# Karat Packaging Inc.: Form 10-Q for the period ended Sep 30, 2022

- Company: [Karat Packaging Inc.](/companies/krt.md) (CIK 1758021)
- Form: 10-Q
- Filed: 2022-11-14
- Accepted by EDGAR: Nov 14, 2022, 16:40 ET
- Period: 2022-09-30
- Accession: 0001628280-22-029881
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1758021/000162828022029881/krt-20220930.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1758021/000162828022029881/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2022-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2022-07-01 to 2022-09-30 | $110.0m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Revenue | 9 months, 2022-01-01 to 2022-09-30 | $330.3m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Cost of revenue | 3 months, 2022-07-01 to 2022-09-30 | $75.8m | us-gaap:CostOfGoodsAndServicesSold |
| Cost of revenue | 9 months, 2022-01-01 to 2022-09-30 | $227.9m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2022-07-01 to 2022-09-30 | $34.2m | us-gaap:GrossProfit |
| Gross profit | 9 months, 2022-01-01 to 2022-09-30 | $102.4m | us-gaap:GrossProfit |
| Operating income | 3 months, 2022-07-01 to 2022-09-30 | $7.9m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2022-01-01 to 2022-09-30 | $25.2m | us-gaap:OperatingIncomeLoss |
| Income tax | 3 months, 2022-07-01 to 2022-09-30 | $1.9m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2022-01-01 to 2022-09-30 | $6.3m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2022-07-01 to 2022-09-30 | $6.1m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2022-01-01 to 2022-09-30 | $19.1m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2022-07-01 to 2022-09-30 | $0.31 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2022-01-01 to 2022-09-30 | $0.96 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2022-07-01 to 2022-09-30 | $0.31 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2022-01-01 to 2022-09-30 | $0.96 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2022-07-01 to 2022-09-30 | 19,938,042 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2022-01-01 to 2022-09-30 | 19,922,047 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2022-01-01 to 2022-09-30 | $12.5m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2022-01-01 to 2022-09-30 | $2.0m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2022-09-30 | $7.5m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2022-09-30 | $124.8m | us-gaap:AssetsCurrent |
| Total assets | at 2022-09-30 | $239.5m | us-gaap:Assets |
| Current liabilities | at 2022-09-30 | $34.8m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2022-09-30 | $85.4m | us-gaap:Liabilities |
| Long-term debt | at 2022-09-30 | $229.0k | us-gaap:LongTermDebtNoncurrent |
| Current portion of debt | at 2022-09-30 | $948.0k | us-gaap:LongTermDebtCurrent |
| Shareholders' equity | at 2022-09-30 | $143.8m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 39,017 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 discussed in Part 1, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2021.*

*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 five other distribution centers located in Sumner, Washington; Summerville, South Carolina; Branchburg, New Jersey; Kapolei, Hawaii; and City of Industry, California. 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 recorded revenues of $110.0 million during the three months ended September 30, 2022, which represents an increase of 7.1% compared to the three months ended September 30, 2021, a particularly strong quarter due to post COVID-19 re-openings.
- We achieved gross margin of 31.1% during the three months ended September 30, 2022, a 210 basis points increase from the three months ended September 30, 2021.
- We recorded net income of $6.2 million during the three months ended September 30, 2022, which represents an increase of 51.1% compared to the three months ended September 30, 2021.
- We acquired over 4,000 new customers during the three months ended September 30, 2022, which consisted of customers through wholesale distribution and e-commerce direct-to-consumer channels.
- We generated record quarterly cash from operating activities of $20.2 million, and repaid $11.6 million on our line of credit during the three months ended September 30, 2022.
- We had financial liquidity of $54.5 million as of September 30, 2022, and declared a special cash dividend of $0.35 per share on our common stock on November 8, 2022.
- We generated consolidated Adjusted EBITDA, a non-GAAP measure defined below, of $11.7 million during the three months ended September 30, 2022, representing an increase of 30.1% compared to the three months ended September 30, 2021.

