# Karat Packaging Inc.: Form 10-Q for the period ended Sep 30, 2023

- Company: [Karat Packaging Inc.](/companies/krt.md) (CIK 1758021)
- Form: 10-Q
- Filed: 2023-11-09
- Accepted by EDGAR: Nov 9, 2023, 16:23 ET
- Period: 2023-09-30
- Accession: 0001628280-23-038270
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1758021/000162828023038270/krt-20230930.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1758021/000162828023038270/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2023-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2023-07-01 to 2023-09-30 | $105.5m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Revenue | 9 months, 2023-01-01 to 2023-09-30 | $310.1m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Cost of revenue | 3 months, 2023-07-01 to 2023-09-30 | $66.6m | us-gaap:CostOfGoodsAndServicesSold |
| Cost of revenue | 9 months, 2023-01-01 to 2023-09-30 | $191.1m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2023-07-01 to 2023-09-30 | $38.9m | us-gaap:GrossProfit |
| Gross profit | 9 months, 2023-01-01 to 2023-09-30 | $118.9m | us-gaap:GrossProfit |
| Operating income | 3 months, 2023-07-01 to 2023-09-30 | $11.4m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2023-01-01 to 2023-09-30 | $37.5m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2023-07-01 to 2023-09-30 | $536.0k | us-gaap:InterestExpense |
| Interest expense | 9 months, 2023-01-01 to 2023-09-30 | $1.5m | us-gaap:InterestExpense |
| Income tax | 3 months, 2023-07-01 to 2023-09-30 | $2.9m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2023-01-01 to 2023-09-30 | $9.0m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2023-07-01 to 2023-09-30 | $9.1m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2023-01-01 to 2023-09-30 | $28.6m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2023-07-01 to 2023-09-30 | $0.45 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2023-01-01 to 2023-09-30 | $1.43 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2023-07-01 to 2023-09-30 | $0.46 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2023-01-01 to 2023-09-30 | $1.44 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2023-07-01 to 2023-09-30 | 19,994,648 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2023-01-01 to 2023-09-30 | 19,962,999 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2023-01-01 to 2023-09-30 | $43.1m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2023-01-01 to 2023-09-30 | $2.9m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2023-09-30 | $28.2m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2023-09-30 | $158.7m | us-gaap:AssetsCurrent |
| Total assets | at 2023-09-30 | $280.0m | us-gaap:Assets |
| Current liabilities | at 2023-09-30 | $45.7m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2023-09-30 | $115.2m | us-gaap:Liabilities |
| Long-term debt | at 2023-09-30 | $219.0k | us-gaap:LongTermDebtNoncurrent |
| Current portion of debt | at 2023-09-30 | $1.1m | us-gaap:LongTermDebtCurrent |
| Shareholders' equity | at 2023-09-30 | $154.2m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 44,891 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 seven other distribution centers located in Sumner, Washington; Summerville, South Carolina; Branchburg, New Jersey; Kapolei, Hawaii; City of Industry, California; Aurora, Illinois; and Sugar Land, Texas. Our distribution centers are strategically located in proximity to major population centers, including the Los Angeles, Houston, Dallas, New York, Seattle, Atlanta, Chicago and Honolulu metro areas.

We manage and evaluate our operations in one reportable segment.

