# Karat Packaging Inc.: Form 10-Q for the period ended Mar 31, 2022

- Company: [Karat Packaging Inc.](/companies/krt.md) (CIK 1758021)
- Form: 10-Q
- Filed: 2022-05-12
- Accepted by EDGAR: May 12, 2022, 16:23 ET
- Period: 2022-03-31
- Accession: 0001628280-22-014093
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1758021/000162828022014093/krt-20220331.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1758021/000162828022014093/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2022-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2022-01-01 to 2022-03-31 | $105.4m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Cost of revenue | 3 months, 2022-01-01 to 2022-03-31 | $71.1m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2022-01-01 to 2022-03-31 | $34.3m | us-gaap:GrossProfit |
| Operating income | 3 months, 2022-01-01 to 2022-03-31 | $9.5m | us-gaap:OperatingIncomeLoss |
| Income tax | 3 months, 2022-01-01 to 2022-03-31 | $2.7m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2022-01-01 to 2022-03-31 | $6.7m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2022-01-01 to 2022-03-31 | $0.34 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2022-01-01 to 2022-03-31 | $0.34 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2022-01-01 to 2022-03-31 | 19,901,384 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2022-01-01 to 2022-03-31 | −$11.4m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2022-01-01 to 2022-03-31 | $824.0k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2022-03-31 | $6.8m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2022-03-31 | $133.5m | us-gaap:AssetsCurrent |
| Total assets | at 2022-03-31 | $240.4m | us-gaap:Assets |
| Current liabilities | at 2022-03-31 | $39.8m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2022-03-31 | $100.1m | us-gaap:Liabilities |
| Long-term debt | at 2022-03-31 | $200.0k | us-gaap:LongTermDebtNoncurrent |
| Current portion of debt | at 2022-03-31 | $1.2m | us-gaap:LongTermDebtCurrent |
| Shareholders' equity | at 2022-03-31 | $130.2m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 29,856 characters.

### Forward-Looking Statements

*The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and accompanying notes. This discussion and analysis contains “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 (the “Exchange Act”). These statements relate to expectations concerning matters that are not historical facts. For example, statements discussing, among other things, business strategies, growth strategies and initiatives, future revenues and future performance and expected costs and liabilities are forward-looking statements. Such forward-looking statements may be identified by words such as “anticipates,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “remain,” “should,” or “will” or the negative of these terms or other comparable terminology. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expect and, therefore, you should not unduly rely on such statements. The risks and uncertainties that could cause those actual results to differ materially from those expressed or implied by these forward-looking statements include but are not limited to:*

- *fluctuations in the demand for our products in light of changes in laws and regulations applicable to food and beverages and changes in consumer preferences;*
- *supply chain disruptions that could interrupt product manufacturing and increase product costs;*
- *our ability to source raw materials and navigate a shortage of available materials;*
- *our ability to compete successfully in our industry;*
- *the impact of earthquakes, fire, power outages, floods, pandemics and other catastrophic events, as well as the impact of any interruption by problems such as terrorism, cyberattacks, or failure of key information technology systems;*
- *our ability to accurately forecast demand for our products or our results of operations;*
- *the impact of problems relating to delays or disruptions in the shipment of our goods through operational ports;*
- *our ability to expand into additional foodservice and geographic markets;*
- *our ability to successfully design and develop new products;*
- *fluctuations in freight carrier costs related to the shipment of our products could have a material adverse impact on our results of operations;*
- *the effects of COVID-19 or other public health crises;*
- *our ability to attract and retain skilled personnel and senior management; and*
- *other risks and uncertainties described in “Risk Factors.”*

*As used in this Quarterly Report on Form 10-Q, “we”, “us”, “our”, “Karat”, “the Company” or “our Company” refer to Karat Packaging Inc., a Delaware corporation, and, unless the context requires otherwise, our operating subsidiaries. References to “Global Wells” or “our variable interest entity” refer to Global Wells Investment Group LLC, a Texas limited liability company and our consolidated variable interest entity, in which the Company has an equity interest and which is controlled by one of our stockholders. References to “Lollicup” refer to Lollicup USA Inc., a California corporation, our wholly-owned subsidiary.*

### Overview

We are a rapidly-growing specialty distributor and select manufacturer of environmentally-friendly disposable foodservice products and related items. We are a nimble supplier of a wide range of products for the foodservice industry, including food and take out containers, bags, tableware, cups, lids, cutlery, straws, specialty beverage ingredients, equipment, gloves and other products. Our products are available in plastic, paper, biopolymer-based and other compostable forms. Our

Karat Earth® line provides environmentally friendly options to our customers, who are increasingly focused on sustainability. We offer customized solutions to our customers, including new product development, design, printing and logistics services.

