HF Foods Group Inc

Note 1 - Organization and Description of Business

Organization and General

HF Foods Group Inc. and subsidiaries (collectively “HF Foods” or the “Company”) is an Asian foodservice distributor that markets and distributes fresh produce, seafood, frozen and dry food, and non-food products to primarily Asian restaurants and other foodservice customers throughout the United States. The Company's business consists ofone operating segment, which is also itsone reportable segment: HF Foods, which operates solely in the United States. The Company's customer base consists primarily of Asian restaurants, and it provides sales and service support to customers who mainly converse in Mandarin or Chinese dialects.

Note 2 - Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and applicable rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. All adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

The condensed consolidated financial statements and related financial information should be read in conjunction with the audited consolidated financial statements and the related notes thereto that are included in our Annual Report on Form 10-K for the year ended December 31, 2023 filed with the SEC on March 26, 2024 (the “2023 Annual Report”). There have been no material changes to the Company’s significant accounting policies as compared to the significant accounting policies described in the 2023 Annual Report.

All significant intercompany balances and transactions have been eliminated in consolidation. For consolidated entities where we own or are exposed to less than 100% of the economics, the Company records net income (loss) attributable to noncontrolling interest in its condensed consolidated statements of operations and comprehensive loss equal to the percentage of the economic or ownership interest retained in such entity by the respective noncontrolling party.

Variable Interest Entities

GAAP provides guidance on the identification of a variable interest entity (“VIE”) and financial reporting for an entity over which control is achieved through means other than voting interests. The Company evaluates each of its interests in an entity to determine whether or not the investee is a VIE and, if so, whether the Company is the primary beneficiary of such VIE. In determining whether the Company is the primary beneficiary, the Company considers if the Company (1) has power to direct the activities that most significantly affect the economic performance of the VIE, and (2) has the obligation to absorb losses or the right to receive the economic benefits of the VIE that could be potentially significant to the VIE. If deemed the primary beneficiary, the Company consolidates the VIE.

The Company previously disclosedone VIE, AnHeart, Inc. (“AnHeart”), for which the Company was not the primary beneficiary and therefore did not consolidate. During the three months ended June 30, 2024, the Company assumed the lease for which AnHeart was a lessee and the Company was a guarantor, and as such, itno longer recognizes AnHeart as a VIE as of June 30, 2024. See Note 13 - Commitments and Contingenciesfor additional information on AnHeart.

Noncontrolling Interests

GAAP requires that noncontrolling interests in subsidiaries and affiliates be reported in the equity section of the Company’s condensed consolidated balance sheets. In addition, the amounts attributable to the net income (loss) of those noncontrolling interests are reported separately in the condensed consolidated statements of operations and comprehensive loss.

As of June 30, 2024 and December 31, 2023, noncontrolling interest equity consisted of the following:

(a)During the quarter ended June 30, 2024, upon dissolution of HFFI, the Company assumed HFFI’s remaining assets and liabilities. In accordance with ASC Topic 810 (“ASC 810”), Consolidation, changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary shall be accounted for as equity transactions. No gain or loss was recognized. As a result of this transaction, noncontrolling interest of $0.8 million was reclassified to additional paid-in capital on the condensed consolidated balance sheets.

Uses of Estimates

The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during each reporting period. Actual results could differ from those estimates. Significant accounting estimates reflected in the Company’s condensed consolidated financial statements include, but are not limited to, inventory reserves, impairment of long-lived assets, impairment of goodwill, and the purchase price allocation and fair value of assets and liabilities acquired with respect to business combinations.

Recent Accounting Pronouncements

In November 2023, the FASB issued Accounting Standards Update (ASU) 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures, which requires enhanced disclosures about segment expenses on an annual and interim basis. This standard is effective for the Company’s consolidated financial statements for the year ending December 31, 2024 and for interim periods beginning in 2025. The impact of the adoption of this ASU is not expected to have a material effect on the Company’s financial position, or operations, however, the Company is currently evaluating the impact of this standard on its disclosures to the consolidated financial statements.