### Business Highlights and Trends

- We recorded net sales of $105.5 million and $310.1 million for the three and nine months ended September 30, 2023, respectively.
- Our gross margin expanded to 36.9% and 38.4% for the three and nine months ended September 30, 2023, respectively, a 580 and 740 basis points increase from the three and nine months ended September 30, 2022, respectively. The gross margin for the nine months ended September 30, 2023 included the impact of 60 basis points due to the write-off $1.7 million of certain raw materials as we disposed of certain machinery and equipment in executing our plan to scale back production in certain locations.
- We recorded net income of $9.1 million and $29.0 million for the three and nine months ended September 30, 2023, respectively, an increase of 49% and 36% compared to three and nine months ended September 30, 2022, respectively. We achieved net income margin of 8.7% and 9.4% for the three and nine months ended September 30, 2023, respectively, a 310 and 300 basis points increase from the three and nine months ended September 30, 2022, respectively. Net income for the nine months ended September 30, 2023 included $2.1 million in impairment expense and loss, net, on disposal of machinery as we executed our strategy to scale back manufacturing in certain locations, and $1.7 million in raw materials write-off, as discussed above.
- We generated net cash from operating activities of $12.0 million and $43.1 million for the three and nine months ended September 30, 2023, respectively, compared to $20.2 million and $12.5 million in the three and nine months ended September 30, 2022, respectively.
- We generated consolidated Adjusted EBITDA, a non-GAAP measure defined below, of $15.2 million and $51.6 million for the three and nine months ended September 30, 2023, respectively, a 30% and 41% increase from the three and nine months ended September 30, 2022, respectively.
- Our Adjusted EBITDA margin, a non-GAAP measure defined below, expanded to 14.4% and 16.6% for the three and nine months ended September 30, 2023, respectively, an increase of 370 and 550 basis points from the three and nine months ended September 30, 2022, respectively.
- We had financial liquidity of $64.4 million and additional short-term investments of $18.1 million as of September 30, 2023. On November 6, 2023, our Board of Directors declared the quarterly cash dividend and increased it to $0.20 per share on our common stock, which will be paid on or around November 30, 2023 to shareholders of record at the close of business on November 20, 2023.
- During the second quarter of 2023, we closed the sale of our equity interest in Bio Earth and had received total consideration of $6.1 million, which comprised of our original deposits plus accrued interest.

### 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. Sale of eco-friendly products represented approximately 33% of total sales in the third quarter of 2023, compared to 27% in the prior year quarter.
- 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.
- We have recently made a strategic business decision to pivot into a more asset-light growth model by increasing import and scaling back manufacturing in certain locations. We believe this will have either a positive or a negative impact on our results of operations, depending on whether we can successfully source and import finished goods at a price that is more favorable than domestically manufacturer products, and effectively realize savings from reduced manufacturing capabilities.

### 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

The amount and percentage changes calculated in the discussion below were based on numbers rounded to the nearest thousands.

*(in thousands)*

*(in thousands)*

|  | Three Months Ended September 30, 2023 | 2022 | Nine Months Ended September 30, 2023 | 2022 |
| --- | ---: | ---: | ---: | ---: |
| Net sales | $105,528 | $109,996 | $310,069 | $330,290 |
| Cost of goods sold | 66,584 | 75,828 | 191,120 | 227,869 |
| Gross profit | 38,944 | 34,168 | 118,949 | 102,421 |
| Operating expenses | 27,564 | 26,258 | 81,498 | 77,218 |
| Operating income | 11,380 | 7,910 | 37,451 | 25,203 |
| Other income | 664 | 143 | 597 | 2,416 |
| Provision for income taxes | 2,904 | 1,900 | 9,045 | 6,323 |
| Net income | $9,140 | $6,153 | $29,003 | $21,296 |

### Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022

#### Net sales

Net sales were $105.5 million for the three months ended September 30, 2023 compared to $110.0 million for the three months ended September 30, 2022, a decrease of $4.5 million, or 4%. This decrease is primarily made up of $10.4 million from unfavorable year-over-year pricing comparison, as we actively passed on savings from ocean freight and raw materials costs to customers and $1.8 million from lower logistic services and shipping revenue, partially offset by $7.7 million from an increase in volume and change in product mix.

#### Cost of goods sold

Cost of goods sold was $66.6 million for the three months ended September 30, 2023 compared to $75.8 million for the three months ended September 30, 2022, a decrease of $9.2 million, or 12%. The decrease was primarily attributable to a reduction of $8.0 million in freight and duty costs to acquire inventory from overseas as a result of lower ocean freight rate, and a decrease of $1.9 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, partially offset by an increase of $0.5 million in inventory reserves adjustments.