While a majority of our revenue is generated from the distribution of our vendors’ products, we have select manufacturing capabilities in the U.S., which allows us to provide customers broad product choices and customized offerings with short lead times. We operate our business strategically and with broad flexibility to provide both our large and small customers with the wide spectrum of products they need to successfully run and grow their businesses. We believe our ability to source products quickly on a cost-effective basis via a diversified global supplier network, complemented by our manufacturing capabilities for select products, has established us as a differentiated provider of high-quality products relative to our competitors and supported a superior margin profile.

We operate an approximately 500,000 square foot distribution center located in Rockwall, Texas, an approximately 300,000 square foot distribution center in Chino, California, and an approximately 76,000 square foot distribution center located in Kapolei, Hawaii. We have selected manufacturing capabilities in all of these facilities. In addition, we operate four other distribution centers located in Sumner, Washington; Summerville, South Carolina; Branchburg, New Jersey and Kapolei, Hawaii. Our distribution centers are strategically located in proximity to major population centers, including the Los Angeles, Dallas, New York, Seattle, Atlanta and Honolulu metro areas.

We manage and evaluate our operations in one reportable segment.

### Business Highlights

- We achieved record quarterly revenues of $105.4 million during three months ended March 31, 2022, which represents an increase of 39.3% compared to the three months ended March 31, 2021.
- We recorded net income of $7.9 million during three months ended March 31, 2022, which represents an increase of 160.4% compared to the three months ended March 31, 2021, despite challenges posed by the commodity input cost inflation, supply chain disruption, and higher labor costs.
- We acquired over 5,000 new customers, which consisted of customers through wholesale distribution and e-commerce direct-to-consumer channels.
- We generated consolidated Adjusted EBITDA, a non-GAAP measure defined below, of $13.0 million for the three months ended March 31, 2022, representing an increase of 90.3% compared to the three months ended March 31, 2021.
- We continue to make strategic investments in our logistics and manufacturing infrastructure to enhance our operation efficiency and position the business for future growth.

### Trends in Our Business

The following trends have contributed to the results of our operations, and we anticipate that they will continue to affect our future results:

- There is a growing trend towards at home dining and mobility-oriented e-commerce, food delivery and take-out dining. We believe this trend will have a positive impact on our results of operations, as more of our customers will require packaging and containers to meet the demands of their increased food delivery and take-out dining consumers.
- Environmental concerns regarding disposable products broadly have resulted in a number of significant changes that are specific to the food-service industry, including regulations applicable to our customers. We believe this trend will have a positive impact on our results of operations, as we expect there will be an increased demand for eco-friendly and compostable single-use disposable products.
- Changes in freight carrier costs related to the shipment of our products, especially relating to overseas shipments. The freight and duty costs totaled $15.2 million during the three months ended March 31, 2022, which represented an increase of $8.7 million from the three months ended March 31, 2021. We believe this trend can have either a positive or a negative impact on our results of operations in the future, depending on whether such freight costs increase or decrease.
- U.S. foreign trade policy continues to evolve, such as the imposition of tariffs on a number of imported food-service disposable products, including those imported from China and other countries. We believe this trend will have either a positive or a negative impact on our results of operations, depending on whether we are able to source our raw materials or manufactured products from countries where tariffs have not been imposed by the current U.S. administration.
- Inflation and the cost of raw materials used to manufacture our products, in particular polyethylene terephthalate, or PET, plastic resin, will continue to fluctuate. Since negotiated sales contracts and the market largely determine the pricing for our products, we are, at times, limited in our ability to raise prices and pass through inflation to our costs. There can also be lags between cost inflation and the implementation of price increases, which could negative impact our gross margin. We believe this trend will have either a positive or a negative impact on our results of operations in the future, depending on whether raw material costs increase or decrease and whether we can successfully implement price increases to pass through inflation.
- Supplier chain disruptions have recently been exacerbated by the lockdowns in China and the conflict between Russia and Ukraine, which could have a long-lasting impact on our operations and financial results. We believe this trend will have either a positive or a negative impact on our results of operations, depending on whether we are able to navigate the challenging environment and adjust our operating models effectively, including the accurate forecast of demand, the successful procurement of raw materials and products and the effective management of our inventory, production and distribution.

