Karat(KRT) - 2023 Q3 - Quarterly Report

PART I - FINANCIAL INFORMATION Item 1. Financial Statements This section presents the unaudited condensed consolidated financial statements, including balance sheets, income statements, statements of stockholders' equity, and cash flows, along with detailed notes explaining the company's operations, accounting policies, and specific financial items for the periods ended September 30, 2023 Condensed Consolidated Balance Sheets (Unaudited) Balance Sheet Highlights (in thousands) | Metric | Sep 30, 2023 | Dec 31, 2022 | | :-------------------------- | :----------- | :----------- | | Total Assets | $279,964 | $252,175 | | Total Liabilities | $115,211 | $100,242 | | Total Stockholders' Equity | $164,753 | $151,933 | | Cash and cash equivalents | $28,162 | $16,041 | | Short-term investments | $18,063 | $0 | | Total current assets | $158,689 | $123,800 | | Total current liabilities | $45,697 | $39,253 | Condensed Consolidated Statements of Income (Unaudited) Income Statement Highlights (Three Months Ended Sep 30, in thousands) | Metric | 2023 | 2022 | Change (YoY) | | :-------------------------- | :--- | :--- | :----------- | | Net sales | $105,528 | $109,996 | -4.1% | | Cost of goods sold | $66,584 | $75,828 | -12.2% | | Gross profit | $38,944 | $34,168 | +14.0% | | Operating income | $11,380 | $7,910 | +43.9% | | Net income | $9,140 | $6,153 | +48.5% | | Basic EPS | $0.46 | $0.31 | +48.4% | | Diluted EPS | $0.45 | $0.31 | +45.2% | Income Statement Highlights (Nine Months Ended Sep 30, in thousands) | Metric | 2023 | 2022 | Change (YoY) | | :-------------------------- | :--- | :--- | :----------- | | Net sales | $310,069 | $330,290 | -6.1% | | Cost of goods sold | $191,120 | $227,869 | -16.2% | | Gross profit | $118,949 | $102,421 | +16.1% | | Operating income | $37,451 | $25,203 | +48.6% | | Net income | $29,003 | $21,296 | +36.2% | | Basic EPS | $1.44 | $0.96 | +50.0% | | Diluted EPS | $1.43 | $0.96 | +49.0% | Condensed Consolidated Statements of Stockholders' Equity (Unaudited) - Total stockholders' equity increased from $151,933 thousand at January 1, 2023, to $164,753 thousand at September 30, 2023[14][15] - Net income attributable to Karat Packaging Inc. for the nine months ended September 30, 2023, was $28,572 thousand[15] - Cash dividends declared for the nine months ended September 30, 2023, totaled $16,917 thousand ($0.35 per share in Q2, $0.50 per share in Q3)[14][15] Condensed Consolidated Statements of Cash Flows (Unaudited) Cash Flow Summary (Nine Months Ended Sep 30, in thousands) | Activity | 2023 | 2022 | Change (YoY) | | :-------------------------------- | :--- | :--- | :----------- | | Net cash provided by operating activities | $43,088 | $12,499 | +244.7% | | Net cash used in investing activities | $(21,341) | $(16,577) | -28.7% | | Net cash (used in) provided by financing activities | $(9,626) | $5,126 | -287.9% | | Net increase in cash and cash equivalents | $12,121 | $1,048 | +1056.6% | | Cash and cash equivalents, End of period | $28,162 | $7,531 | +274.0% | Notes to Condensed Consolidated Financial Statements 1. Nature of Operations - The Company is a manufacturer and distributor of single-use disposable products (food containers, tableware, cups, lids, cutlery, straws) in plastic, paper, and biopolymer-based forms[22] - Offers customized solutions including new product development, design, printing, and logistics services, and distributes specialty food/beverage products[22] - Operates manufacturing facilities and distribution centers in California, Texas, and Hawaii, plus seven other distribution centers[24] 2. Summary of Significant Accounting Policies - Financial statements are unaudited and prepared in accordance with US GAAP for interim information[25] - Consolidates Karat Packaging, its wholly-owned subsidiaries (Lollicup, Lollicup Franchising), and Global Wells (a variable interest entity where the Company is the primary beneficiary)[27][31] Fair Value Measurements at September 30, 2023 (in thousands) | Category | Level 1 | Level 2 | Level 3 | | :-------------------- | :------ | :------ | :------ | | Cash equivalents | $19,024 | $— | $— | | Short-term investments | $18,063 | $— | $— | | Total Fair Value | $37,087 | $— | $— | - Adopted ASU 2016-13 (CECL model) in Q1 2023, which did not have a material impact on consolidated financial statements[40] 3. Goodwill Goodwill Activity (in thousands) | Metric | Amount | | :---------------------- | :----- | | Balance at Dec 31, 2022 | $3,510 | | Goodwill acquired | $— | | Balance at Sep 30, 2023 | $3,510 | 4. Joint Venture - Company initially invested in Bio Earth joint venture for a bagasse factory in Taiwan, with a 49% interest[42] - Made net payments of $6.0 million under the JV Agreement through March 31, 2023[42][44] - Sold all equity interest in Bio Earth to Keary Global (a related party) for $6.1 million (original deposits + 5% interest) by the end of Q2 2023[45][46] 5. Inventories Inventories (in thousands) | Category | Sep 30, 2023 | Dec 31, 2022 | | :------------------ | :----------- | :----------- | | Raw materials | $9,427 | $18,061 | | Semi-finished goods | $2,413 | $1,850 | | Finished goods | $60,539 | $52,044 | | Inventory reserve | $(722) | $(749) | | Total Inventories | $71,657 | $71,206 | - Incurred inventory write-offs of $3,225 thousand for the nine months ended September 30, 2023, including $1,710 thousand for raw materials due to scaling back production[48] 6. Property and Equipment Property and Equipment, Net (in thousands) | Category | Sep 30, 2023 | Dec 31, 2022 | | :-------------------------------- | :----------- | :----------- | | Total property and equipment, net | $96,690 | $95,568 | - Depreciation and amortization expense on property and equipment was $8,038 thousand for the nine months ended September 30, 2023, up from $7,732 thousand in the prior year[51] 7. Line of Credit - The Company has a $40.0 million line of credit with Hanmi Bank, extended to March 14, 2025[52][53] - Interest rate revised to one-month SOFR + 2.50% (1.0% SOFR floor)[53] - No outstanding borrowings as of September 30, 2023; $36.3 million available[55] - Company was in compliance with all financial covenants[55] 8. Accrued Expenses Accrued Expenses (in thousands) | Category | Sep 30, 2023 | Dec 31, 2022 | | :-------------------------- | :----------- | :----------- | | Accrued miscellaneous expenses | $2,368 | $1,646 | | Accrued payroll | $1,180 | $1,586 | | Accrued shipping expenses | $1,478 | $1,918 | | Total accrued expenses | $8,858 | $9,005 | 9. Long-Term Debt Long-Term Debt (in thousands) | Category | Sep 30, 2023 | Dec 31, 2022 | | :-------------------------------- | :----------- | :----------- | | 2026 Term Loan | $21,711 | $22,168 | | 2027 Term Loan | $28,287 | $20,563 | | Long-term debt, net of current portion | $48,668 | $41,558 | - Exercised option for additional $8.0 million advances under the 2027 Term Loan in March 2023[59] - Future maturities include $20.8 million in 2026 and $26.6 million in 2027[59] 10. Interest Rate Swap - Global Wells terminated a ten-year floating-to-fixed interest rate swap in June 2022[60] - Recognized $825 thousand cash proceeds as gain on settlement, included in interest income[60] - Recognized $2,159 thousand in interest income related to the swap for the nine months ended September 30, 2022[61] 11. Stock-Based Compensation - Stock-based compensation expense for the nine months ended September 30, 2023, was $743 thousand, down from $1,774 thousand in 2022[65] - 1,334,017 shares available for further award grants under the Plan as of September 30, 2023[65] Stock Option Activity (Sep 30, 2023) | Metric | Number of Options | Weighted-Average Exercise Price | | :-------------------------------- | :---------------- | :------------------------------ | | Outstanding at Dec 31, 2022 | 420,000 | $18.6 | | Exercised | (5,800) | $17.7 | | Forfeited | (10,000) | $18.9 | | Outstanding at Sep 30, 2023 | 404,200 | $18.6 | Unvested Restricted Stock Units (Sep 30, 2023) | Metric | Number of Shares Outstanding | Weighted Average Grant Date Fair Value | | :-------------------------- | :------------------------- | :------------------------------------- | | Unvested at Dec 31, 2022 | 82,146 | $11.47 | | Vested | (4,550) | $16.64 | | Forfeited | (1,667) | $10.00 | | Unvested at Sep 30, 2023 | 75,929 | $11.19 | 12. Earnings Per Share Basic EPS (Three Months Ended Sep 30, in thousands, except per share data) | Metric | 2023 | 2022 | | :-------------------------------- | :--- | :--- | | Net income attributable to Karat Packaging Inc. | $9,065 | $6,096 | | Weighted average common shares in issue | 19,891 | 19,809 | | Basic earnings per share | $0.46 | $0.31 | Diluted EPS (Nine Months Ended Sep 30, in thousands, except per share data) | Metric | 2023 | 2022 | | :-------------------------------- | :--- | :--- | | Net