### 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 long-lasting 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 $16.3 million, or 14.8% of net sales, during the three months ended September 30, 2022, compared to $14.4 million, or 14.1% of net sales during the three months ended September 30, 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 and whether the previously imposed tariffs are removed.
- Inflation and the cost of raw materials used to manufacture our products, including polyethylene terephthalate, or PET, plastic resin, aluminum and paper boards may 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 any impacts of inflation to our costs. There can also be lags between cost inflation and the implementation of price increases, which could negatively impact our gross margin. We believe price fluctuations 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 offset the impacts of inflation.
- Supplier chain disruptions 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.
- Fluctuations in foreign currency exchange rates could impact either positively or negatively various aspects of our business activities, including but not limited to our purchasing power and capacity to source inventory.

### COVID-19 Update

Information regarding COVID-19 update is contained in Note 16 — *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

*(in thousands)*

*(in thousands)*

|  | Three Months Ended September 30, 2022 | 2021 | Nine Months Ended September 30, 2022 | 2021 |
| --- | ---: | ---: | ---: | ---: |
| Net sales | $109,996 | $102,711 | $330,290 | $272,910 |
| Cost of goods sold | 75,828 | 72,918 | 227,869 | 193,393 |
| Gross profit | 34,168 | 29,793 | 102,421 | 79,517 |
| Operating expenses | 26,258 | 24,428 | 77,218 | 63,511 |
| Operating income | 7,910 | 5,365 | 25,203 | 16,006 |
| Other income (expense) | 143 | (24) | 2,416 | 4,456 |
| Provision for income taxes | 1,900 | 1,268 | 6,323 | 4,001 |
| Net income | $6,153 | $4,073 | $21,296 | $16,461 |

### Three Months Ended September 30, 2022 Compared to the Three Months Ended September 30, 2021

#### Net sales

Net sales were $110.0 million for the three months ended September 30, 2022 compared to $102.7 million for the three months ended September 30, 2021, an increase of $7.3 million, or 7.1%. The increase in net sales was driven by an increase of $2.8 million in product sales to our existing customers, and incremental net sales of $4.5 million from more than 4,000 new customers in the three months ended September 30, 2022. Of the total net sales increase of $7.3 million compared to the three months ended September 30, 2021, $12.2 million was primarily attributable to favorable pricing partially offset by a decrease of $4.6 million primarily due to volume and change in product mix as compared to strong prior year volumes due to post-COVID re-openings.

#### Cost of goods sold

Cost of goods sold was $75.8 million for the three months ended September 30, 2022 compared to $72.9 million for the three months ended September 30, 2021, an increase of $2.9 million, or 4.0%. The increase in cost of goods sold was primarily due to an increase of $1.9 million in freight and duty costs to acquire inventory from overseas and an increase of $1.0 million in product costs driven by the general increase in raw materials and labor costs. The increase was partially offset by efficiencies and productivity improvements realized and the favorable foreign currency exchange rate impact from the strengthening of the US Dollar against Taiwan New Dollar.

#### Gross profit

Gross profit was $34.2 million for the three months ended September 30, 2022 compared to $29.8 million for the three months ended September 30, 2021, an increase of $4.4 million, or 14.7%. Gross margin was 31.1% for the three months ended September 30, 2022 compared to 29.0% for the three months ended September 30, 2021. Despite the higher freight and duty costs, which as a percentage of net sales increased from 14.1% in three months ended September 30, 2021 to 14.8% in three months ended September 30, 2022, the gross margin increased primarily due to margin expanding factors including a shift to higher margin products such as environmentally-friendly items, price increases implemented previously to partially offset increased product, ocean freight and labor costs, favorable foreign currency exchange rate from the strengthening of the US Dollar against Taiwan New Dollar and improved operating efficiencies and leverage.

#### Operating expenses

Operating expenses for the three months ended September 30, 2022 were $26.3 million compared to $24.4 million for the three months ended September 30, 2021, an increase of $1.9 million, or 7.8%. The increase was primarily due to an increase of $1.3 million in payroll-related costs due to workforce expansion and higher labor costs, an increase of $0.8 million in rental expense as we expanded our distribution network, and an increase of $0.6 million in production expenses due to higher repair and maintenance costs incurred, partially offset by a decrease of $0.5 million in professional service expense.

#### Operating income

Operating income for the three months ended September 30, 2022 was $7.9 million compared to $5.4 million for the three months ended September 30, 2021, an increase of $2.5 million, or 47.4%. The increase was primarily due to an increase in gross profit of $4.4 million partially offset by the increase in operating expenses of $1.9 million, as discussed above.