### COVID-19 Update

Information regarding COVID-19 update is contained in Note 15 — *COVID-19* in the Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

### Critical Accounting Policies and Estimates

The following discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with US GAAP. The preparation of these financial statements in accordance with US GAAP requires us to make estimates and judgments.

There have been no material changes in our critical accounting policies, or in the estimates and assumptions underlying those policies, from those described under the heading “Critical Accounting Policies and Estimates” in Item 7 of Part II of our 2021 Form 10-K filed on March 31, 2022.

### Results of Operations

### Three Months Ended March 31, 2022 Compared to the Three Months Ended March 31, 2021

*(in thousands)*

|  | Three Months Ended March 31, 2022 | 2021 |
| --- | ---: | ---: |
| Net sales | $105,413 | $75,673 |
| Cost of goods sold | 71,124 | 54,047 |
| Gross profit | 34,289 | 21,626 |
| Operating expenses | 24,798 | 17,855 |
| Operating income | 9,491 | 3,771 |
| Other income | 1,129 | 465 |
| Provision for income taxes | 2,677 | 1,186 |
| Net income | $7,943 | $3,050 |

#### Net Sales

Net sales were $105.4 million for the three months ended March 31, 2022 compared to $75.7 million for the three months ended March 31, 2021, an increase of $29.7 million, or 39.3%. The increase in net sales was primarily driven by an increase of $22.8 million in product sales to our existing customers, as we continue to grow wallet share with existing customers, and an incremental net sales of $6.8 million from more than 5,000 new customers in the three months ended March 31, 2022. Out of the total net sales increase of $29.7 million compared to three months ended March 31, 2021, approximately $16.3 million was attributable to price increases due to the pass through of inflation, $7.4 million was incremental sales from new SKUs, $4.0 million was primarily associated with the sales volume increase and $1.9 million represented an increase in logistic services and shipping revenue.

#### Cost of goods sold

Cost of goods sold increased by $17.1 million, or 31.6% to $71.1 million for the three months ended March 31, 2022 compared to $54.0 million for the three months ended March 31, 2021. The increase in cost of goods sold was primarily due to an increase of $8.1 million in product costs driven by the general increase in costs in line with the increase in product sales partially offset by efficiencies and productivity improvements realized, favorable foreign currency exchange rate impact from the strengthening of the US Dollar against Taiwan New Dollar, and an increase of $8.7 million in freight and duty costs to acquire inventory from overseas, due to elevated ocean freight rates.

#### Gross profit

Gross profit increased $12.7 million, or 58.6%, to $34.3 million for the three months ended March 31, 2022 compared to $21.6 million for the three months ended March 31, 2021. Gross profit margin was 32.5% for the three months ended March 31, 2022 compared to 28.6% for the three months ended March 31, 2021. The margin expansion resulted primarily from the shift to higher margin products, such as our environmentally-friendly products, price increases implemented throughout the second half of 2021 and during the three months ended March 31, 2022 to pass through the increased product costs, favorable foreign currency exchange rate impact from the strengthening of the US Dollar against Taiwan New Dollar, and improved operating efficiencies and fixed cost leverage. Such favorable impacts on the gross margin were partially offset by higher freight and duty costs, which as a percentage of net sales increased from 6.2% in three months ended March 31, 2021 to 14.4% in three months ended March 31, 2022.

#### Operating expenses

Operating expenses for the three months ended March 31, 2022 were $24.8 million compared to $17.9 million for the three months ended March 31, 2021, an increase of $6.9 million, or 38.9%. The increase was primarily due to an increase of $3.4 million in shipping and transportation costs to deliver products to our customers primarily due to increased volume and higher fuel costs, an increase of $1.6 million in payroll-related costs due to workforce expansion, an increase of $0.5 million in production expenses due to higher repair and maintenance expense with increased manufacturing volume, and an increase of $0.6 million in stock-based compensation expense.