In December 2023, the FASB issued ASU 2023-09, Income Taxes (“Topic 740”): Improvements to Income Tax Disclosures (“ASU 2023-09”), which requires public entities to disclose specific categories in its annual effective tax rate reconciliation and disaggregated information about significant reconciling items by jurisdiction and by nature. ASU 2023-09 also requires entities to disclose their income tax payments (net of refunds) to international, federal, and state and local jurisdictions. This guidance is effective for fiscal years beginning after December 15, 2024, and requires prospective application with the option to apply it retrospectively. Early adoption is permitted. The Company is currently evaluating the impact of this guidance on the consolidated financial statements and disclosures.

Note 3 - Revenue

The following table presents the Company's net revenue disaggregated by principal product categories:

Note 4 - Balance Sheet Components

Accounts receivable, net consisted of the following:

Movement of allowance for expected credit losses was as follows:

Prepaid expenses and other current assets consisted of the following:

Property and equipment, net consisted of the following:

(1) The cost and accumulated depreciation of property and equipment related to finance leases was $31.0 million and $12.3 million at June 30, 2024 and $22.2 million and $10.3 million at December 31, 2023, which primarily relates to Automobiles. During the six months ended June 30, 2024, the Company entered into finance leases for automobiles which mature in 4 to 6 years and have a weighted average discount rate of 6.6%. The total future minimum lease payments under finance leases as of June 30, 2024 is $30.1 million. As of June 30, 2024, the Company had additional leases that had not yet commenced which totaled $16.9 million in future minimum lease payments.

Depreciation expense was $2.5 million and $2.4 million for the three months ended June 30, 2024 and 2023, respectively. Depreciation expense was $5.1 million and $5.0 million for the six months ended June 30, 2024 and 2023, respectively. During the three months ended June 30, 2023, the Company impaired machinery and recognized impairment expense of $1.2 million in distribution, selling and administrative expense in the condensed consolidated statements of operations and comprehensive income.

Long-term investments consisted of the following:

The investment in Tamron is accounted for using the measurement alternative under Accounting Standards Codification (“ASC”) Topic 321 Investments—Equity Securities, which is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments, if any. The investment in Asahi is accounted for under the equity method due to the fact that the Company has significant influence but does not exercise control over this investee. The Company determined there wasno impairment as of June 30, 2024 for these investments.

Accrued expenses and other liabilities consisted of the following:

Note 5 - Fair Value Measurements

The following table presents the Company's hierarchy for its assets and liabilities measured at fair value on a recurring basis as of the dates indicated:

The Company follows the provisions of ASC Topic 820 Fair Value Measurement which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

•Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.

•Level 2 - Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data.

•Level 3 - Inputs are unobservable inputs which reflect the reporting entity’s own assumptions about what assumptions market participants would use in pricing the asset or liability based on the best available information.

Any transfers of assets or liabilities between Level 1, Level 2, and Level 3 of the fair value hierarchy will be recognized at the end of the reporting period in which the transfer occurs. There were no transfers between fair value levels in any of the periods presented herein.

The carrying amounts reported in the condensed consolidated balance sheets for cash, accounts receivable, other current assets, accounts payable, checks issued not presented for payment and accrued expenses and other liabilities approximate their fair value based on the short-term maturity of these instruments.

See Note 7 - Derivative Financial Instruments for additional information regarding the Company’s interest rate swaps.

Carrying Value and Estimated Fair Value of Outstanding Debt -The following table presents the carrying value and estimated fair value of the Company’s outstanding debt as described in Note 8 - Debt, including the current portion, as of the dates indicated:

The carrying value of the variable rate debt approximates its fair value because of the variability of interest rates associated with these instruments. For the Company's fixed rate debt, the fair values were estimated using discounted cash flow analyses, based on the current incremental borrowing rates for similar types of borrowing arrangements.

See Note 8 - Debt for additional information regarding the Company's debt.

Nonrecurring Fair Values

The Company measures fair value of certain assets on a nonrecurring basis when events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. No adjustments to fair value from the write-down of asset values due to impairment were made during the three and six months ended June 30, 2024 and 2023.

There were no assets carried at nonrecurring fair value at June 30, 2024 and December 31, 2023.