#### Other income

Other income for the three months ended September 30, 2022 was $0.1 million, compared to other expense of $0.0 million for the three months ended September 30, 2021. The $0.1 million other income for the three months ended September 30, 2022 consisted primarily of a gain on foreign currency transactions of $0.4 million, rental income of $0.2 million, partially offset by a net interest expense of $0.5 million. The $0.0 million other expense for the three months ended September 30, 2021 primarily consisted of rental income of $0.2 million, partially offset by a net interest expense of $0.3 million.

#### Provision for income taxes

Provision for income taxes was $1.9 million and $1.3 million for the three months ended September 30, 2022 and 2021, respectively. The Company’s effective tax rate for the three months ended September 30, 2022 and 2021 was 23.6% and 23.7%, respectively. The effective tax rate was consistent between the two periods.

#### Net income

Net income for the three months ended September 30, 2022 was $6.2 million, compared to $4.1 million for the three months ended September 30, 2021, an increase of $2.1 million, or 51.1%. The increase was primarily driven by an increase in operating income of $2.5 million and an increase in other income of $0.2 million, partially offset by an increase in the provision for income taxes of $0.6 million, as discussed above.

### Nine Months Ended September 30, 2022 Compared to the Nine Months Ended September 30, 2021

#### Net sales

Net sales were $330.3 million for the nine months ended September 30, 2022 compared to $272.9 million for the nine months ended September 30, 2021, an increase of $57.4 million, or 21.0%. The increase in net sales was primarily driven by an increase of $48.1 million in product sales to our existing customers, and incremental net sales of $9.3 million from more than 13,000 new customers acquired in the nine months ended September 30, 2022. Of the total net sales increase of $57.4 million compared to nine months ended September 30, 2022, $41.5 million was primarily attributable to favorable pricing, $13.6 million was primarily related to the increase in volume and change in product mix as compared to strong prior year volumes due to post-COVID re-openings, and $2.2 million as a result of an increase in logistic services and shipping revenue.

#### Cost of goods sold

Cost of goods sold was $227.9 million for the nine months ended September 30, 2022 compared to $193.4 million for the nine months ended September 30, 2021, an increase of $34.5 million, or 17.8%. The increase in cost of goods sold was primarily due to an increase of $21.5 million in freight and duty costs to acquire inventory from overseas as a result of elevated ocean freight rates and an increase of $12.7 million in product costs driven by the general increase in raw materials and labor costs partially offset by efficiencies and productivity improvements realized and the favorable foreign currency exchange rate impact from the strengthening of the US Dollar against Taiwan New Dollar.

#### Gross profit

Gross profit was $102.4 million for the nine months ended September 30, 2022 compared to $79.5 million for the nine months ended September 30, 2021, an increase of $22.9 million, or 28.8%. Gross profit margin was 31.0% for the nine months ended September 30, 2022 compared to 29.1% for the nine months ended September 30, 2021. The margin expansion resulted primarily from the shift to higher margin products, such as our environmentally-friendly products, price increases implemented previously to partially offset increased product, ocean freight and labor 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 11.2% in the nine months ended September 30, 2021 to 15.8% in the nine months ended September 30, 2022.

#### Operating expenses

Operating expenses for the nine months ended September 30, 2022 were $77.2 million compared to $63.5 million for the nine months ended September 30, 2021, an increase of $13.7 million, or 21.6%. The increase was primarily due to an increase of $5.5 million in shipping and transportation costs to transfer inventory among our warehouses and to deliver products to our customers, an increase of $4.4 million in payroll-related costs due to workforce expansion and costs incurred for temporary labor to cover COVID-19 related illness, an increase of $1.6 million in rental expense as we expanded our distribution network, an increase of $1.2 million in production expenses due to higher repair and maintenance costs incurred, an increase of $0.5 million in bad debt expense, and an increase of $0.7 million in stock-based compensation expense, partially offset by a decrease of $0.9 million in professional service expense.