#### Operating income

Operating income for the three months ended March 31, 2022 was $9.5 million compared to $3.8 million the three months ended March 31, 2021, an increase of $5.8 million, or 154.3%. The increase was primarily due to an increase in gross profit of $12.7 million partially offset by the increase in operating expenses of $6.9 million.

#### Other income

Other income for the three months ended March 31, 2022 was $1.1 million, compared to $0.5 million for the three months ended March 31, 2021, an increase of $0.6 million, or 121.3%. The higher other income was driven by a decrease in interest expense of $0.6 million, as the average debt outstanding decreased from $96.9 million during the three months ended March 31, 2021 to $42.4 million during the three months ended March 31, 2022. The Company recognized an interest income of $1.3 million in both the three months ended March 31, 2022 and the three months ended March 31, 2021 from the change in the fair value of its interest rate swap(s).

#### Provision for income taxes

Provision for income taxes was $2.7 million and $1.2 million for the three months ended March 31, 2022 and 2021, respectively. The Company’s effective tax rate for the three months ended March 31, 2022 and 2021 was 25.2% and 28.0%, respectively. The higher effective tax rate during the three months ended March 31, 2021 resulted primarily from the inclusion of certain non-deductible costs related to our initial public offering completed in April 2021.

#### Net income

Net income for the three months ended March 31, 2022 was $7.9 million compared to $3.1 million for the three months ended March 31, 2021, an increase of $4.9 million, or 160.4%. The increase was primarily driven by an increase in operating income of $5.8 million and an increase in other income of $0.6 million, partially offset by an increase in the provision for income taxes of approximately $1.5 million, as discussed above.

### Non-GAAP Financial Measure

We use certain non-GAAP financial measures to assess our financial and operating performance that are not defined by, or calculated in accordance with US GAAP. A non-GAAP financial measure is defined as a numerical measure of a company’s financial performance that (i) excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the comparable measure calculated and presented in accordance with US GAAP in the Consolidated Statements of Income; or (ii) includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the comparable measure so calculated and presented.

Our primary non-GAAP financial measures are listed below and reflect how we evaluate our operating results.

#### Adjusted EBITDA and Adjusted EBITDA Margin

Adjusted EBITDA is a financial measure equal to net income excluding (i) interest (income) expense, net, (ii) provision for income taxes, (iii) depreciation and amortization, (iv) IPO related expenses, and (v) stock-based compensation expense. Adjusted EBITDA margin is calculated by dividing Adjusted EBITDA by revenue.

We present Adjusted EBITDA and adjusted EBITDA margin as supplemental measures of our financial performance. Adjusted EBITDA and adjusted EBITDA margin assist management in assessing our core operating performance. We also believe these measures provide investors with useful perspective on underlying business results and trends and facilitate a comparison of our performance from period to period.

Adjusted EBITDA and adjusted EBITDA margin should not be considered in isolation or as alternatives to net income or cash flows from operating activities and net income margin or other measures determined in accordance with GAAP. Also, Adjusted EBITDA and adjusted EBITDA margin are not necessarily comparable to similarly titled measures presented by other companies.

Set forth below is a reconciliation of net income to Adjusted EBITDA and net income margin to adjusted EBITDA margin.

*(in thousands, except percentages)*

|  | Three Months Ended March 31, 2022 Amount | % of Revenue | 2021 Amount | % of Revenue |
| --- | ---: | ---: | ---: | ---: |
| Net income: | $7,943 | 7.5% | $3,050 | 4.0% |
| Add (deduct): |  |  |  |  |
| Interest income, net | (840) | (0.8) | (278) | (0.4) |
| Provision for income taxes | 2,677 | 2.5 | 1,186 | 1.6 |
| Depreciation and amortization | 2,584 | 2.5 | 2,464 | 3.3 |
| Stock-based compensation expense | 611 | 0.6 | — | — |
| IPO related expenses | — | — | 396 | 0.5 |
| Adjusted EBITDA | $12,975 | 12.3% | $6,818 | 9.0% |

30

### Liquidity and Capital Resources

### Sources and Uses of Funds

Our primary sources of liquidity are cash provided by operations, borrowings under our line of credit with the Hanmi Bank (the “Line of Credit”) and promissory notes, and during the year ended December 31, 2021, net proceeds of our IPO offering totaling $67.6 million. On an annual basis, we have typically generated positive cash flows from operations. Our ability to generate positive cash flow from operations in the future will be, at least in part, dependent on global economic conditions and ability to navigate challenging macro environment at times.

