# Karat Packaging Inc.: Form 10-Q for the period ended Mar 31, 2023

- Company: [Karat Packaging Inc.](/companies/krt.md) (CIK 1758021)
- Form: 10-Q
- Filed: 2023-05-10
- Accepted by EDGAR: May 10, 2023, 16:59 ET
- Period: 2023-03-31
- Accession: 0001628280-23-017302
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1758021/000162828023017302/krt-20230331.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1758021/000162828023017302/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2023-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2023-01-01 to 2023-03-31 | $95.8m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Cost of revenue | 3 months, 2023-01-01 to 2023-03-31 | $57.7m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2023-01-01 to 2023-03-31 | $38.1m | us-gaap:GrossProfit |
| Operating income | 3 months, 2023-01-01 to 2023-03-31 | $12.7m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2023-01-01 to 2023-03-31 | $407.0k | us-gaap:InterestExpense |
| Income tax | 3 months, 2023-01-01 to 2023-03-31 | $2.8m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2023-01-01 to 2023-03-31 | $9.0m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2023-01-01 to 2023-03-31 | $0.45 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2023-01-01 to 2023-03-31 | $0.45 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2023-01-01 to 2023-03-31 | 19,939,923 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2023-01-01 to 2023-03-31 | $14.2m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2023-01-01 to 2023-03-31 | $1.0m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2023-03-31 | $23.2m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2023-03-31 | $141.6m | us-gaap:AssetsCurrent |
| Total assets | at 2023-03-31 | $273.3m | us-gaap:Assets |
| Current liabilities | at 2023-03-31 | $44.2m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2023-03-31 | $111.9m | us-gaap:Liabilities |
| Long-term debt | at 2023-03-31 | $202.0k | us-gaap:LongTermDebtNoncurrent |
| Current portion of debt | at 2023-03-31 | $962.0k | us-gaap:LongTermDebtCurrent |
| Shareholders' equity | at 2023-03-31 | $150.9m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 33,355 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 set forth in Item I, Part 1A, “Risk Factors” of the Annual Report on Form 10-K for the year ended December 31, 2022 as filed with the Securities and Exchange Commission (the "SEC") on March 16, 2023 (the "2022 Form 10-K").*

*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.*

*Due to rounding, numbers presented throughout this report may not add up precisely to totals we provide and percentages may not precisely reflect the absolute figures.*

### Overview

We are a rapidly-growing specialty distributor and select manufacturer of 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.

### 2023 Business Highlights and Trends

- We recorded net sales of $95.8 million for the three months ended March 31, 2023.
- We continued to drive significant margin expansion, achieving a record gross margin of 39.8% for the three months ended March 31, 2023, a 730 basis points increase from the three months ended March 31, 2022.
- We recorded net income of $9.2 million for the three months ended March 31, 2023, an increase of 15.6% compared to three months ended March 31, 2022.
- We generated net cash provided by operating activities of $14.2 million for the three months ended March 31, 2023 compared to net cash used in operating activities of $11.4 million for the three months ended March 31, 2022.
- We generated consolidated Adjusted EBITDA, a non-GAAP measure defined below, of $15.3 million for the three months ended March 31, 2023, representing an increase of $2.3 million, or 17.6% compared the three months ended March 31, 2022.
- We had financial liquidity of $62.1 million and additional short-term investments of $10.0 million as of March 31, 2023, and declared a special dividend of $0.35 per share on our common stock on May 8, 2023.

### 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 continue to 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.
- Most of our products are sourced from vendors abroad and as a result we incur freight costs from these overseas import shipments. We believe fluctuations in freight cost can have either a positive or a negative impact on our results of operations, 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.
- 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 effectiveness 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 manage our global supply chain 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.