income attributable to Karat Packaging Inc. | $28,572 | $19,107 | | Adjusted weighted average common shares | 19,963 | 19,922 | | Diluted earnings per share | $1.43 | $0.96 | 13. Leases Total Lease Expense (in thousands) | Period | 2023 | 2022 | | :-------------------------- | :----- | :----- | | Three Months Ended Sep 30 | $1,972 | $1,552 | | Nine Months Ended Sep 30 | $5,347 | $3,771 | - Weighted average remaining lease term is 4.41 years (Sep 30, 2023), up from 4.27 years (Dec 31, 2022)[77] - Weighted average discount rate is 5.8% (Sep 30, 2023), up from 5.3% (Dec 31, 2022)[77] - Future lease payments total $20.4 million, with $5.3 million due in 2024[77] 14. Impairment Expense and (Gain) Loss, Net, on Disposal of Machinery and Equipment - Company is executing a strategy to increase imports and scale back U.S. manufacturing[80] Impairment Expense and (Gain) Loss, Net, on Disposal of Machinery (in thousands) | Metric | 3 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2023 | | :---------------------------------------------------- | :---------------------------- | :---------------------------- | | (Gain) loss, net, on disposal of machinery in scaling back manufacturing | $(310) | $1,612 | | Impairment of deposits | $— | $523 | | Impairment expense and (gain) loss, net, on disposal of machinery | $(310) | $2,231 | 15. Related Party Transactions - Keary Global and Keary International are related parties (owned/controlled by CEO's brother) and serve as inventory suppliers and purchasing agents[82] Related Party Payables and Purchases (in thousands) | Metric | Sep 30, 2023 | Dec 31, 2022 | | :-------------------------------- | :----------- | :----------- | | Accounts payable to related parties | $2,555 | $4,940 | | Purchases from related parties (9 months) | $32,384 | $33,051 | 16. Income Taxes Income Tax Expense and Effective Tax Rate | Period | Income Tax Expense (in thousands) | Effective Tax Rate | | :-------------------------- | :------------------------------ | :----------------- | | Three Months Ended Sep 30, 2023 | $2,904 | 24.1% | | Three Months Ended Sep 30, 2022 | $1,900 | 23.6% | | Nine Months Ended Sep 30, 2023 | $9,045 | 23.8% | | Nine Months Ended Sep 30, 2022 | $6,323 | 22.9% | - Effective tax rate differs from the 21% federal statutory rate primarily due to state taxes[84] - Deferred current year quarterly estimate tax payments until October 2023 under Winter Storm Relief, making a $9.6 million payment[89][92] 17. Commitments and Contingencies - Management believes pending legal claims and proceedings are not likely to have a material effect on the Company's financial position or results of income[90] 18. Secondary Offering - Secondary public offering completed by selling stockholders on September 12, 2023[91] - Company did not receive proceeds but incurred $453 thousand in transaction costs[91] 19. Subsequent Events - Made $9.6 million tax payments in October 2023 related to deferred quarterly estimates[92] - Global Wells made a $3,956 thousand pro rata distribution to its members in October 2023[92] - Received $1,272 thousand deposit refund from cancelled machinery purchase in October 2023[93] - Declared a quarterly cash dividend of $0.20 per share on November 6, 2023, payable November 30, 2023[95] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on the company's financial condition and results of operations, highlighting key business trends, financial performance for the three and nine months ended September 30, 2023, liquidity, and capital resources, including a reconciliation of non-GAAP financial measures Overview - Karat Packaging is a rapidly-growing specialty distributor and select manufacturer of disposable foodservice products[99] - Offers a wide range of products (food containers, tableware, cups, lids, cutlery, straws, specialty beverage ingredients) in various materials, including eco-friendly options (Karat Earth® line)[99] - Provides customized solutions (new product development, design, printing, logistics) and operates strategically with a diversified global supplier network and U.S. manufacturing[99][100] Business Highlights and Trends Business Highlights (3 Months Ended Sep 30, 2023) | Metric | Amount (in millions) | Change (YoY) | | :-------------------- | :------------------- | :----------- | | Net sales | $105.5 | -4% | | Gross margin | 36.9% | +580 bps | | Net income | $9.1 | +49% | | Net income