Our Line of Credit is available for working capital and general corporate purposes, and consists of a $40.0 million revolving loan facility, which also includes a standby letter of credit sublimit. The Line of Credit was secured by our assets and guaranteed by our stockholders. We are not required to pay a commitment (unused) fee on the undrawn portion of the Line of Credit and interest is payable monthly.

Additionally, as described in Note 8 — *Long-term Debt* to the condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, as of March 31, 2022, we have a $21,580,000 term loan that matures in May 2029 (the “2029 Term Loan”) and a $23,000,000 term loan that matures September 30, 2026 (the “2026 Term Loan”). The 2029 Term Loan provides for an annual interest at prime rate less 0.25% and principal payments ranging from $24,000 to $40,000 along with interest are due monthly throughout the term of the loan, with the remaining principal balance due at maturity. The loan is collateralized by substantially all of our and Global Well’s assets and is guaranteed by us and certain of our stockholders. The 2026 Term Loan had an initial balance of $16,115,000 and an option to request for additional advances up to a maximum of $6,885,000 through September 2022, which we exercised in February 2022. Interest accrues at a fixed rate of 3.5%. Principal and interest payments of $116,000 are due monthly throughout the term of the loan, with the remaining principal balance due at maturity. The loan is collateralized by substantially all of Global Wells’ assets and is guaranteed by Global Wells and one of our stockholders. In accordance with the loan agreement, Global Wells is required to comply with certain financial covenants, including a minimum debt service coverage ratio.

As of March 31, 2022, we were in compliance with the financial covenants under all of our loan agreements, and do not expect material uncertainties in our continued ability to be in compliance with all financial covenants through the remaining term of all of our loan agreements. As of March 31, 2022, we had $10.2 million in outstanding balance on our Line of Credit bearing an interest per annual of 3.25%, $20.7 million in outstanding balance under the 2029 Term Loan, and $22.6 million in outstanding balance under the 2026 Term Loan.

As described in Note 16 — *Subsequent Events* in the Notes to the condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, our joint venture agreement to build the factory in Taiwan requires significant investments, which we expect to make within the next 12 months. We currently believe our current cash, ongoing cash flows from our operations and funding available under our Line of Credit will provide sufficient funds for this investment.

Our ongoing operations and growth strategy may require us to continue to make investments in our logistics and manufacturing infrastructure and our e-commerce platform. In addition, we may consider making strategic acquisitions and investments, which could require significant liquidity. The COVID-19 pandemic and the recent lockdowns in China and the conflict between Russia and Ukraine created significant uncertainty in the global economy and capital markets and long-lasting chaos in the global supply chain, which could have lingering adverse effects beyond 2022. We currently believe that our cash on hand, ongoing cash flows from our operations and funding available under our borrowings will be adequate to meet our working capital needs, service our debt, make lease payments, and fund for capital expenditures to further enhance our manufacturing and logistics infrastructure and our e-commerce platform for at least the next 12 months.

Beyond the next 12 months, if we require additional capital resources to grow our business, either organically or through acquisition, we may seek to sell additional equity securities, increase use of our Line of Credit, and raise additional debt. The sale of additional equity securities or certain forms of debt financing could result in additional dilution to our stockholders. We may not be able to obtain financing arrangements in amounts or on terms acceptable to us in the future. In the event we are unable to obtain additional financing when needed, we may be compelled to delay or curtail our plans to develop our business, which could have a material adverse effect on our operations, market position and competitiveness. Notwithstanding the potential liquidity challenges described above, we expect to meet our long-term liquidity needs with cash flows from operations and financing arrangements.