### Critical Accounting 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 2022 Form 10-K.

### Results of Operations

### Three months ended March 31, 2023 Compared to the Three Months Ended March 31, 2022

*(in thousands)*

|  | Three Months Ended March 31, 2023 | 2022 |
| --- | ---: | ---: |
| Net sales | $95,801 | $105,413 |
| Cost of goods sold | 57,657 | 71,124 |
| Gross profit | 38,144 | 34,289 |
| Operating expenses | 25,412 | 24,798 |
| Operating income | 12,732 | 9,491 |
| Other (expense) income, net | (728) | 1,129 |
| Provision for income taxes | 2,818 | 2,677 |
| Net income | $9,186 | $7,943 |

#### Net sales

Net sales were $95.8 million for the three months ended March 31, 2023 compared to $105.4 million for the three months ended March 31, 2022, a decrease of $9.6 million, or 9%. This decrease is primarily made up of $2.4 million from pricing reductions as we actively passed on savings from ocean freight and raw materials costs to customers, $5.0 million from the decrease in volume and change in product mix, and $2.2 million from lower logistic services and shipping revenue.

#### Cost of goods sold

Cost of goods sold was $57.7 million for the three months ended March 31, 2023 compared to $71.1 million for the three months ended March 31, 2022, a decrease of $13.5 million, or 19%. The decrease was primarily due to a reduction of $9.5 million in freight and duty costs to acquire inventory from overseas, as ocean freight rates continually fell throughout the second half of 2022 and into 2023, and a decrease of $4.0 million in product costs due to lower sales in the current period combined with reduced pricing on certain raw materials used in production as well as some imported finished goods.

#### Gross profit

Gross profit was $38.1 million for the three months ended March 31, 2023 compared to $34.3 million for the three months ended March 31, 2022, an increase of $3.9 million, or 11%. Gross margin was 39.8% for the three months ended March 31, 2023 compared to 32.5% for the three months ended March 31, 2022. The margin expansion resulted primarily from a significant decrease in ocean freight costs, which as a percentage of net sales was 5.9% during the three months ended March 31, 2023, down from 14.4% during the three months ended March 31, 2022. Despite the price reductions to pass on cost savings to customers and the unfavorable foreign currency exchange rate impact from the weakening of the United States Dollar against Taiwan New Dollar, gross margin also benefited from our efforts to increase import while scaling back manufacturing in high cost states such as California, shift towards high margin items such as eco-friendly products, reduce certain raw material costs and improve operating efficiencies.

#### Operating expenses

Operating expenses were $25.4 million for the three months ended March 31, 2023 compared to $24.8 million for the three months ended March 31, 2022, an increase of $0.6 million, or 2%. The increase was primarily due to an increase of $1.2 million in payroll-related costs due to workforce expansion, an increase of $0.5 million in rental expense primarily due to additional properties leased in May 2022, an increase of $0.8 million in marketing expense as we increase online marketing efforts to support online sales growth. These increases were partially offset by a decrease of $1.2 million in shipping and transportation costs to transfer inventory between our warehouses and to deliver products to our customers due to the decrease in shipping rates and a decrease of $0.7 million in bad debt expense.

#### Operating income

Operating income was $12.7 million for the three months ended March 31, 2023 compared to $9.5 million for the three months ended March 31, 2022, an increase of $3.2 million, or 34%. The increase was primarily due to an increase in gross profit of $3.9 million partially offset by an increase in operating expenses of $0.6 million, as discussed above.

#### Other income, net

Other expense, net was $0.7 million for the three months ended March 31, 2023 compared to other income, net of $1.1 million for the three months ended March 31, 2022. The $0.7 million other expense, net for the three months ended March 31, 2023 consisted primarily of a loss on foreign currency transactions of $0.4 million, interest expense on the term loans of $0.4 million, partially offset by rental income of $0.2 million. The $1.1 million other income, net for the three months ended March 31, 2022 consisted primarily of interest income of $1.3 million due to the change in fair value of an interest rate swap, and rental income of $0.2 million, partially offset by interest expense incurred primarily on the line of credit and term loans totaling $0.5 million.