#### Operating income

Operating income for the nine months ended September 30, 2022 was $25.2 million compared to $16.0 million for the nine months ended September 30, 2021, an increase of $9.2 million, or 57.5%. The increase was primarily due to an increase in gross profit of $22.9 million partially offset by the increase in operating expenses of $13.7 million, as discussed above.

#### Other income

Other income for the nine months ended September 30, 2022 was $2.4 million, compared to $4.5 million for the nine months ended September 30, 2021, a decrease of $2.1 million, or 47.1%. The $2.4 million other income for the nine months ended September 30, 2022 consisted primarily of a gain on foreign currency transactions of $1.4 million, rental income of $0.7 million, and a net interest income of $0.6 million, which was made up of a gain associated with the interest swap of $2.2 million partially offset by interest expense on the Line of Credit and term loans totaling $1.6 million. The $4.5 million other income for the nine months ended September 30, 2021 consisted primarily of gain on forgiveness of debt of $5.0 million and rental income of $0.7 million, partially offset by a net interest expense of $1.2 million, which represented interest expense on the Line of Credit and term loans totaling $2.3 million partially offset by the change in the interest swap fair value of $1.1 million.

#### Provision for income taxes

Provision for income taxes was $6.3 million and $4.0 million for the nine months ended September 30, 2022 and 2021, respectively. The Company’s effective tax rate for the nine months ended September 30, 2022 and 2021 was 22.9% and 19.6%, respectively. The effective tax rate was lower for the nine months ended September 30, 2021, primarily due to the gain on forgiveness of debt of $5.0 million, which was a discrete item not presented in the nine months ended September 30, 2022.

#### Net income

Net income for the nine months ended September 30, 2022 was $21.3 million compared to $16.5 million for the nine months ended September 30, 2021, an increase of $4.8 million, or 29.4%. The increase was primarily driven by an increase in operating income of $9.2 million partially offset by a decrease in other income of $2.1 million and an increase in the provision for income taxes of approximately $2.3 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, which beginning in the fourth quarter of fiscal 2021, is calculated as net income excluding (i) interest (income) expense, net, (ii) provision for income taxes, (iii) depreciation and amortization, (iv) IPO related expenses, (v) stock-based compensation expense and (vi) gain on forgiveness of debt. Adjusted EBITDA margin is calculated by dividing Adjusted EBITDA by revenue. The prior period Adjusted EBITDA has been revised to conform to this definition.

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 September 30, 2022 Amount | % of Revenue | 2021 Amount | % of Revenue |
| --- | ---: | ---: | ---: | ---: |
| Net income: | $6,153 | 5.6% | $4,073 | 4.0% |
| Add: |  |  |  |  |
| Interest expense, net | 493 | 0.4 | 308 | 0.3 |
| Provision for income taxes | 1,900 | 1.7 | 1,268 | 1.2 |
| Depreciation and amortization | 2,604 | 2.5 | 2,534 | 2.5 |
| Stock-based compensation expense | 598 | 0.5 | 848 | 0.8 |
| **Adjusted EBITDA** | **$11,748** | **10.7%** | **$9,031** | **8.8%** |

31

*(in thousands, except percentages)*

|  | Nine Months Ended September 30, 2022 Amount | % of Revenue | 2021 Amount | % of Revenue |
| --- | ---: | ---: | ---: | ---: |
| Net income: | $21,296 | 6.4% | $16,461 | 6.0% |
| Add (deduct): |  |  |  |  |
| Interest (income) expense, net | (584) | (0.2) | 1,158 | 0.4 |
| Provision for income taxes | 6,323 | 1.9 | 4,001 | 1.5 |
| Depreciation and amortization | 7,752 | 2.4 | 7,477 | 2.7 |
| Stock-based compensation expense | 1,774 | 0.6 | 1,088 | 0.4 |
| IPO related expenses | — | — | 997 | 0.4 |
| Gain on forgiveness of debt | — | — | (5,000) | (1.8) |
| **Adjusted EBITDA** | **$36,561** | **11.1%** | **$26,182** | **9.6%** |

32

### 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 our ability to navigate challenging macro environment at times.