### Liquidity Position

The following table summarizes total current assets, liabilities and working capital at March 31, 2022 compared to December 31, 2021:

*(in thousands)*

|  | March 31, 2022 | December 31, 2021 | Increase |
| --- | ---: | ---: | ---: |
| Current assets | $133,530 | $102,872 | $30,658 |
| Current liabilities | 39,825 | 30,764 | 9,061 |
| Working capital | $93,705 | $72,108 | $21,597 |

As of March 31, 2022, we had a working capital of $93.7 million, as compared to working capital of $72.1 million at December 31, 2021, representing an increase of $21.6 million, or 30.0%. The improvement in working capital from December 31, 2021 was driven by a increase of $30.7 million in current assets, including (1) an increase of $10.6 million in accounts receivable primarily resulting from the sales growth during the quarter, (2) an increase in inventory of $18.9 million as we stock up in anticipation of higher sales volume in the upcoming summer months. These improvements were partially offset by an increase of $9.1 million in current liabilities, mainly from an increase of $5.6 million in accounts payable primarily resulting from increased inventory purchase, an increase of $1.9 million in income taxes payable, and an increase of $1.5 million in other payable from bank overdraft and credit card payable.

For additional information on financing entered into subsequent to March 31, 2022, see Note 16 — *Subsequent Events* in the Notes to the Condensed Consolidated Financial Statements included in this Quarter Report on Form 10-Q.

### Cash Flows

The following table summarizes cash flow for the three months ended March 31, 2022 and 2021:

*(in thousands)*

|  | Three Months Ended March 31, 2022 | 2021 |
| --- | ---: | ---: |
| Net cash (used in) provided by operating activities | $(11,427) | $4,504 |
| Net cash used in investing activities | (4,795) | (2,094) |
| Net cash provided by (used in) financing activities | 16,559 | (1,897) |
| Net change in cash and cash equivalents | $337 | $513 |

*Cash flows (used in) provided by operating activities.* For the three months ended March 31, 2022, net cash used in operating activities was $11.4 million, primarily the result of net income of $7.9 million, adjusted for certain non-cash items totaling $2.9 million, consisting mainly of depreciation and amortization, changes in fair value of interest rate swaps, reserve for inventory obsolescence, provision for bad debt and stock-based compensation. In addition, cash decreased $22.2 million, primarily as a result of changes in working capital, which includes an increase of $19.3 million in inventory build up to accommodate higher demand, an increase of $11.1 million in accounts receivable stemming from higher sales, and an increase in prepaid expense of $0.9 million, partially offset by an increase in account payable and accrual expense totaling $6.1 million, other payable of $1.5 million and an increase in income taxes payable of $1.9 million. For the three months ended March 31, 2021, net cash provided by operating activities was $4.5 million, primarily as a result of net income of $3.1 million, adjusted for certain non-cash items of an aggregate $1.1 million consisting of depreciation and amortization, and changes in fair value of interest rate swaps partially offset by a decrease in cash of $0.3 million due to changes in working capital.

*Cash flows used in investing activities.* Net cash used in investing activities for three months ended March 31, 2022 was $4.8 million, which included the purchase of manufacturing equipment for our California and Texas facility totaling $0.8 million and deposits paid for additional manufacturing equipment of $4.0 million. Net cash used in investing activities for three months ended March 31, 2021 was $2.1 million, which consisted of the purchase of manufacturing equipment for our Texas facility totaling $0.3 million, deposits paid for additional manufacturing equipment of $0.9 million, and cash paid of $0.9 million for our acquisition of Pacific Cup, Inc.

*Cash flows provided by (used in) financing activities.* Net cash provided in financing activities for the three months ended March 31, 2022 was $16.6 million, which included primarily borrowing of $10.2 million under the Line of Credit, and additional borrowing under the 2026 Term Loan of $6.9 million partially offset by payments on debts of $0.3 million, and noncontrolling interest tax withholding payment of $0.3 million. Net cash used in financing activities for the three months ended March 31, 2021 was $1.9 million, which consisted payments under the term loans.

### Related Party Transactions

For a description of significant related party transactions, see Note 13 — *Related Party Transactions* in the Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

### Recent Accounting Pronouncements

Information regarding recent accounting pronouncements is contained in Note 2 — *Summary of Significant Accounting Policies* in the Notes to the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

## Controls and procedures

As filed, 7,119 characters.