#### Gross profit

Gross profit was $38.9 million for the three months ended September 30, 2023 compared to $34.2 million for the three months ended September 30, 2022, an increase of $4.8 million, or 14%. Gross margin increased to 36.9% for the three months ended September 30, 2023, compared to 31.1% for the three months ended September 30, 2022. Despite the unfavorable impact from price reductions, gross margin benefited from a significant decrease in ocean freight costs, which as a percentage of net sales was 7.9% during the three months ended September 30, 2023, down from 14.8% during the three months ended September 30, 2022. Additional margin expansion factors also included strong United States Dollar against Taiwan New Dollar, and our efforts to scale back manufacturing in the U.S. in favor of imports which carry higher margin.

#### Operating expenses

Operating expenses were $27.6 million for the three months ended September 30, 2023 compared to $26.3 million for the three months ended September 30, 2022, an increase of $1.3 million, or 5%. The increase was primarily due to an increase of $1.4 million in labor costs primarily due to workforce expansion and the shift towards import as we reduced production but increased warehouse headcount, an increase of $0.6 million in marketing expense as we increased online marketing efforts to grow our e-commerce sales channel, an increase of $0.6 million in professional expenses primarily due to transaction costs incurred in connection with the secondary offering, and an increase of $0.3 million in rental expense primarily due to additional leased warehouses as we continued to expand our distribution capabilities. These increases were partially offset by a decrease of $1.7 million in shipping and transportation costs due to lower shipping rates. See Note 18 - *Secondary Offering* for further information.

#### Operating income

Operating income was $11.4 million for the three months ended September 30, 2023 compared to $7.9 million for the three months ended September 30, 2022, an increase of $3.5 million, or 44%. The increase was primarily due to an increase in gross profit of $4.8 million, partially offset by an increase in operating expenses of $1.3 million, as discussed above.

#### Other income, net

Other income, net was $0.7 million for the three months ended September 30, 2023 compared to $0.1 million for the three months ended September 30, 2022. The increase of $0.5 million was primarily due to an increase in interest income of $0.5 million.

#### Provision for income taxes

Provision for income taxes was $2.9 million for the three months ended September 30, 2023 compared to $1.9 million for the three months ended September 30, 2022, an increase of $1.0 million, or 53%. The Company’s effective tax rate was 24.1% for the three months ended September 30, 2023 compared to 23.6% for the three months ended September 30, 2022 primarily due to the change in the non-taxable non-controlling interest income.

#### Net income

Net income was $9.1 million for the three months ended September 30, 2023 compared to $6.2 million for the three months ended September 30, 2022, an increase of $3.0 million, or 49%. The increase was primarily driven by an increase in operating income of $3.5 million, and an increase in other income, net of $0.5 million, partially offset by an increase in the provision for income taxes of approximately $1.0 million, as discussed above.

### Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

#### Net sales

Net sales were $310.1 million for the nine months ended September 30, 2023 compared to $330.3 million for the nine months ended September 30, 2022, a decrease of $20.2 million, or 6%. This decrease is primarily made up of $22.6 million from unfavorable year-over-year pricing comparison, as we actively passed on savings from ocean freight and raw materials costs to customers and $6.2 million from lower logistic services and shipping revenue, partially offset by $8.6 million from an increase in volume and change in product mix.

#### Cost of goods sold

Cost of goods sold was $191.1 million for the nine months ended September 30, 2023 compared to $227.9 million for the nine months ended September 30, 2022, a decrease of $36.7 million, or 16%. The decrease was primarily attributable to a reduction of $31.4 million in freight and duty costs to acquire inventory from overseas as a result of lower ocean freight rate, and a decrease of $8.0 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. These decreases were partially offset by a $1.7 million write-off of raw materials in 2023 as we disposed of certain machinery and equipment in executing the plan to scale back production in the U.S.