As described in Note 7 — Line of Credit to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, the Line of Credit is available for working capital and general corporate purposes, and is secured by our assets. It consists of a $40.0 million revolving loan facility, which also includes a standby letter of credit sublimit, that was amended and increased to $2,000,000 on August 18, 2022. We are not required to pay a commitment (unused) fee on the undrawn portion of the Line of Credit and interest is payable monthly. As of September 30, 2022, the amount issued under the standby letter of credit was $1.1 million, and the maximum remaining amount that could be borrowed under the Line of Credit was $38.9 million.

As described in Note 9 — *Long-Term Debt* to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, on June 17, 2022, we entered into a $28.7 million term loan agreement which matures July 1, 2027 (the “2027 Term Loan”). The 2027 Term Loan has an initial balance of $20.7 million and an option to request for additional advances up to a maximum of $8.0 million through June 30, 2023, which we have not exercised as of September 30, 2022. Interest accrues at a fixed rate of 4.375% per annum, and principal and interest payments of $0.1 million are due monthly throughout the term of the loan, with the remaining principal balance due at maturity. The 2027 Term Loan is collateralized by substantially all of Global Wells’ assets and is guaranteed by one of the Company’s stockholders. In accordance with the loan agreement, Global Wells is required to comply with certain financial covenants, including a minimum debt coverage ratio. Proceeds from the 2027 Term Loan were used to pay down an existing term loan with the same lender, which was set to mature in May 2029 with interest accruing at prime rate less 0.25%, and had an outstanding balance of $20.6 million as of the repayment date.

Additionally, as of September 30, 2022, we have a $23.0 million term loan that matures in September 30, 2026 (the “2026 Term Loan”). The 2026 Term Loan had an initial balance of $16.1 million and an option to request for additional advances up to a maximum of $6.9 million through September 2022, which we exercised in February 2022. Interest accrues at a fixed rate of 3.50% per annum. Principal and interest payments of $0.1 million 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 September 30, 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 September 30, 2022, we had $0.0 million in outstanding balance on the Line of Credit bearing an interest per annum of prime rate less 0.25% (6% as of September 30, 2022), $20.6 million in outstanding balance under the 2027 Term Loan, and $22.3 million in outstanding balance under the 2026 Term Loan.

As described in Note 4 — *Joint Venture* 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. As of September 30, 2022, we made payments totaling $4.0 million towards this investment. As described in Note 17 — *Subsequent Events* in the Notes to the Condensed Consolidated Financial Statements included in this Quarter Report on Form 10-Q, we made the final remaining investment payment of $1.88 million pursuant to the JV Agreement on November 9, 2022. Additionally, our Board of Directors declared a special cash dividend of $0.35 per common share, which will be paid on or around November 30, 2022 to shareholders of record at the close of business on November 21, 2022.

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 rapidly changing macroeconomic and geopolitical dynamics created significant uncertainty in the global economy and capital markets and long-lasting disruptions in the global supply chain, which could have long-lasting 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. We continue to explore other options to further expand our liquidity to support the business growth and enhance shareholder value.

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 the 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 September 30, 2022 compared to December 31, 2021:

*(in thousands)*

|  | September 30, 2022 | December 31, 2021 | Increase |
| --- | ---: | ---: | ---: |
| Current assets | $124,807 | $102,872 | $21,935 |
| Current liabilities | 34,828 | 30,764 | 4,064 |
| Working capital | $89,979 | $72,108 | $17,871 |

As of September 30, 2022, we had a working capital of $90.0 million, as compared to working capital of $72.1 million at December 31, 2021, representing an increase of $17.9 million, or 24.8%. The improvement in working capital from December 31, 2021 was driven by an increase of $21.9 million in current assets, including an increase of $4.0 million in accounts receivable primarily resulting from the sales growth during the third quarter, an increase in inventory of $14.8 million to accommodate higher sale demand, and an increase in prepaid expense of $2.1 million. These improvements were partially offset by an increase of $4.1 million in current liabilities, mainly from an increase of $3.3 million in accounts payable and relate party payable primarily resulting from increased inventory purchase, and an increase of $0.7 million in accrual expense.

