UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2021

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to ______________

Commission file number 001-40336

Karat Packaging Inc.

(Exact name of registrant as specified in its charter)

Delaware	83-2237832
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
6185 Kimball Avenue, Chino, CA	91708
(Address of principal executive offices)	(Zip Code)

(626) 965-8882

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.001 par value	KRT	The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☒
		Emerging growth company	☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

The number of shares of Common Stock, $0.001 par value, outstanding on November 12, 2021 was 19,799,424 shares.

TABLE OF CONTENTS

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements	2
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3.	Quantitative and Qualitative Disclosure About Market Risk	45
Item 4.	Controls and Procedures	45
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	46
Item 1A.	Risk Factors	46
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	47
Item 4.	Mine Safety Disclosures	47
Item 5.	Other Information	47
SIGNATURES		49

i

KARAT PACKAGING INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands, except share and per share data)

PART I - FINANCIAL INFORMATION

Financial Statements

	September 30, 2021		December 31, 2020
Assets
Current assets
Cash and cash equivalents (including $0.7 million and $0.1 million associated with variable interest entity at September 30, 2021 and December 31, 2020)	$	1,679	$	448
Accounts receivable, net of allowance for doubtful accounts of $0.3 million and $0.3 million at September 30, 2021 and December 31, 2020, respectively (including $0.0 and $0.0 million associated with variable interest entity at September 30, 2021 and December 31, 2020)	33,276		23,838
Inventories	60,207		48,961
Prepaid expenses and other current assets (including $0.1 million and $0.1 million associated with variable interest entity at September 30, 2021 and December 31, 2020)	5,690		6,530
Total current assets	100,852		79,777
Property and equipment, net (including $46.9 million and $47.8 million associated with variable interest entity at September 30, 2021 and December 31, 2020, respectively)	94,041		95,533
Deposits	4,237		2,456
Goodwill	3,510		3,113
Intangible assets, net	387		—
Deferred tax asset	64		64
Other assets (including $0.0 million and $0.1 million associated with variable interest entity at September 30, 2021 and December 31, 2020)	399		161
Total assets	$	203,490	$	181,104
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable (including $0.0 million and $0.6 million associated with variable interest entity at September 30, 2021 and December 31, 2020, respectively)	$	19,028	$	20,069
Accrued expenses (including $0.4 million and $0.1 million associated with variable interest entity at September 30, 2021 and December 31, 2020, respectively)	8,161		4,959
Related party payable	2,611		5,038
Credit cards payable	131		794
Income taxes payable	106		41
Customer deposits (including $0.1 million and $0 million associated with variable interest entity at September 30, 2021 and December 31, 2020)	1,125		551
Capital leases, current portion	186		321
Debt, current portion (including $1.2 million and $0.7 million associated with variable interest entity at September 30, 2021 and December 31, 2020)	1,166		11,364
Total current liabilities	32,514		43,137

2

	September 30, 2021		December 31, 2020
Deferred tax liability	6,181		6,181
Line of credit	—		33,169
Long-term debt, net of current portion and debt discount of $0.2 million and $0.1 million at September 30, 2021 and December 31, 2020, respectively (including $35.6 million and $36.7 million associated with variable interest entity at September 30, 2021 and December 31, 2020, respectively, and debt discount of $0.2 million and $0.1 million associated with variable interest entity at September 30, 2021 and December 31, 2020, respectively)	35,629		53,410
Capital leases, net of current portion	106		290
Other liabilities (including $2.9 million and $3.9 million associated with variable interest entity at September 30, 2021 and December 31, 2020, respectively)	4,051		5,049
Total liabilities	78,481		141,236
Commitments and Contingencies (Note 13)	—		—
Karat Packaging Inc. stockholders’ equity
Common stock, $0.001 par value, 100,000,000 shares authorized, 19,737,500 and 19,714,500 shares issued and outstanding, respectively, at September 30, 2021; 15,190,000 and 15,167,000 shares issued and outstanding, respectively, at December 31, 2020	20		15
Additional paid in capital	82,656		13,981
Treasury stock, $0.001 par value, 23,000 and 23,000 shares on September 30, 2021 and December 31, 2020, respectively	(248)		(248)
Retained earnings	33,805		18,656
Total Karat Packaging Inc. stockholders’ equity	116,233		32,404
Noncontrolling interest	8,776		7,464
Total stockholders’ equity	125,009		39,868
Total liabilities and stockholders’ equity	$	203,490	$	181,104

The accompanying notes to the condensed consolidated financial statements are an integral part of these statements.