#### Gross profit

Gross profit was $118.9 million for the nine months ended September 30, 2023 compared to $102.4 million for the nine months ended September 30, 2022, an increase of $16.5 million, or 16%. Gross margin was 38.4% for the nine months ended September 30, 2023, including a 60-basis-point impact from the write-off of raw materials associated with the disposal of certain machinery as discussed above, compared to 31.0% for the nine months ended September 30, 2022. Despite the unfavorable impact from the inventory write-offs and price reductions, gross margin benefited from a significant decrease in ocean freight costs, which as a percentage of net sales was 6.7% during the nine months ended September 30, 2023, down from 15.8% during the nine months ended September 30, 2022. Additional margin expansion factors also included strong United States Dollar against Taiwan New Dollar, and our efforts to scale back manufacturing in the U.S. in favor of imports which carry higher margin and improve operating efficiencies.

#### Operating expenses

Operating expenses were $81.5 million for the nine months ended September 30, 2023 compared to $77.2 million for the nine months ended September 30, 2022, an increase of $4.3 million, or 6%. The operating expenses for the nine months ended September 30, 2023 included impairment expense and loss, net, on disposal of machinery of $2.2 million due to our scaling back manufacturing in the U.S. Additionally, the increase in operating expenses was also attributable to an increase of $3.6 million in labor costs primarily due to workforce expansion and the shift towards import as we reduced production but increased warehouse headcount, an increase of $2.1 million in marketing expense as we increased online marketing efforts to grow our e-commerce sales channel, an increase of $1.2 million in rental expense as we continued to expand our distribution capabilities. These increases were partially offset by a decrease of $4.0 million in shipping and transportation costs due to lower shipping rates, a decrease of $1.0 million in in stock-based compensation expense, and a decrease of $0.9 million in bad debt expense.

#### Operating income

Operating income was $37.5 million for the nine months ended September 30, 2023 compared to $25.2 million for the nine months ended September 30, 2022, an increase of $12.2 million, or 49%. The increase was primarily due to an increase in gross profit of $16.5 million, partially offset by an increase in operating expenses of $4.3 million, as discussed above.

#### Other income, net

Other income, net was $0.6 million for the nine months ended September 30, 2023 compared to $2.4 million for the nine months ended September 30, 2022. The decrease of $1.8 million was primarily due to a decrease in the gain on foreign currency transactions of $1.0 million and a decrease in interest income of $1.1 million. Interest income was $1.0 million during the nine months ended September 30, 2023, which was primarily earned on cash and cash equivalents and short-term investments. Interest income during the nine months ended September 30, 2022 represented a gain associated with an interest rate swap of $2.2 million.

#### Provision for income taxes

Provision for income taxes was $9.0 million for the nine months ended September 30, 2023 compared to $6.3 million for the nine months ended September 30, 2022, an increase of $2.7 million, or 43%. The Company’s effective tax rate was 23.8% for the nine months ended September 30, 2023 compared to 22.9% for the nine months ended September 30, 2022 primarily due to the change in the non-taxable non-controlling interest income.

#### Net income

Net income was $29.0 million for the nine months ended September 30, 2023 compared to $21.3 million for the nine months ended September 30, 2022, an increase of $7.7 million, or 36%. The increase was primarily driven by an increase in operating income of $12.2 million, partially offset by a decrease in other income, net of $1.8 million and an increase in the provision for income taxes of approximately $2.7 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 calculated as net income excluding (i) interest income, (ii) interest expense, (iii) provision for income taxes, (iv) depreciation and amortization, (v) stock-based compensation expense, (vi) secondary offering transaction costs, (vii) write-off of certain inventory items outside the normal course of business, and (viii) impairment expense and (gain) loss, net, on disposal of machinery outside the normal course of business. 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 US 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 September 30, 2023 Amount | % of Net Sales | 2022 Amount | % of Net Sales |
| --- | ---: | ---: | ---: | ---: |
| **Net income:** | **$9,140** | **8.7%** | **$6,153** | **5.6%** |
| Add (deduct): |  |  |  |  |
| Interest income | (454) | (0.4) | — | — |
| Interest expense | 536 | 0.5 | 493 | 0.4 |
| Provision for income taxes | 2,904 | 2.8 | 1,900 | 1.7 |
| Depreciation and amortization | 2,708 | 2.6 | 2,604 | 2.5 |
| Stock-based compensation expense | 250 | 0.2 | 598 | 0.5 |
| Secondary offering transaction costs (2) | 453 | 0.4 | — | — |
| Gain on disposal of machinery (1) | (310) | (0.4) | — | — |
| **Adjusted EBITDA** | **$15,227** | **14.4%** | **$11,748** | **10.7%** |