Note 6 - Goodwill and Acquired Intangible Assets

Goodwill

The Company performed a quantitative goodwill impairment assessment as of December 31, 2023, as a result of the Company’s results of operations compared to previous forecasts, combined with the level of the Company’s stock price. The fair value was determined using an average of the income approach, comparable public company analysis, and comparable acquisitions analysis. The fair value of the reporting unit exceeded the carrying value, and therefore the Company concluded no impairment was required to be recorded during the year ended December 31, 2023.

The annual goodwill impairment test in 2023 resulted in an estimated fair value that exceeded carrying value by approximately 10% at December 31, 2023. The most critical assumptions in determining fair value using the income approach were projections of future cash flows such as forecasted revenue growth rates, gross profit margins, and the discount rate. The market approaches were primarily impacted by an enterprise value multiple of EBITDA. A significant change in these assumptions or a sustained decline in the Company’s stock price could result in an interim impairment test and/or potential goodwill impairment in the future.

The Company determined that there were no events or circumstances during the six months ended June 30, 2024 that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Goodwill was $85.1 million as of June 30, 2024 and December 31, 2023.

Acquired Intangible Assets

The components of the intangible assets are as follows:

Amortization expense for acquired intangible assets was $4.1 million for the three months ended June 30, 2024 and 2023. Amortization expense for acquired intangible assets was $8.1 million for the six months ended June 30, 2024 and 2023.

Note 7 - Derivative Financial Instruments

Derivative Instruments

The Company utilizes interest rate swaps ("IRS") for the sole purpose of mitigating interest rate fluctuation risk associated with floating rate debt instruments (as defined in Note 8 - Debt). The Company does not use any other derivative financial instruments for trading or speculative purposes.

On August 20, 2019, HF Foods entered intotwo IRS contracts with East West Bank (the "EWB IRS") for initial notional amounts of $1.1 million and $2.6 million, respectively. On April 20, 2023, the Company amended the corresponding mortgage term loans, which pegged thetwo mortgage term loans to 1-month Term SOFR (Secured Overnight Financing Rate) +2.29% per annum for the remaining duration of the term loans. The amended EWB IRS contracts fixed thetwo term loans at 4.23% per annum until maturity in September 2029.

On December 19, 2019, HF Foods entered into an IRS contract with Bank of America (the "BOA IRS") for an initial notional amount of $2.7 million in conjunction with a newly contracted mortgage term loan of corresponding amount. On December 19, 2021, the Company entered into the Second Amendment to Loan Agreement, which pegged the mortgage term loan to Term SOFR +2.5%. The BOA IRS was modified accordingly to fix the SOFR based loan to approximately 4.50%. The term loan and corresponding BOA IRS contract mature in December 2029.

On March 15, 2023, the Company entered into an amortizing IRS contract with JPMorgan Chase for an initial notional amount of $120.0 million, effective from March 1, 2023 and expiring in March 2028, as a means to partially hedge its existing floating rate loans exposure. Pursuant to the agreement, the Company will pay the swap counterparty a fixed rate of 4.11% in exchange for floating payments based on Term SOFR.

The Company evaluated the aforementioned IRS contracts currently in place and did not designate those as cash flow hedges. Hence, the fair value changes of these IRS contracts are accounted for and recognized as a change in fair value of interest rate swap contracts in the condensed consolidated statements of operations and comprehensive income (loss).

As of June 30, 2024, the Company determined that the fair values of the IRS contracts were $1.1 million in an asset position. As of December 31, 2023, the fair values of the IRS contracts were $0.4 million in an asset position and $1.6 million in a liability position. The Company includes these inother long-term assets andother long-term liabilities, respectively, on the consolidated balance sheets. In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible, as well as consider counterparty credit risk in its assessment of fair value. The inputs used to determine the fair value of the IRS are classified as Level 2 on the fair value hierarchy.

Note 8 - Debt

Long-term debt at June 30, 2024 and December 31, 2023 is summarized as follows:

(a)Loan balance consists of real estate term loan and equipment term loan, collateralized byone real property and specific equipment. The real estate term loan is pegged to TERM SOFR +2.5%.

(b)Real estate term loans with East West Bank are collateralized bythree real properties. Balloon payments of $1.9 million and $3.0 million are due at maturity in 2027 and 2029, respectively.

(c)Real estate term loan with a principal balance of $103.8 million as of June 30, 2024 and $106.3 million as of December 31, 2023 is secured by assets held by the Company and has a maturity date of January 2030.