3

KARAT PACKAGING INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(In thousands, except share and per share data)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Net sales	$	102,711	$	76,317	$	272,910	$	225,137
Cost of goods sold	72,918		53,286		193,393		155,308
Gross profit	29,793		23,031		79,517		69,829
Operating expenses:
Selling expense	9,855		6,112		24,026		16,241
General and administrative expense (including $0.7 million and $0.8 million associated with variable interest entity for the three months ended September 30, 2021 and 2020, respectively; and $2.0 million and $1.4 million for the nine months ended September 30, 2021 and 2020, respectively, associated with variable interest entity)	14,573		9,877		39,485		27,948
Total operating expenses	24,428		15,989		63,511		44,189
Operating income	5,365		7,042		16,006		25,640
Other income (expense)
Rental income (including $0.2 million and $0.0 associated with variable interest entity for the three months ended September 30, 2021 and 2020, respectively; and $0.7 million and $0.0 for the nine months ended September 30, 2021 and 2020, respectively, associated with variable interest entity)	246		66		738		66
Other income	101		24		223		86
Loss on foreign currency transactions	(63)		(268)		(347)		(377)
Interest expense (including $0.3 million and $0.3 million associated with variable interest entity for the three months ended September 30, 2021 and 2020, respectively; and $0.3 million and $2.9 million for the nine months ended September 30, 2021 and 2020, respectively, associated with variable interest entity)	(308)		(847)		(1,158)		(4,858)
Gain on forgiveness of debt	—		—		5,000		—
Total other income (expense)	(24)		(1,025)		4,456		(5,083)
Income before provision for income tax	5,341		6,017		20,462		20,557
Provision for income tax	1,268		1,451		4,001		5,483
Net income	$	4,073	$	4,566	$	16,461	$	15,074
Net income (loss) attributable to noncontrolling interest	$	287	$	494	$	1,312	$	(1,521)
Net income attributable to Karat Packaging Inc.	$	3,786	$	4,072	$	15,149	$	16,595
Basic and diluted earnings per share:
Basic	$	0.19	$	0.27	$	0.84	$	1.09
Diluted	$	0.19	$	0.26	$	0.84	$	1.07
Weighted average common shares outstanding, basic	19,710,043		15,180,879		17,945,205		15,185,440
Weighted average common shares outstanding, diluted	19,881,295		15,451,879		18,110,127		15,456,440

The accompanying notes to the condensed consolidated financial statements are an integral part of these statements.

4

KARAT PACKAGING INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)

(In thousands, except share and per share data)

	Common Stock			Treasury Stock				Additional Paid-in Capital		Retained Earnings		Total Stockholders’ Equity attributable to Karat Packaging Inc.		Noncontrolling Interest		Total Stockholders’ Equity
	Shares	Amount		Shares		Amount
Balance, January 1, 2020	15,190,000	$	15	—		$	—	$	13,981	$	1,745	$	15,741	$	8,313	$	24,054
Net income (loss)	—	—		—		—		—		2,451		2,451		(1,884)		567
Balance, March 31, 2020	15,190,000	$	15	$	—	$	—	$	13,981	$	4,196	$	18,192	$	6,429	$	24,621
Treasury stock acquired	—	—		(10,000)		(107)		—		—		(107)		—		(107)
Cash dividends	—	—		—		—		—		(607)		(607)		—		(607)
Net income (loss)	—	—		—		—		—		10,072		10,072		(131)		9,941
Balance, June 30, 2020	15,190,000	$	15	(10,000)		$	(107)	$	13,981	$	13,661	$	27,550	$	6,298	$	33,848
Treasury stock acquired	—	—		(13,000)		(141)		—		—		(141)		—		(141)
Cash dividends	—	—		—		—		—		—		—		—		—
Net income (loss)	—	—		—		—		—		4,072		4,072		494		4,566
Balance, September 30, 2020	15,190,000	$	15	(23,000)		$	(248)	$	13,981	$	17,733	$	31,481	$	6,792	$	38,273