25

*(in thousands, except percentages)*

| Reconciliation of Adjusted EBITDA and Adjusted EBITDA Margin (Unaudited) | Nine Months Ended September 30, 2023 Amount | % of Net Sales | 2022 Amount | % of Net Sales |
| --- | ---: | ---: | ---: | ---: |
| **Net income:** | **$29,003** | **9.4%** | **$21,296** | **6.4%** |
| Add (deduct): |  |  |  |  |
| Interest income | (1,040) | (0.3) | (2,160) | (0.7) |
| Interest expense | 1,516 | 0.5 | 1,576 | 0.5 |
| Provision for income taxes | 9,045 | 2.9 | 6,323 | 1.9 |
| Depreciation and amortization | 8,058 | 2.6 | 7,752 | 2.4 |
| Stock-based compensation expense | 743 | 0.2 | 1,774 | 0.6 |
| Secondary offering transaction costs (2) | 453 | 0.1 | — | — |
| Write-off of inventory (1) | 1,710 | 0.6 | — | — |
| Impairment expense and loss, net, on disposal of machinery (1) | 2,135 | 0.6 | — | — |
| **Adjusted EBITDA** | **$51,623** | **16.6%** | **$36,561** | **11.1%** |

(1) The write-off of inventory and impairment expense and (gain) loss, net, on disposal of machinery represent costs incurred in connection with the scaling back of production in the U.S. As part of the execution of this strategy, certain machinery and equipment was disposed of or impaired, and raw materials associated with those machinery and equipment were written-off.

(2) Secondary offering transaction costs represent legal and professional fees incurred in connection with the completion of the secondary offering, which were directly related to the offering and were incremental to our normal operating expenses.

### 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%. On June 20, 2023, we amended the Line of Credit which increased the standby letter of credit sublimit from $2 million to $5 million. As of September 30, 2023, the amount issued under the standby letter of credit was $3.7 million, and the maximum remaining amount that could be borrowed under the Line of Credit was $36.3 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 September 30, 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 September 30, 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 September 30, 2023, we had no outstanding balance on the Line of Credit, $28.3 million in outstanding balance under the 2027 Term Loan, and $21.7 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, we entered into a joint venture agreement (the "JV Agreement") in April 2022 to establish a new corporation, Bio Earth, to build a bagasse factory in Taiwan. Through March 31, 2023, we had made net payments totaling $6.0 million as stipulated in the JV Agreement. In May 2023, we entered into a share transfer agreement to sell all of our equity interest in Bio Earth to Keary Global. Concurrent with the share transfer agreement, the Company also 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. As of the end of the second quarter of 2023, the share transfer to Keary Global had been completed and we received the full amount of the total consideration owed to us in connection with the sale of our equity interest in Bio Earth of $6.1 million, representing the original deposits totaling $6.0 million plus interest which accrued at 5% per annum.

Additionally, as described in Note 19 — *Subsequent Events* in the Notes to the condensed consolidated financial statements, on November 6, 2023, our Board of Directors declared a regular quarterly dividend of $0.20 per share on our common stock, which will be paid on or around November 30, 2023 to shareholders of record at the close of business on November 20, 2023. Prior to this, we paid out special and regular quarterly dividend totaling $16.9 million in the current fiscal year.

As described in Note 14 — *Impairment Expense and (Gain) Loss, Net, on Disposal of Machinery,* in February 2023, management started to pivot into a more asset-light growth model by increasing import and scaling back manufacturing in certain locations. As part of the execution of this strategy, management reached an agreement with two unrelated third-party vendors in Taiwan to sell them certain of our manufacturing machinery and equipment. We also cancelled certain equipment purchase commitments that we had previously paid deposits towards. We expanded our efforts to scale back manufacturing across all U.S. manufacturing facilities in the third and fourth quarter of 2023. As of September 30, 2023, we had received $0.5 million in deposit refunds and $0.6 million from sale of the machinery and equipment. We expect to receive approximately $1.9 million in additional net cash proceeds from sale of the various manufacturing equipment in the next 12 months.