(d)Secured by vehicles.

The terms of the various loan agreements related to long-term bank borrowings require the Company to comply with certain financial covenants, including, but not limited to, a fixed charge coverage ratio and effective tangible net worth. As of June 30, 2024, the Company was in compliance with its covenants.

Credit Facility

The outstanding principal balance on the line of credit as of June 30, 2024 was $66.4 million and outstanding letters of credit amounted to $3.8 million leaving access to approximately $29.9 million in additional funds through our $100.0 million line of credit, subject to a borrowing base calculation.

On March 31, 2022, the Company amended the $100.0 million asset-secured revolving credit facility agreement, extending forfive years, with a maturity date of November 4, 2027. On February 6, 2024, the Company amended the agreement to (i) remove a cap on permitted indebtedness in respect of capital lease obligations, subject to certain enumerated conditions; (ii) create a reserve on the borrowing base, which will be reduced on a dollar-for-dollar basis once the Company has made expenditures in excess of such amount relating to the development and construction of certain real property, and which amounts shall be excluded from certain financial covenants under the JPM Credit Agreement and; (iii) remove certain sublease income from various financial covenants.

Note 9 - Earnings (Loss) Per Share

The Company computes earnings per share (“EPS”) in accordance with ASC Topic 260 (“ASC 260”), Earnings per Share. ASC 260 requires companies with complex capital structures to present basic and diluted EPS. Basic EPS is measured as net income divided by the weighted average common shares outstanding for the period. Diluted EPS is similar to basic EPS, but presents the dilutive effect on a per share basis of potential common shares (e.g., convertible securities, options, warrants and restricted stock) as if they had been converted at the beginning of the periods presented, or issuance date, if later. Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS. There were 37,084 and 967,779 potential common shares related to performance-based restricted stock units and restricted stock units that were excluded from the calculation of diluted EPS for the three months ended June 30, 2024 and 2023, respectively, because their effect could have been anti-dilutive. There were 1,354,908 and 620,402 potential common shares related to performance-based restricted stock units and restricted stock units that were excluded from the calculation of diluted EPS for the six months ended June 30, 2024 and 2023, respectively, because their effect could have been anti-dilutive.

The following table sets forth the computation of basic and diluted EPS:

Note 10 - Income Taxes

The determination of the Company’s overall effective income tax rate requires the use of estimates. The effective income tax rate reflects the income earned and taxed in U.S. federal and various state jurisdictions based on enacted tax law, permanent differences between book and tax items, tax credits and the Company’s change in relative income in each jurisdiction. Changes in tax laws and rates may affect recorded deferred tax assets and liabilities and the Company’s effective income tax rate in the future. As of June 30, 2024, the Company had no subsidiaries outside the U.S., as such, no foreign income tax was recorded.

For the three and six months ended June 30, 2024, the Company's effective income tax rate of 87.2% and 129.6%, respectively, differed from the federal statutory tax rate primarily as a result of discrete tax items, permanent differences and state income taxes. The Company’s tax provision for the three and six months ended June 30, 2024 includes a discrete tax expense of $1.0 million related to the Company’s SEC settlement and $0.1 million tax expense related to stock-based compensation shortfalls. Absent the discrete items, the estimated annual effective income tax rate from continuing operations for the three and six months ended June 30, 2024 was 25.5% and 25.1%, respectively. For the three and six months ended June 30, 2023, the Company's effective income tax rate of (15.5)% and 21.5%, respectively, differed from the federal statutory tax rate primarily as a result of permanent differences and state income taxes.

During the three months ended June 30, 2024, the Company dissolved one of its subsidiaries, HFFI. The Company is in the process of determining the tax impact of the dissolution. However, the Company does not expect the dissolution of HFFI to have a significant impact on the income tax provision as HFFI’s deferred tax assets were subject to a full valuation allowance.

Note 11 - Related Party Transactions

The Company makes regular purchases from and sales to various related parties. Related party affiliations were attributed to transactions conducted between the Company and those business entities partially or wholly owned by the Company, the Company's officers and/or shareholders who owned no less than 10% shareholdings of the Company.