	Common Stock			Treasury Stock			Additional Paid-in Capital		Retained Earnings		Total Stockholders’ Equity attributable to Karat Packaging Inc.		Noncontrolling Interest		Total Stockholders’ Equity
	Shares	Amount		Shares	Amount
Balance, January 1, 2021	15,190,000	$	15	(23,000)	$	(248)	$	13,981	$	18,656	$	32,404	$	7,464	$	39,868
Net income	—	—		—	—		—		1,780		1,780		1,270		3,050
Balance, March 31, 2021	15,190,000	$	15	(23,000)	$	(248)	$	13,981	$	20,436	$	34,184	$	8,734	$	42,918
Issuance of common stock in connection with our initial public offering, net of issuance costs of $5,088	4,542,500	5		—	—		67,587		—		67,592		—		67,592
Stock-based compensation	—	—		—	—		240		—		240		—		240
Net income	—	—		—	—		—		9,583		9,583		(245)		9,338
Balance, June 30, 2021	19,732,500	$	20	(23,000)	$	(248)	$	81,808	$	30,019	$	111,599	$	8,489	$	120,088
Stock-based compensation	—	—		—	—		848		—		848		—		848
Issuance of common stock upon vesting of restricted stock units	5,000	—		—	—		—		—		—		—		—
Net income	—	—		—	—		—		3,786		3,786		287		4,073
Balance, September 30, 2021	19,737,500	$	20	(23,000)	$	(248)	$	82,656	$	33,805	$	116,233	$	8,776	$	125,009

The accompanying notes to the condensed consolidated financial statements are an integral part of these statements.

5

KARAT PACKAGING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

	Nine Months Ended September 30,
	2021		2020
Cash flows from operating activities
Net income	$	16,461	$	15,074
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization	7,477		6,103
Provision for bad debt	—		98
Reserve for inventory obsolescence	133		—
Gain on sales of asset	—		(19)
Change in fair value of interest rate swap	(1,298)		2,028
Amortization of loan fees	9		9
Stock-based compensation	1,088		—
Gain on forgiveness of PPP loan	(5,000)		—
(Increase) decrease in operating assets
Accounts receivable	(9,438)		(2,458)
Inventories	(11,226)		(13,187)
Prepaid expenses and other current assets	840		(2,332)
Due from affiliated companies	—		(840)
Deposits	(64)		1,739
Other assets	(238)		—
Increase (decrease) in operating liabilities
Accounts payable	(1,041)		801
Accrued expenses	3,202		1,069
Related party payable	(2,427)		1,170
Credit cards payable	(663)		(317)
Income taxes payable	65		3,088
Customer deposits	574		(11)
Other liabilities	300		285
Net cash (used in) provided by operating activities	$	(1,246)	$	12,300
Cash flows from investing activities
Purchases of property and equipment	(3,947)		(27,621)
Proceeds on disposal of property and equipment	—		24
Deposits paid for property and equipment	(3,792)		(5,640)
Effect on initial consolidation of Lollicup Franchising Inc, net of cash acquired	—		(893)
Acquisition of Pacific Cup, Inc., net of cash acquired	(900)		—
Net cash used in investing activities	$	(8,639)	$	(34,130)
Cash flows from financing activities
Proceeds from line of credit	1,470		5,190
Payments on line of credit	(34,639)		—
Proceeds from long-term debt, net of issuance cost	15,997		24,542
Payments on long-term debt	(38,985)		(5,497)
Issuance of common stock in connection with initial public offering, net of issuance costs	67,592		—
Dividends paid to shareholders	—		(607)
Payments on capital lease obligations	(319)		(285)
Treasury stock acquired	—		(248)
Net cash provided by financing activities	$	11,116	$	23,095
Net increase in cash and cash equivalents	1,231		1,265