As described in Note 16 — *Income Taxes*, in March 2023, the Internal Revenue Service ("IRS"), under the Winter Storm Relief, announced that taxpayers in California affected by severe winter storms, flooding, landslides, and mudslides have until November 15, 2023, to file various individual and business tax returns and make tax payments. We took advantage of this tax relief and deferred current year quarterly estimate tax payment until October 2023 when we made a tax payment of approximately $9.6 million.

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 September 30, 2023 compared to December 31, 2022:

*(in thousands)*

|  | September 30, 2023 | December 31, 2022 | Increase/(Decrease) |
| --- | ---: | ---: | ---: |
| Current assets | $158,689 | $123,800 | $34,889 |
| Current liabilities | 45,697 | 39,253 | 6,444 |
| Working capital | $112,992 | $84,547 | $28,445 |

As of September 30, 2023, we had working capital of $113.0 million compared to working capital of $84.5 million as of December 31, 2022, representing an increase of $28.4 million, or 34%. The improvement in working capital was driven by an increase of $34.9 million in current assets partially offset by an increase of $6.4 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 $30.2 million and an increase in account receivable of $4.1 million. The increase in current liabilities was primarily driven by an increase of $8.0 million in income taxes payable primarily due to the deferral of federal and California state income taxes under the Winter Storm Relief declared by the Internal Revenue Service partially offset by a decrease of $1.6 million in accounts payable and related party payables.

### Cash Flows

The following table summarizes cash flow for the nine months ended September 30, 2023 and 2022:

*(in thousands)*

|  | Nine Months Ended September 30, 2023 | 2022 |
| --- | ---: | ---: |
| Net cash provided by operating activities | $43,088 | $12,499 |
| Net cash used in investing activities | (21,341) | (16,577) |
| Net cash (used in) provided by financing activities | (9,626) | 5,126 |
| Net change in cash and cash equivalents | $12,121 | $1,048 |

*Cash flows provided by operating activities.* Net cash provided by operating activities was $43.1 million for the nine months ended September 30, 2023, primarily the result of net income of $29.0 million, adjusted for certain non-cash items totaling $17.2 million, consisting mainly of depreciation and amortization of fixed assets and operating right-of-use assets, write-off of inventory, loss, net, on disposal of machinery, stock-based compensation, adjustments to allowance for doubtful accounts, and impairment of deposit. In addition, cash decreased $3.1 million, primarily as a result of changes in working capital, which included a decrease of $3.6 million from inventory build-up, a decrease of $3.4 million from an increase in accounts receivable, a decrease of $3.3 million from a reduction in operating lease liabilities, and a decrease of $0.7 million from lower accounts and related party payables, partially offset by an increase of $8.0 million from the deferral of federal and California state income taxes under the Winter Storm Relief declared by the IRS. Net cash provided by operating activities was $12.5 million for the nine months ended September 30, 2022, primarily the result of net income of $21.3 million, adjusted for certain non-cash items totaling $11.8 million, consisting mainly of depreciation and amortization of fixed assets and operating right-of-use assets, change in fair value of interest rate swap, stock-based compensation, and adjustments to allowance for doubtful accounts and inventory reserves. In addition, cash decreased $20.6 million, primarily as a result of changes in working capital, which included a decrease of $15.3 million from inventory build-up, a decrease of $5.1 million from an increase in accounts receivable, a decrease of $2.9 million from a reduction in operating lease liabilities, and a decrease of $2.3 million from a higher balance of prepaid expenses and other current assets, partially offset by an increase of $3.3 million from higher accounts and related party payables, and an increase of $1.1 million from higher accrued expenses.