### Evaluation of Disclosure Controls and Procedures

In connection with the preparation of this Quarterly Report, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2022. Based on this evaluation, management concluded that certain material weaknesses in our internal control over financial reporting identified in our Annual Report on Form 10-K for the year ended December 31, 2021 were under ongoing remediation and therefore continued to exist, and as such, our disclosure controls and procedures were not effective as of March 31, 2022 for the following reasons:

#### Control Environment, Risk Assessment

Management did not maintain appropriately designed entity-level controls impacting the control environment and risk assessment procedures to prevent or detect material misstatements to the consolidated financial statements. These deficiencies were attributed to: (i) lack of structure and responsibility, insufficient number of qualified resources and inadequate oversight and accountability over the performance of controls, including retention of control evidence, and (ii) ineffective identification and assessment of risks impacting internal control over financial reporting.

#### Control Activities and Information and Communication

These material weaknesses contributed to the following additional material weaknesses within certain business processes and the information technology environment:

- Management did not design and implement controls over the completeness and accuracy of underlying data used in the operation of certain controls within its financial reporting process.
- Management did not design and implement review controls at a sufficient precision level to detect a material misstatement in financial statement areas including income taxes, valuation of accounts receivable, and valuation of inventory.

As set forth below, management has taken and will continue to take steps to remediate the control deficiencies identified above. Notwithstanding such control deficiencies, management concludes that the financial statements included in this report fairly represent, in all material aspects, our financial condition, results of operations and cash flows for the periods presented.

### Management’s Remediation Plan

As reported in the Annual Report on Form 10-K for the year ended December 31, 2021, we are engaged in remedial actions in response to the deficiencies discussed above, and we plan to continue efforts underway to improve internal control over financial reporting.

The following remedial actions were implemented during the first quarter of 2022 to remediate the material weakness related to the failure of management to design and maintain effective general controls over information systems that support the financial reporting process:

- We performed a thorough review of users’ access rights to our significant information technology systems and implemented restrictions to user access to allow for appropriate segregation of duties.
- We implemented a policy to restrict and monitor NetSuite user and access to financial applications and data to appropriate Company personnel.

In addition to the remediation of the material weakness described above, the following additional remedial actions were implemented during the first quarter of 2022:

- We hired our new Chief Financial Officer in February 2022, who brings a strong background in accounting, financial reporting and business operations in the public company marketplace.
- We adopted a process to identify and assess our disclosure controls and procedures, including the preparation of presentation and disclosure requirement checklists to be reviewed by management.

Commencing in the second fiscal quarter of 2022, we are also in the process of implementing the following enhancements to our control environment:

- We added accounting and information technology employees with appropriate experience, certification, education and training to the organization to strengthen our internal accounting team, to provide oversight, structure and reporting lines, and to provide additional review over our disclosures.
- We are seeking to hire a qualified Corporate Controller, whose primary responsibilities will include improving the design, implementation, execution, and supervision of our controls. We expect to continue evaluating our needs for additional personnel.
- We started the process to provide extensive training to existing and new employees in order to enhance the level of communication and understanding of controls with personnel that provide key information and perform key roles.
- Under the supervision of our Audit Committee, Chief Executive Officer and Chief Financial Officer, we are initiating a project to implement a Sarbanes-Oxley compliance program under the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in its 2013 Internal Control – Integrated Framework. We are in the process of conducting an enterprise risk assessment and establishing reporting objectives.
- We are in the process of identifying third-party service providers to assist with the design and preparation of the implementation plan and perform testing of the effectiveness of internal controls.

We are committed to continuing to improve our internal control processes and will continue to review, optimize and enhance our financial reporting controls and procedures. We believe the measures described above have strengthened our internal control over financial reporting, however, the remaining material weaknesses will not be considered remediated until a sustained period of time has passed to allow for continued operation of the new controls and for management to test the operational effectiveness of the new controls. Testing is expected to continue during the year ending December 31, 2022 and will continue to provide an update on the status of our remediation activities on a quarterly basis.

### Changes in Internal Control Over Financial Reporting

Other than the changes noted above to remediate the previously reported material weaknesses, there were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

### Limitations on Effectiveness of Controls and Procedures

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

## Risk factors

As filed, 236 characters.

There have been no material changes to the Risk Factors previously disclosed in our Registration Statement on Form 10-K, (Registration No. 333-253270), as filed with the SEC on March 31, 2022, which are incorporated herein by reference.

Filed May 12, 2022.
Source: SEC EDGAR, the filing index for accession 0001628280-22-014093. Last ingested by Listed: Nov 10, 2026, 06:36 ET. No prices; not investment advice.