6

	Nine Months Ended September 30,
	2021		2020
Cash and cash equivalents
Beginning of year	$	448	$	802
End of year	$	1,679	$	2,067
Supplemental disclosures of non-cash investing and  financing activities:
Capital expenditures funded by capital lease borrowings	$	—	$	23
Transfers from deposit to property and equipment	$	3,215	$	15,749
Acquisition of Pacific Cup, Inc. included within deposits	$	100	$	—
Forgiveness of PPP loan	$	5,000	$	—
Supplemental disclosures of cash flow information:
Cash paid for income tax	$	3,324	$	2,395
Cash paid for interest	$	2,472	$	2,869

The accompanying notes to the condensed consolidated financial statements are an integral part of these statements.

7

KARAT PACKAGING INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.Nature of Operations

Lollicup USA Inc. (“Lollicup”) was incorporated on January 21, 2001 under the laws of the State of California as an S-corporation. Effective January 1, 2018, Lollicup elected to convert from an S-Corporation to a C-Corporation. Karat Packaging Inc. (“Karat Packaging”) was incorporated on September 26, 2018 as a Delaware corporation and became the holding company for Lollicup (collectively, the “Company”) through a share exchange with the shareholders of Lollicup.

The Company is a manufacturer and distributor of environmentally friendly, single-use disposable products used in a variety of restaurant and foodservice settings. The Company supplies a wide range of products for the foodservice industry, including food containers, tableware, cups, lids, cutlery, and straws. The products are available in plastic, paper, biopolymer-based and other compostable forms. In 2020, the Company began to supply personal protective equipment related products to their customer such as face shields and face masks. In addition to manufacturing and distribution, the Company offers customized solutions to the customers, including new product development, design, printing, and logistics services.

The Company also supplies products to smaller chains and businesses including boutique coffee houses, bubble tea cafes, pizza parlors and frozen yogurt shops, as well as to national and regional supermarkets and convenience stores.

The Company currently operates manufacturing facilities and distribution and fulfillment center in Chino, California, Rockwall, Texas, and Kapolei, Hawaii. In addition, the Company operates three other distribution centers located in Branchburg, New Jersey, Summer, Washington and Summerville, South Carolina. The distribution and fulfillment centers are strategically located in proximity to major population centers, including the Los Angeles, New York, and Seattle metro areas. On March 1, 2021, the Company completed the acquisition of the assets of Pacific Cup Inc., a paper cup manufacturer based in Kapolei, Hawaii, which allowed the Company to expand its presence into Hawaii.

2.Summary of Significant Accounting Policies

Basis of Presentation: The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles as promulgated in the United States of America (“US GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8-3 of Regulation S-X. Accordingly, these condensed consolidated financial statements do not include all the information and footnotes required by US GAAP for complete financial statements. The financial information as of September 30, 2021 and for the three and nine months ended September 30, 2021 and 2020 is unaudited; however, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2021 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2021.

The condensed consolidated balance sheet at December 31, 2020 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by US GAAP for complete financial statements. These financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2020.

Principles of Consolidation: The condensed consolidated financial statements include the accounts of Karat Packaging and its wholly-owned operating subsidiaries, Lollicup, Lollicup Franchising, LLC (“Lollicup Franchising”) (effective September 1, 2020, refer to Note 3), Pacific Cup, Inc. (effective March 1, 2021, refer to Note 3), and Global Wells, a variable interest entity wherein the Company is the primary beneficiary. All intercompany accounts and transactions have been eliminated.

Noncontrolling Interests: The Company consolidates its variable interest entity, Global Wells, in which the Company is the primary beneficiary. The Company became the primary beneficiary of Global Wells on March 23, 2018 upon execution of an operating lease agreement allowing the Company to lease Global Wells’ facility. 