*Cash flows used in investing activities.* Net cash used in investing activities was $21.3 million for the nine months ended September 30, 2023, which primarily included $18.0 million in net purchases of short-term investments, $5.4 million of deposits paid for the purchase of property and equipment, and $2.9 million paid to directly purchase property and equipment, partially offset by $4.0 million of net refund from the joint venture investment, $0.6 million of proceeds from the sale of machinery and equipment, and $0.5 million of deposits refunded from cancelled machinery orders. Net cash used in investing activities was $16.6 million for the nine months ended September 30, 2022, which included $11.5 million of deposits paid for the purchase of property and equipment, $4.0 million of investment made pursuant to the JV Agreement, and $2.0 million paid to purchase property and equipment, partially offset by proceeds of $0.8 million for the settlement of the interest rate swap.

*Cash flows (used in) provided by financing activities.* Net cash used in financing activities was $9.6 million for the nine months ended September 30, 2023, which primarily included $16.9 million of cash dividends paid to shareholders, and $0.7 million of term loan repayments, partially offset by $8.0 million of additional borrowings under the 2027 Term Loan. Net cash provided by financing activities was $5.1 million for the nine months ended September 30, 2022, which primarily included additional borrowing under the 2026 Term Loan of $6.9 million, and borrowings under the 2027 Term Loan of $20.6 million, partially offset by $21.3 million of term loan repayments, and $1.1 million of noncontrolling interest tax withholding payment.

### Related Party Transactions

For a description of significant related party transactions, see Note 15 — *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, 9,374 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 September 30, 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 September 30, 2023 due to the material weaknesses described in Part II—Item 9A of the Form 10-K for the year ended December 31, 2022 filed with the SEC on March 16, 2023.

### Material Weaknesses in Internal Control over Financial Reporting

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 registrant's annual or interim financial statements will not be prevented or detected on a timely basis.

Refer to the management report on internal control over financial reporting for the material weaknesses in Part II—Item 9A of the Form 10-K for the year ended December 31, 2022 filed with the SEC on March 16, 2023. The same material weaknesses continue to exist as of September 30, 2023. Each of the material weaknesses could result in a misstatement of certain 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.

#### Actions Taken During the Year Ended December 31, 2022

The following remedial actions were taken in the prior fiscal year:

- 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.

#### Actions Taken During the Three Months Ended March 31, 2023

The following remedial actions were taken in the first quarter of the current fiscal year:

- Improved the process of retaining evidence of sales arrangements with customers including adopting a required retention period for applicable customer purchase orders.
- Management held additional training for warehouse employees to appropriately perform and document the three-way match between sales orders, shipping documents, and sales invoices.
- Enhanced training programs for personnel that provide key information and perform key roles associated with ICFR. Management designed 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.
- Management enhanced 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.
- Management adopted a Company-wide approval matrix that establishes clear guidelines on authority levels for all types of cash disbursement transactions.

#### Actions Taken During the Three Months Ended June 30, 2023

The following remedial actions were taken in the second quarter of the current fiscal year:

- Enhanced policies and procedures to improve Information Technology General Controls and the Company's overall IT environment. Examples of some of management's efforts include:
- Adopted the policy and procedure to regularly perform a thorough review of user's access rights relating to the Company's significant information technology systems;
- Maintained and monitored restrictions to user access where needed to allow for appropriate segregation of duties; and
- Maintained and enforced procedures and controls around system development and change management.
- Management has reviewed user access and established 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.

#### Actions Taken During the Three Months Ended September 30, 2023

The following remedial actions were taken in the third quarter of the current fiscal year:

- Updated and enhanced the standard operating procedures of year-end physical counts to ensure all inventory items are counted at all warehouses in a consistent manner.
- Developed and adopted IT policies around software development and implementation, information security, data backup, and change management.
- Continued 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.

#### Ongoing Remediation Efforts

The following remedial actions are currently in the process of being taken or completed:

- Continue to evaluate the Company's needs for additional personnel and add, as needed, additional headcount primarily within the accounting and information technology departments. Management continues to 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.

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

Other than those described above, there have been no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 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 Nov 9, 2023.
Source: SEC EDGAR, the filing index for accession 0001628280-23-038270. Last ingested by Listed: Nov 5, 2026, 17:42 ET. No prices; not investment advice.