Mr. Xiao Mou Zhang (“Mr. Zhang”), the Chief Executive Officer of the Company, and certain of his immediate family members (collectively greater than 10% shareholders) have ownership interests in various related parties involved in (i) the distribution of food and related products to restaurants and other retailers and (ii) the supply of fresh food, frozen food, and packaging supplies to distributors. Mr. Zhang does not have any involvement in negotiations with any of the above-mentioned related parties.

The Company believes that Mr. Zhou Min Ni (“Mr. Ni”), the Company’s former Co-Chief Executive Officer, together with various trusts for the benefit of Mr. Ni's four children, are collectively beneficial owners of more than 10% of the outstanding shares of the Company’s common stock, and he and certain of his immediate family members have ownership interests in related parties involved in (i) the distribution of food and related products to restaurants and other retailers and (ii) the supply of fresh food, frozen food, and packaging supplies to distributors.

The related party transactions as of June 30, 2024 and December 31, 2023 and for the three and six months ended June 30, 2024 and 2023 are identified as follows:

Related Party Sales, Purchases, and Lease Agreements

Purchases

Below is a summary of purchases of goods and services from related parties recorded for the three and six months ended June 30, 2024 and 2023:

(a)The Company, through its subsidiary Mountain Food, LLC, owns an equity interest in this entity.

(b)An equity interest is held bythree Irrevocable Trusts for the benefit of Mr. Zhang's children.

(c)Mr. Zhou Min Ni owns an equity interest in this entity.

Sales

Below is a summary of sales to related parties recorded for the three and six months ended June 30, 2024 and 2023:

(b)The Company, through its subsidiary Mountain Food, LLC, owns an equity interest in this entity.

(c)Tina Ni, one of Mr. Zhou Min Ni’s family members, owns an equity interest in this entity indirectly through its parent company.

(d)Mr. Zhou Min Ni owns an equity interest in this entity indirectly through its parent company.

(e)Mr. Zhou Min Ni owns an equity interest in this entity.

(f)Tina Ni, one of Mr. Zhou Min Ni’s family members, owns an equity interest in this entity.

Lease Agreements

The Company leases various facilities to related parties.

In 2020, the Company renewed a warehouse lease from Yoan Chang Trading Inc. under an operating lease agreement which expired on December 31, 2020. In February 2021, the Company executed a newfive-year operating lease agreement with Yoan Chang Trading Inc., effective January 1, 2021 and expiring on December 31, 2025. Rent expense, which is included in distribution, selling and administrative expenses in the condensed consolidated statements of operations and comprehensive income (loss), was $0.1 million and $0.1 million for the three months ended June 30, 2024 and 2023, respectively and $0.1 million and $0.2 million for the six months ended June 30, 2024 and 2023, respectively.

Beginning 2014, the Company leased a warehouse to Asahi Food, Inc. under a commercial lease agreement which was rescinded March 1, 2020. A new commercial lease agreement for a period ofone year was entered into, expiring February 28, 2021, with a total offour renewal periods with each term beingone year. Rental income was $36 thousand and $36 thousand for the three months ended June 30, 2024 and 2023, respectively and $72 thousand and $72 thousand for the six months ended June 30, 2024 and 2023, respectively. Rental income is included in other income in the condensed consolidated statements of operations and comprehensive income (loss).

Related Party Balances

Accounts Receivable - Related Parties, Net

Below is a summary of accounts receivable with related parties recorded as of June 30, 2024 and December 31, 2023, respectively:

(b)The Company, through its subsidiary Mountain Food, LLC, owns an equity interest in this entity.

(c)Mr. Zhou Min Ni owns an equity interest in this entity.

(d)Mr. Zhou Min Ni owns an equity interest in this entity indirectly through its parent company.

(e)Tina Ni, one of Mr. Zhou Min Ni’s family members, owns an equity interest in this entity.

The Company has reserved for 100% of the accounts receivable for Enson Seafood GA, Inc. as of June 30, 2024 and December 31, 2023. All other accounts receivable from these related parties are current and considered fully collectible. No additional allowance is deemed necessary as of June 30, 2024 and December 31, 2023.