#### Provision for income taxes

Provision for income taxes was $2.8 million for the three months ended March 31, 2023 compared to $2.7 million for the three months ended March 31, 2022, an increase of $0.1 million, or 5%. The Company’s effective tax rate was 23.5% for the three months ended March 31, 2023 compared to 25.2% for the three months ended March 31, 2022 primarily due to the change in the non-taxable non-controlling interest income.

#### Net income

Net income was $9.2 million for the three months ended March 31, 2023 compared to $7.9 million for the three months ended March 31, 2022, an increase of $1.2 million, or 16%. The increase was primarily driven by an increase in operating income of $3.2 million, partially offset by a decrease in other income, net of $1.9 million and an increase in the provision for income taxes of approximately $0.1 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 U.S. 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 is calculated as net income excluding (i) interest income, (ii) interest expense, (iii) provision for income taxes, (iv) depreciation and amortization, and (v) stock-based compensation expense. Adjusted EBITDA margin is calculated by dividing Adjusted EBITDA by net sales.

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)*

| Reconciliation of Adjusted EBITDA and Adjusted EBITDA Margin (unaudited) | Three Months Ended March 31, 2023 Amount | % of Net Sales | 2022 Amount | % of Net Sales |
| --- | ---: | ---: | ---: | ---: |
| **Net income:** | **$9,186** | **9.6%** | **$7,943** | **7.5%** |
| Add (deduct): |  |  |  |  |
| Interest income | (67) | (0.1) | (1,313) | (1.2) |
| Interest expense | 407 | 0.4 | 473 | 0.4 |
| Provision for income taxes | 2,818 | 2.9 | 2,677 | 2.5 |
| Depreciation and amortization | 2,633 | 2.8 | 2,584 | 2.5 |
| Stock-based compensation expense | 277 | 0.3 | 611 | 0.6 |
| **Adjusted EBITDA** | **$15,254** | **15.9%** | **$12,975** | **12.3%** |

### 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. 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, 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 and a standby letter of credit sublimit. We are not required to pay a commitment (unused) fee on the undrawn portion of the Line of Credit and interest is payable monthly. On March 14, 2023, we amended the Line of Credit. Prior to March 14, 2023, interest accrued at the annual rate of prime less 0.25% with a minimum floor of 3.25%. The amendment on March 14, 2023, among other things, (1) extended the maturity date to March 14, 2025, and (2) revised the interest on any Line of Credit borrowings to an annual rate of one month term Secured Overnight Financing Rate ("SOFR") plus 2.50%, with a SOFR floor of 1.0%. As of March 31, 2023, 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, 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 had 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 2023, which we exercised in March 2023. Interest accrues at a fixed rate of 4.375% 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 2027 Term Loan is collateralized by substantially all of Global Wells’ assets and is guaranteed by 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. 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 March 31, 2023, we have a $23.0 million term loan that matures 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 2026 Term 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, 2023, 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, 2023, we had $0.0 million in outstanding balance on the Line of Credit, $28.5 million in outstanding balance under the 2027 Term Loan, and $22.0 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, our joint venture agreement (the "JV Agreement") to establish a new corporation, Bio Earth, to build a factory in Taiwan required significant investment. As of March 31, 2023, we made net payments totaling $6.0 million as stipulated in the JV Agreement. As described in Note 17 — *Subsequent Events* in the Notes to the condensed consolidated financial statements included in Part I, Item 1 in this Quarterly Report on Form 10-Q, on May 8, 2023, we entered into a share transfer agreement to sell all of our equity interest in Bio Earth to Keary Global for a total consideration of $6.0 million, representing the original investments totaling $6.0 million and interest accruing at 5% per annum totaling $38,000. The transaction is expected to close within three months upon receipt of Taiwanese regulatory approval.