margin | 8.7% | +310 bps | | Adjusted EBITDA | $15.2 | +30% | | Adjusted EBITDA margin | 14.4% | +370 bps | Business Highlights (9 Months Ended Sep 30, 2023) | Metric | Amount (in millions) | Change (YoY) | | :-------------------- | :------------------- | :----------- | | Net sales | $310.1 | -6% | | Gross margin | 38.4% | +740 bps | | Net income | $29.0 | +36% | | Net income margin | 9.4% | +300 bps | | Adjusted EBITDA | $51.6 | +41% | | Adjusted EBITDA margin | 16.6% | +550 bps | - Financial liquidity of $64.4 million and $18.1 million in short-term investments as of September 30, 2023[104] - Quarterly cash dividend increased to $0.20 per share, declared November 6, 2023[104] Trends in Our Business - Growing trend towards at-home dining and mobility-oriented e-commerce, food delivery, and take-out dining[107] - Increased demand for eco-friendly and compostable single-use disposable products; eco-friendly sales were 33% of total sales in Q3 2023 (up from 27% in Q3 2022)[107] - Fluctuations in freight carrier costs and raw material costs (e.g., PET plastic resin, aluminum, paper boards) impact results, with potential lags in price increases[107] - Strategic pivot to a more asset-light growth model by increasing imports and scaling back U.S. manufacturing[107] Critical Accounting Estimates - No material changes in critical accounting policies, estimates, and assumptions from the 2022 Form 10-K[106] Results of Operations Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022 - Net sales decreased by $4.5 million (4%) to $105.5 million, primarily due to $10.4 million from unfavorable pricing and $1.8 million from lower logistics services, partially offset by $7.7 million from increased volume/product mix[109] - Cost of goods sold decreased by $9.2 million (12%) to $66.6 million, mainly due to an $8.0 million reduction in ocean freight and duty costs and $1.9 million in lower product costs[110] - Gross profit increased by $4.8 million (14%) to $38.9 million, with gross margin expanding to 36.9% (from 31.1%), driven by lower ocean freight costs (7.9% of net sales vs. 14.8% prior year) and shift to imports[111] - Operating expenses increased by $1.3 million (5%) to $27.6 million, primarily due to increased labor, marketing, professional fees (secondary offering), and rental expenses, partially offset by lower shipping costs[112] - Net income increased by $3.0 million (49%) to $9.1 million[117] Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022 - Net sales decreased by $20.2 million (6%) to $310.1 million, primarily due to $22.6 million from unfavorable pricing and $6.2 million from lower logistics services, partially offset by $8.6 million from increased volume/product mix[118] - Cost of goods sold decreased by $36.7 million (16%) to $191.1 million, mainly due to a $31.4 million reduction in ocean freight and duty costs and $8.0 million in lower product costs, partially offset by a $1.7 million raw materials write-off[119] - Gross profit increased by $16.5 million (16%) to $118.9 million, with gross margin expanding to 38.4% (from 31.0%), despite inventory write-offs and price reductions, primarily due to lower ocean freight costs (6.7% of net sales vs. 15.8% prior year) and shift to imports[120] - Operating expenses increased by $4.3 million (6%) to $81.5 million, including $2.2 million impairment expense and loss on disposal of machinery, and increases in labor, marketing, and rental expenses, partially offset by decreases in shipping, stock-based compensation, and bad debt expenses[121][122] - Net income increased by $7.7 million (36%) to $29.0 million[126] Non-GAAP Financial Measure - Adjusted EBITDA is calculated as net income excluding interest income/expense, income taxes, depreciation/amortization, stock-based compensation, secondary offering costs, and certain inventory write-offs/impairment expenses[130] Adjusted EBITDA and Margin (3 Months Ended Sep 30, in thousands, except percentages) | Metric | 2023 | % of Net Sales | 2022 | % of Net Sales | | :-------------------- | :--- | :------------- | :--- | :------------- | | Net income | $9,140 | 8.7% | $6,153 | 5.6% | | Adjusted EBITDA | $15,227 | 14.4% | $11,748 | 10.7% | Adjusted EBITDA and Margin (9 Months Ended Sep 30, in thousands, except percentages) | Metric | 2023 | % of Net Sales | 2022 | % of Net Sales | | :-------------------- | :--- | :------------- | :--- | :------------- | | Net income | $29,003 | 9.4% | $21,296 | 6.4% | | Adjusted EBITDA | $51,623 | 16.6% | $36,561 | 11.1% | Liquidity and Capital Resources - Primary liquidity sources are cash from operations, a $40.0 million line of credit (with $36.3 million available as of Sep 30, 2023), and promissory notes[141][142] - Working capital increased by $28.4 million (34%) to $113.0 million as of September 30, 2023, driven by increased cash, short-term investments, and accounts receivable[152] Cash Flow Summary (Nine Months Ended Sep 30, in thousands) | Activity | 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 | - Expects current cash, operations, and borrowings to meet working capital, debt service, lease payments, and capital expenditures for at least the next 12 months[150] Related Party Transactions - Refer to Note 15 for significant related party transactions[157] Recent Accounting Pronouncements - Refer to Note 2 for information on recent accounting pronouncements[158] Item 3. Quantitative and Qualitative Disclosure About Market Risk This item is not required for smaller reporting companies, and thus no disclosures are provided - Not required for smaller reporting companies[159] Item 4. Controls and Procedures This section addresses the effectiveness of the company's disclosure controls and procedures and internal control over financial reporting, identifying ongoing material weaknesses and outlining management's remediation plan Evaluation of Disclosure Controls and Procedures - Disclosure controls and procedures were not effective as of September 30, 2023[160] - Ineffectiveness is due to material weaknesses described in the 2022 Form 10-K[160] Material Weaknesses in Internal Control over Financial Reporting - Same material weaknesses in ICFR continue to exist as of September 30, 2023[162] - These weaknesses could result in material misstatements but have not led to restatements or affected current financial statement accuracy[162] Management's Remediation Plan - Remedial actions include reviewing user access rights, increasing personnel with accounting/IT knowledge, engaging third-party service providers for control design, and enhancing training programs[163][164][165] - Specific improvements include enhanced controls for inventory adjustments, a company-wide approval matrix for cash disbursements, and updated IT General Controls policies[165][166] - Remediation efforts are ongoing, with continuous assessment and expected completion during 2023[167] Changes in Internal Control Over Financial Reporting - No other material changes in ICFR during the quarter, apart from ongoing remediation efforts[168] Limitations on Effectiveness of Controls and Procedures - Controls and procedures provide only reasonable assurance due to inherent limitations and resource constraints[169] PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is involved in various routine legal proceedings, but management does not anticipate any material adverse effect on its financial condition or results of operations - No material adverse effect expected from current legal proceedings[172] Item 1A. Risk Factors There have been no material changes to the risk factors previously disclosed in the 2022 Form 10-K - No material changes to previously disclosed risk factors in the 2022 Form 10-K[173] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds No unregistered sales of equity securities or use of proceeds to report - None to report[174] Item 3. Defaults Upon Senior Securities No defaults upon senior securities to report - None to report[175] Item 4. Mine Safety Disclosures Not applicable to the Company's operations - Not applicable[176] Item 5. Other Information On November 6, 2023, the Board of Directors declared an increased quarterly cash dividend of $0.20 per share and approved compensation for executive directors commensurate with non-employee directors - Quarterly cash dividend increased to $0.20 per share, declared November 6, 2023[177] - Board approved compensation for executive directors commensurate with non-employee directors[178] Item 6. Exhibits Lists the exhibits filed with the Form 10-Q, including various agreements, certifications, press releases, and XBRL documents - Includes Separation Agreement, Employment Agreement, Business Loan Agreement, Certifications (302, 906), Press Release, and XBRL documents[179][180] SIGNATURES - Report signed by Alan Yu (CEO) and Jian Guo (CFO) on November 9, 2023[185]