Accounts Payable - Related Parties

All the accounts payable to related parties are payable upon demand without interest. Below is a summary of accounts payable with related parties recorded as of June 30, 2024 and December 31, 2023, respectively:

Note 12 - Stock-Based Compensation

In 2021, the Company began issuing awards under the HF Foods Group Inc. 2018 Omnibus Equity Incentive Plan (the “2018 Incentive Plan”), which reserves up to 3,000,000 shares of the Company's common stock for issuance of awards to employees and non-employee directors. On June 3, 2024, the Company’s shareholders approved an amendment to the 2018 Incentive Plan which increased the number of shares of the Company's common stock available for issuance under the 2018 Incentive Plan to 7,000,000, an increase of 4,000,000 shares. As of June 30, 2024, the Company had 1,065,174 time-based vesting restricted stock units unvested,981,894 performance-based restricted stock units unvested,1,086,403 shares of common stock vested and 3,866,529 shares remaining available for future awards under the 2018 Incentive Plan.

Stock-based compensation expense was $0.5 million and $0.8 million for the three months ended June 30, 2024 and 2023, respectively. Stock-based compensation expense was $1.3 million and $1.8 million for the six months ended June 30, 2024 and 2023, respectively. Stock-based compensation expense was included in distribution, selling and administrative expenses in the Company's condensed consolidated statements of operations and comprehensive income (loss).

As of June 30, 2024, there was $6.8 million of total unrecognized compensation cost related to all non-vested outstanding RSUs and PSUs outstanding under the 2018 Incentive Plan, with a weighted average remaining service period of 2.32 years.

Note 13 - Commitments and Contingencies

From time to time, the Company is a party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of business. When the Company becomes aware of a claim or potential claim, it assesses the likelihood of any loss or exposure. In accordance with authoritative guidance, the Company records loss contingencies in its financial statements only for matters in which losses are probable and can be reasonably estimated. Where a range of loss can be reasonably estimated with no best estimate in the range, the Company records the minimum estimated liability. If the loss is not probable or the amount of the loss cannot be reasonably estimated, the Company discloses the nature of the specific claim if the likelihood of a potential loss is reasonably possible and the amount involved is material. The Company continuously assesses the potential liability related to its pending litigation and revises its estimates when additional information becomes available. Adverse outcomes in some or all of these matters may result in significant monetary damages or injunctive relief against the Company that could adversely affect its ability to conduct business. There also exists the possibility of a material adverse effect on the Company’s financial statements for the period in which the effect of an unfavorable outcome becomes probable and reasonably estimable. Legal costs associated with loss contingencies are expensed as incurred.

On June 6, 2024, the SEC announced that it had accepted an Offer of Settlement submitted by the Company in order to resolve the previously disclosed formal, non-public SEC investigation of allegations that the Company and certain of its current and former directors and officers violated the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by making allegedly false and misleading statements. Under the settlement, without admitting or denying the SEC’s findings in this matter, the Company consented to the entry of an administrative civil cease-and-desist order by the SEC (the “Order”) with respect to violations of Sections 17(a) of the Securities Act, and of Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), and 14(a) of the Securities Exchange Act of 1934, as amended, and Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13, 13a-15(a), and 14a-9 thereunder, resulting from the materially false and misleading disclosures and other fraudulent conduct implemented by its former Chairman and CEO Zhou Min Ni and former CFO Jian Ming “Jonathan” Ni. The Company agreed to payment of a civil monetary penalty of $3.9 million, paid during the three months ended June 30, 2024, which was recorded in other income (expense), net in the Company’s condensed consolidated statements of operations and comprehensive income (loss).

The Order states that, in determining to accept the Company’s Offer of Settlement, the SEC considered the numerous remedial actions promptly undertaken by the Company and its cooperation during the investigation. The Company’s resolution follows charges brought by the SEC against the two former executives in a District Court action filed on June 3, 2024. As a result of the SEC’s district court complaint against them, the two former executives agreed to pay civil fines and disgorgement, and agreed to be subject to officer and director bars. Zhou Min Ni also agreed to a conduct-based injunction which enjoins him from directly or indirectly participating in the management of, or otherwise exercising any control of influence over the Company. The Special Litigation Committee of the Board of Directors previously obtained a monetary settlement from the former executives that was ratified by the Delaware Chancery Court.