Concurrent with the share transfer agreement on May 8, 2023, the Company entered into an Agreement with Keary Global, Bio Earth and Happiness Moon Co., Ltd. (“Happiness Moon”) pursuant to which (i) Lollicup agreed to transfer all Bio Earth shares, as well as its rights and obligations under the JV Agreement to Keary Global, (ii) Happiness Moon and Bio Earth agree to foregoing and (iii) Bio Earth shall manage the regulatory and registration requirements related to the share transfer.

Additionally, as described in Note 17 — *Subsequent Events* in the Notes to the condensed consolidated financial statements, on May 8, 2023 our Board of Directors declared a special cash dividend of $0.35 per common share, which will be paid on or around May 31, 2023 to shareholders of record at the close of business on May 23, 2023.

In February 2023, management committed to a plan to sell certain manufacturing equipment to an unrelated third-party vendor in Taiwan, as we started to pivot into a more asset-light growth model by increasing import and scaling back manufacturing in California. We also cancelled certain equipment purchase commitments that we had previously paid deposits towards. We expect to receive approximately $3.7 million in total cash proceeds from both the sale of equipment to the vendor and the deposit refunds in the next 12 to 24 months.

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 rapidly changing macroeconomic and geopolitical dynamics created significant uncertainty in the global economy and capital markets, which could have long-lasting adverse effects beyond 2023. 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 capital expenditures to further enhance our operating infrastructure and 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 acquire 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, 2023 compared to December 31, 2022:

*(in thousands)*

|  | March 31, 2023 | December 31, 2022 | Increase/(Decrease) |
| --- | ---: | ---: | ---: |
| Current assets | $141,555 | $123,800 | $17,755 |
| Current liabilities | 44,182 | 39,253 | 4,929 |
| Working capital | $97,373 | $84,547 | $12,826 |

As of March 31, 2023, we had working capital of $97.4 million compared to working capital of $84.5 million as of December 31, 2022, representing an increase of $12.8 million, or 15%. The improvement in working capital was driven by an increase of $17.8 million in current assets partially offset by an increase of $4.9 million in current liabilities. The increase in current assets was primarily driven by an increase in cash and cash equivalents and short-term investments of $17.2 million mainly due to strong cash flows from operating activities totaling $14.2 million, and an increase in account receivable of $3.1 million from higher sales, partially offset by a decrease in prepaid expenses and other current assets of $2.2 million. The increase in current liabilities was primarily driven by an increase of $4.1 million in accounts payable and related party payables and an increase of $1.8 million in income taxes payable, partially offset by a decrease in accrual expense of $1.1 million

### Cash Flows

The following table summarizes cash flow for the three months ended March 31, 2023 and 2022:

*(in thousands)*

|  | Three Months Ended March 31, 2023 | 2022 |
| --- | ---: | ---: |
| Net cash provided by (used in) operating activities | $14,185 | $(11,427) |
| Net cash used in investing activities | (14,685) | (4,795) |
| Net cash provided by financing activities | 7,684 | 16,559 |
| Net change in cash and cash equivalents | $7,184 | $337 |

*Cash flows provided by (used in) operating activities.* Net cash provided by operating activities was $14.2 million for the three months ended March 31, 2023, primarily the result of net income of $9.2 million, adjusted for certain non-cash items totaling $3.9 million, consisting mainly of depreciation and amortization of property, equipment, and operating right- of-use assets. In addition, cash increased $1.1 million, primarily as a result of changes in working capital, which primarily included a decrease of $1.0 million in prepaid expenses and other current assets, an increase of $1.8 million in income taxes payable, and an increase of $3.0 million in accounts payable and related party payable, partially offset by an increase of $2.4 million in accounts receivable as a result of higher sales, a decrease of $1.1 million in accrued expenses and a decrease of $1.1 million in operating lease liability. Net cash used in operating activities was $11.4 million for the three months ended March 31, 2022, primarily the result of net income of $7.9 million, adjusted for certain non-cash items totaling $3.5 million, consisting mainly of depreciation and amortization of property, changes in fair value of an interest rate swap, reserve for inventory obsolescence, allowance for doubtful accounts and stock-based compensation. In addition, cash decreased $22.9 million, primarily as a result of changes in working capital, which included 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 of $6.1 million in accounts payable and accrued expenses, increase of $1.5 million in other payables, and an increase of $1.9 million in income taxes payable.

