairment charges — 1,200 (1,200) Business transformation costs (1) 1,180 402 778 Other non-routine expense (2) 584 1,850 (1,266) Adjusted EBITDA $ 27,568 $ 24,203 $ 3,365 _________________ (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 September 30, 2024, we had cash of approximately $11.4 million, checks issued not presented for payment of $12.0 million and access to approximately $27.3 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 September 30, 2024. 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. Our liquidity is also affected by the entry of an administrative civil cease-and-desist order by the SEC, whereby we agreed to payment of a civil monetary penalty of $3.9 million. We made this payment during the nine months ended September 30, 2024. 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 September 30, 2024, 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. 28 The following table summarizes cash flow data for the three months ended September 30, 2024 and 2023: Nine Months Ended September 30, (In thousands) 2024 2023 Change Net cash (used in) provided by operating activities $ (3,299) $ 20,624 $ (23,923) Net cash used in investing activities (9,423) (2,595) (6,828) Net cash provided by (used in) financing activities 8,935 (28,018) 36,953 Net decrease in cash and cash equivalents $ (3,787) $ (9,989) $ 6,202 Operating Activities Net cash (used in) provided by operating activities consists primarily of net income, which includes the $3.9 million SEC settlement payment, 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 (used in) provided by operating activities decreased by $23.9 million primarily due to the timing of working capital outlays and the $3.9 million SEC settlement payment partially offset by improved operating income. Investing Activities Net cash used in investing activities increased by $6.8 million primarily due to increased capital project spend in the nine months ended September 30, 2024. Financing Activities Net cash provided by (used in) financing activities decreased by $37.0 million to $8.9 million provided by financing activities primarily due to net line of credit activity, as well as the checks issued not presented for payment activity for the nine months ended September 30, 2024 compared to the nine months ended September 30, 2023. Critical Accounting Policies and Estimates We have prepared the financial information in this Quarterly Report in accordance with GAAP. Preparing our condensed 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 2023 Annual Report on Form 10-K includes a summary of the critical accounting policies and estimates we believe are the most important to aid in understanding our financial results. There have been no changes to those critical accounting policies and estimates that have had a material impact on our reported amounts of assets, liabilities, revenue, or expenses during the three months ended September 30, 2024. 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 as of December 31, 2023. A quantitative goodwill impairment analysis requires valuation of the respective reporting unit, which requires complex analysis and judgment. The results of the testing as of December 31, 2023, concluded that the estimated fair value exceeded carrying value by approximately 10%, and no impairment existed as of that date. As of September 30, 2024, the Company concluded that a triggering event occurred due to a sustained decline in the Company’s stock price since December 31, 2023, which required interim testing for goodwill impairment in accordance with ASC 350. Accordingly, the Company performed a quantitative assessment as of September 30, 2024. The results of the testing as of September 30, 2024 concluded that the estimated fair value exceeded carrying value by approximately 1% and no impairment existed as of that date. For both the September 30, 2024 and December 31, 2023 impairment tests, 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 29 approach requires detailed forecasts of cash flows, including significant assumptions such as revenue growth rates, gross profit margin, distribution, selling, and administrative expenses, 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. We corroborated the reasonableness of the total fair value of the reporting unit at both September 30, 2024 and December 31, 2023 by assessing the implied enterprise value control premium based on our market capitalization and also considered the lack of liquidity in the Company’s common stock. The Company’s common stock is fairly thinly traded, with a higher level of internal stockholders than its peers, and no major analyst coverage. As a result, the implied value from the traded stock price is based on limited investment public interest. Our market capitalization is calculated using the number of common shares issued and the common stock’s 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 1% or $5 million at September 30, 2024, and 10% or $45.0 million at December 31, 2023. No goodwill impairment was recorded for the nine months ended September 30, 2024 or the year ended December 31, 2023. Additionally, see Note 6 - Goodwill and Acquired Intangible Assets of our condensed consolidated financial statements on this Form 10-Q for disclosure regarding the Company’s single reporting unit. 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, for the September 30, 2024 impairment test, 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 revenue growth rate assumption would result in a decrease in the fair value of our reporting unit of approximately $13.7 million, $34.1 million, $7.9 million, and $10.1 million, respectively, which would likely result in an impairment. For the December 31, 2023 impairment test, 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 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 further 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. Furthermore, as disclosed in Note 14 - Subsequent Events of our condensed consolidated financial statements on this Form 10-Q, on October 24, 2024, the Board of Directors of the Company terminated Xiao Mou (Peter) Zhang as Chief Executive Officer of the Company, effective as of October 24, 2024. In addition, on October 24, 2024, Xi (Felix) Lin was appointed to serve as Interim Chief Executive Officer, effective as of October 24, 2024. Mr. Lin continues to serve as the Company’s Chief Operating Officer and President. Prior to his termination as Chief Executive Officer of the Company, Xiao Mou (Peter) Zhang was determined to be the Company’s chief operating decision maker for purposes of segment reporting. The Company will need to analyze the impact of this change on not only segment reporting, but also on the determination of reporting units. If changes in reporting units are concluded to be applicable, such changes could also impact future goodwill impairment assessments. 30 Recent Accounting Pronouncements For a discussion of recent accounting pronouncements, see Note 2 - Summary of Significant Accounting Policies to the condensed consolidated financial statements in this Quarterly Report on Form 10-Q.