AnHeart Lease Guarantee

The Company provided a guarantee fortwo separate leases fortwo properties located in Manhattan, New York, at 273 Fifth Avenue and 275 Fifth Avenue, for 30 years and 15 years, respectively. The Company previously determined that AnHeart was a VIE as a result of the guarantee. However, the Company concluded it was not the primary beneficiary of AnHeart and therefore did not consolidate, because it did not have the power to direct the activities of AnHeart that most significantly impact AnHeart's economic performance. During the three months ended June 30, 2024, the Company assumed the lease for 275 Fifth Avenue and no longer recognized AnHeart as a VIE. As a result of the lease assumption, the lease guarantee liability of $5.4 million was reversed and an operating lease right-of-use asset and liability of $4.9 million was recorded on the condensed consolidated balance sheets. As a result of the reversal, a gain of $5.4 million was recorded to other expense (income), net on the condensed consolidated statements of operations and comprehensive income (loss).

On February 10, 2021, the Company entered into an Assignment and Assumption of Lease Agreement (“Assignment”), dated effective as of January 21, 2021, with AnHeart and Premier 273 Fifth, LLC, pursuant to which it assumed the lease of the premises at 273 Fifth Avenue (the “273 Lease Agreement”). At the same time, the closing documents were delivered to effectuate the amendment of the 273 Lease Agreement pursuant to an Amendment to Lease (the “Lease Amendment”). The Assignment and the Lease Amendment were negotiated in light of the Company’s guarantee obligations as guarantor under the Lease Agreement. The Company agreed to observe all the covenants and conditions of the Lease Agreement, as amended, including the payment of all rents due. Under the terms of the Lease Agreement and the Assignment, the Company has undertaken to construct, at its own expense, a building on the premises at a minimum cost of $2.5 million. The Lease Amendment permits subletting of the premises, and the Company intends to sublease the newly constructed premises to defray the rental expense undertaken pursuant to its guaranty obligations. In March 2024, the Company began construction of a multi-use facility on 273 Fifth Avenue and committed $7.0 million for the completion of the construction project. The Company incurred $2.2 million in construction costs which was recorded in construction in progress within property and equipment, net in the Company’s condensed consolidated balance sheet as of June 30, 2024. The Company expects to complete construction in June 2025.

On January 17, 2022, the Company received notice that AnHeart had defaulted on its obligations as tenant under the lease for 275 Fifth Avenue. On February 7, 2022, the Company undertook its guaranty obligations by assuming responsibility for payment of monthly rent and other tenant obligations, including past due rent as well as property tax obligations beginning with the January 2022 rent due. On February 25, 2022, the Company instituted a legal action to pursue legal remedies against AnHeart and Minsheng. In March 2022, the Company agreed to stay that litigation against AnHeart in exchange for AnHeart’s payment of certain back rent from January to April 2022 and its continued partial payment of monthly rent. AnHeart subsequently defaulted on these obligations. On October 25, 2023, the Company commenced a new legal action by filing a complaint in New York County Supreme Court to pursue legal remedies against AnHeart and Minsheng (the “2023 Action”). As of the filing of the new summons and complaint, AnHeart and Minsheng are indebted to the Company in the amount of $474,000. AnHeart and the Company have since reached a settlement agreement (the “Settlement Agreement”) for AnHeart to pay the Company $40,000 a month in rent through December 2024 and commence regular monthly rental payments in accordance with the lease for 275 Fifth Avenue. The Settlement Agreement also provides that AnHeart will paytwenty-four monthly installments of $11,250 from January 2025 through December 2026 as payment for all back rent due.

Effective April 30, 2024, the Company through its subsidiary assumed the lease of a building located on the premises of 275 Fifth Avenue, New York, New York. The Company was the guarantor of this lease under a lease guarantee agreement dated July 2018, and in February 2022, upon receiving notice of default, the Company undertook its lease guarantee obligations. The assumption of the lease had no impact on the Company’s obligations as guarantor.

The lease covers certain portions of the ground floor, lower lever, and second floor of the building. The lease term ends on April 30, 2034 and is renewable at the option of the Company for up totwo additional five-year terms. The Company shall pay rent of approximately $45,000 per month with provisions for yearly increases.

Note 14 - Subsequent Events

Other than as disclosed elsewhere, no subsequent events have occurred that would require recognition in the condensed consolidated financial statements or disclosure in the accompanying notes.