*Cash flows used in investing activities.* Net cash used in investing activities was $14.7 million for the three months ended March 31, 2023, which primarily included $10.0 million in purchase of short-term investments, $2.0 million of net investment pursuant to the JV Agreement, $1.7 million of deposits paid for additional property and equipment, and $1.0 million paid to purchase property and equipment. Net cash used in investing activities was $4.8 million for the three months ended March 31, 2022, which included $4.0 million of deposits paid for additional property and equipment, and $0.8 million paid to purchase property and equipment.

*Cash flows provided by financing activities.* Net cash provided by financing activities was $7.7 million for the three months ended March 31, 2023, which primarily included an additional borrowing under the 2027 Term Loan of $8.0 million, partially offset by payments on long-term debt of $0.2 million. Net cash provided by financing activities was $16.6 million for the three months ended March 31, 2022, which primarily included borrowing of $10.2 million under the Line of Credit, and an 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.

### 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 condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

## Controls and procedures

As filed, 11,791 characters.

### Evaluation of Disclosure Controls and Procedures

In connection with the preparation of this Quarterly Report on Form 10-Q, the Company's management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of its disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2023. Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of March 31, 2023 due to the material weaknesses described below:

### Material Weaknesses in Internal Control over Financial Reporting

Management has determined that the Company has the following material weaknesses in its internal control over financial reporting at March 31, 2023. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.

- *Control Environment, Risk Assessment, and Monitoring Activities*

Management did not maintain appropriately designed entity-level controls impacting the control environment, risk assessment procedures and monitoring activities 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, (ii) ineffective identification and assessment of risks impacting internal control over financial reporting, and (iii) insufficient evaluation and determination as to whether the components of internal controls were present and functioning based upon evidence maintained for certain management review controls and activity level controls across substantially all financial statement areas.

- *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 maintain effective general controls over information systems that support the financial reporting process. Specifically, management did not design and maintain (i) effective logical user access controls, including user access reviews, to ensure appropriate segregation of duties and adequate restrictions of users, including those with privileged access, and (ii) appropriate review and authorization of change management in the systems.
- Management did not design and maintain effective controls over the completeness and accuracy of underlying data used in the operation of certain management review controls and activity level controls across substantially all financial statement areas.
- Management did not design and implement management review controls at a sufficient level of precision to detect a material misstatement across substantially all financial statement areas that include complex and judgmental areas of accounting and disclosure.
- Management did not design and maintain effective activity level controls over balances recorded within revenue and accounts receivable, including controls over (i) the approval of arrangements with customers and pricing changes, and (ii) the approval and matching of sales orders, shipping documents, and sales invoices in the revenue recognition process.
- Management did not design and maintain effective activity level controls over the balances recorded within inventory and cost of sales, including controls over (i) the year-end physical inventory counts and inventory count variances, and (ii) inventory costing and bill of material analysis.
- Management did not design and maintain effective activity level controls over the procurement process, including controls over (i) vendor master file changes, (ii) the approval and matching of purchase orders, invoices, and receiving documents, and (iii) authorization of vendor payments.

Each of the material weaknesses above could result in a misstatement of substantially all account balances or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. The material weaknesses identified did not result in the restatement of any previously reported financial statements or any related financial disclosure, nor does management believe that they had any effect on the accuracy of the Company’s financial statements for the current reporting period.

### Management’s Remediation Plan

As reported in the 2022 Form 10-K, we are engaged in remedial actions in response to the deficiencies discussed above, and we plan to continue efforts to improve internal control over financial reporting.