### Cash Flows

The following table summarizes cash flow for the nine months ended September 30, 2022 and 2021:

*(in thousands)*

|  | Nine Months Ended September 30, 2022 | 2021 |
| --- | ---: | ---: |
| Net cash provided by (used in) operating activities | $12,499 | $(1,246) |
| Net cash used in investing activities | (16,577) | (8,639) |
| Net cash provided by financing activities | 5,126 | 11,116 |
| Net change in cash and cash equivalents | $1,048 | $1,231 |

*Cash flows provided by (used in) operating activities.* For the nine months ended September 30, 2022, net cash provided by operating activities was $12.5 million, primarily the result of net income of $21.3 million, adjusted for certain non-cash items totaling $8.9 million, consisting mainly of depreciation and amortization, adjustments to accounts receivable and inventory reserves, and stock-based compensation partially offset by the gain on the interest rate swap. In addition, cash decreased $17.7 million, primarily as a result of changes in working capital, which includes an increase of $15.3 million in inventory buildup to accommodate higher sales volume, an increase of $5.1 million in accounts receivable stemming from higher sales, and an increase in prepaid expense of $2.3 million, partially offset by an increase in account payable and accrual expense totaling $1.6 million and related party payable of $2.9 million. For the nine months ended September 30, 2021, net cash used by operating activities was $1.2 million, primarily as a result of net income of $16.5 million, adjusted for certain non-cash items of an aggregate $2.4 million consisting of changes in fair value of interest rate swaps, gain on forgiveness of debt, depreciation and amortization, reserve for inventory obsolescence, and stock-based compensation partially offset by a decrease in cash of $20.1 million due to changes in working capital.

*Cash flows used in investing activities.* Net cash used in investing activities for nine months ended September 30, 2022 was $16.6 million, which included the purchase of manufacturing equipment for our facilities totaling $2.0 million, deposits paid for additional manufacturing equipment of $11.5 million, and investment pursuant to the JV Agreement of $4.0 million. Net cash used in investing activities for nine months ended September 30, 2021 was $8.6 million, which consisted of the purchase of manufacturing equipment totaling $3.9 million, deposits paid for additional manufacturing equipment of $3.8 million, and net cash paid of $0.9 million for our acquisition of Pacific Cup.

*Cash flows provided by financing activities.* Net cash provided by financing activities for the nine months ended September 30, 2022 was $5.1 million, which included an additional borrowing under the 2026 Term Loan of $6.9 million, and a borrowing under the 2027 Term Loan of $20.6 million, partially offset by $21.3 million term loan repayments, and noncontrolling interest tax withholding payment of $1.1 million. The company also withdrew $21.1 million under the Line of Credit, and paid off this amount during nine months ended September 30, 2022. Net cash provided by financing activities for the nine months ended September 30, 2021 was $11.1 million, which primarily consisted of net proceeds from the issuance of common stock in connection with our initial public offering of $67.6 million, partially offset by net payments on the Line of Credit of $33.2 million, net payments under the term loans of 23.0 million, and payments on capital lease obligations of $0.3 million.

### Related Party Transactions

For a description of significant related party transactions, see Note 14 — *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, 7,447 characters.

### Evaluation of Disclosure Controls and Procedures

In connection with the preparation of this Quarterly Report on Form 10-Q, 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 September 30, 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 September 30, 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 Quarterly Report on Form 10-Q 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 nine months 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 hired a Corporate Controller in June 2022, whose primary responsibilities include improving the design, implementation, execution, and supervision of our internal controls.
- 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.
- Under the supervision of our Audit Committee, Chief Executive Officer and Chief Financial Officer, we initiated 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, completed an enterprise risk assessment and established reporting objectives and material weakness remediation plan.
- We engaged a third-party service provider to assist with the design and preparation of an internal controls compliance plan and perform testing of the effectiveness of internal controls. We have completed the design and documentation of significant process transaction flows and key controls in our business processes and overall IT environment, including the identification of potential control gaps and the implementation of controls to mitigate such risks. We are in the process of performing an internal control design effectiveness assessment.
- We provided 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.
- 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 expect to continue evaluating our needs for additional personnel.
- We reallocated resources and reassigned job roles in order to ensure proper segregation of duties.

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, 192 characters.

There have been no material changes to the Risk Factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021, which are incorporated herein by reference.

Filed Nov 14, 2022.
Source: SEC EDGAR, the filing index for accession 0001628280-22-029881. Last ingested by Listed: Nov 10, 2026, 06:36 ET. No prices; not investment advice.