The following remedial actions were taken during the year ended December 31, 2022 to remediate the material weaknesses in internal control over financial reporting:

- Performed a thorough review of users’ access rights to our significant information technology systems and implemented certain updates to allow for appropriate segregation of duties.
- Increased the number of personnel with the appropriate level of knowledge related to accounting transactions, accounting matters, and relevant systems, including the addition of a Chief Financial Officer and Controller.
- Engaged a third-party service provider to assist management with the design and implementation of internal controls.
- Started an initial risk assessment based on the criteria established by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") to identify internal control over financial reporting ("ICFR") risks and control objectives.
- With the assistance from the third-party service provider, and under the supervision of the Company's Audit Committee, Chief Executive Officer and Chief Financial Officer, started the design and implementation of significant process transaction flows and key controls in the Company's business processes, including revenue, inventory, income taxes, and overall IT environment.
- Management started to adopt a process to identify and assess the Company's disclosure controls and procedures, including the preparation and review of presentation and disclosure requirement checklists.

Additionally, management is in the process of implementing the below changes to the Company's processes to improve its internal control over financial reporting:

- Evaluate the Company's needs for additional personnel and add, as needed, additional headcount primarily within the accounting and information technology departments. Management will onboard individuals with the appropriate education, experience, certifications, and training. The hiring of new employees is expected to create and ensure proper reporting lines and segregation of duties, while also providing additional oversight and structure to the organization.
- Continue to update the risk assessment, objectives, processes and control design and documentation, including such design and documentation as related to the completeness and accuracy of underlying data and a sufficient precision level in management review controls to detect material misstatement across all financial statement areas.
- Improve the process of retaining evidence of sales arrangements with customers including adopting a required retention period for applicable customer purchase orders. Management is in the process of holding additional training for warehouse employees to appropriately perform and document the three-way match between sales orders, shipping documents, and sales invoices.
- Update and enhance the standard operating procedures of both periodic and year-end physical counts to ensure all inventory items are counted at all warehouses in a consistent manner. Management is also in the process of continuing to enforce the newly-implemented controls requiring inventory adjustments to be reviewed and approved by the appropriate level of management and to be appropriately recorded and inventory costing analysis to be appropriately reviewed.
- Continue to enforce the newly adopted Company-wide approval matrix that establishes clear guidelines on authority levels for all types of cash disbursement transactions. Management is in the process of reviewing user access and establishing appropriate reporting lines within the accounts payable department to ensure proper segregation of duties for and performance of controls and procedures including vendor master file changes and the three-way match between purchase orders, receiving documents, and vendor invoices.
- Enhance training programs for personnel that provide key information and perform key roles associated with ICFR. Management plans to design such training programs in order to improve the level of understanding of the design and proper implementation of controls by the control owners and to instruct such individuals on appropriate level of documentation practices for evidencing review, especially over the completeness and accuracy of underlying data and the precision level used in the review.
- Continue to enhance policies and procedures to improve Information Technology General Controls and the Company's overall IT environment. Examples of some of management's planned efforts include:
- Adopt the policy and procedure to regularly perform a thorough review of user's access rights relating to the Company's significant information technology systems.
- Maintain and monitor restrictions to user access where needed to allow for appropriate segregation of duties, and
- Maintain and enforce procedures and controls around system development and change management.

Management is committed to remediating the material weaknesses in a timely fashion and to making continuous improvements to the Company's internal control over financial reporting. Management believes the measures described above have strengthened the Company's internal control over financial reporting, Management will continually assess the effectiveness of the remediation efforts and may determine to take additional measures to address control deficiencies or modify the remediation plan described above. The 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 ended December 31, 2023 and management will continue to provide an update on the status of our remediation activities on a quarterly basis.

### Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2023, 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, 143 characters.

There have been no material changes to the Risk Factors previously disclosed in the 2022 Form 10-K, which are incorporated herein by reference.

Filed May 10, 2023.
Source: SEC EDGAR, the filing index for accession 0001628280-23-017302. Last ingested by Listed: Nov 6, 2026, 17:16 ET. No prices; not investment advice.