Noncontrolling interests represent third-party equity ownership interests in Global Wells. The Company recognizes noncontrolling interests as equity in the condensed consolidated financial statements separate from Company’s stockholders’ equity. The amount of net income (loss) attributable to noncontrolling interests is disclosed in the condensed consolidated statements of income.

8

KARAT PACKAGING INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Estimates and Assumptions: Management uses estimates and assumptions in preparing financial statements in accordance with US GAAP. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could differ materially from the estimates that were assumed in preparing the condensed consolidated financial statements. Estimates that are significant to the condensed consolidated financial statements include stock-based compensation, allowance for doubtful accounts, reserve for slow-moving and obsolete inventory, deferred taxes, and estimated useful lives of property and equipment, with effects of changes could result in future impairments of goodwill, intangibles, and long-lived assets.

Reporting Segment: The Company manages and evaluates its operations in one reportable segment. This segment consists of manufacturing and supply of a broad portfolio of single-use products that are used to serve food and beverages and are available in plastic, paper, foam, post-consumer recycled content and renewable materials. It also consists of the distribution of personal protective equipment related products such as face shields and face masks.

Earnings per Share: Basic earnings per common share is calculated by dividing net income attributable to Karat Packaging by the weighted average number of common shares outstanding during the related period. Diluted earnings per common share is calculated by adjusting weighted average outstanding shares, assuming conversion of all potentially dilutive shares.

Cash and cash equivalents: The Company considers all highly liquid investments purchased with an original maturity at the date of purchase of three months or less to be cash equivalents. At September 30, 2021 and December 31, 2020, cash and cash equivalents were comprised of cash held in money market, cash on hand and cash deposited with banks.

Concentration of Credit Risk: The financial instruments that potentially subject the Company to credit risk consist of cash and cash equivalents in financial institutions, which exceed federally insured limits, short-term investments, and non-affiliated trade receivables. The Company routinely assesses the financial strength of its customers and generally does not require collateral for trade receivables. Further, the Company has money market accounts which exceeded the federally insured limits by approximately $0.4 million and $0.2 million as of September 30, 2021 and December 31, 2020, respectively.

Accounts Receivable and Allowance for Doubtful Accounts: Accounts receivable consists primarily of amounts due from customers. Accounts receivable are carried at their estimated collectible amounts and are periodically evaluated for collectability based on past credit history. The Company recognizes an allowance for bad debt on accounts receivable in an amount equal to the estimated probable losses net of recoveries. The allowance is based on an analysis of historical bad debt write-offs, current past due customers in the aging as well as an assessment of specific identifiable customer accounts considered at risk or uncollectible.

Inventories: Inventories consist of raw materials, work-in-process, and finished goods. Inventory cost is determined using the first-in, first-out (FIFO) method and valued at lower of cost or net realizable value. The Company maintains reserves for excess and obsolete inventory considering various factors including historic usage, expected demand, anticipated sales price, and product obsolescence.

Property and Equipment: Property and equipment are carried at cost, net of accumulated depreciation and amortization, and net of impairment losses, if any. Depreciation of property and equipment are computed by straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized using the straight-line method over the term of the lease, or the estimated life of the improvement, whichever is less.

The estimated useful life of property and equipment are as follows:

Machinery and equipment	5 years to 10 years
Leasehold improvements	Lower of useful life or lease term
Vehicles	3 years to 5 years
Furniture and fixtures	7 years
Building	28 years to 40 years
Property held under capital leases	3 years to 5 years
Computer hardware and software	3 years

9

KARAT PACKAGING INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Normal repairs and maintenance are expensed as incurred, whereas significant changes that materially increase values or extend useful lives are capitalized and depreciated over the estimated useful lives of the related assets.

Deposits: Deposits include payments made for machinery and equipment related to the Rockwall, Texas manufacturing facility. As of September 30, 2021 and December 31, 2020, the Company had deposits of approximately $3.8 million and $1.8 million, respectively, relating to machinery and equipment for this facility. Included in deposits are also payments made to the lessors of leased properties as security for the full and faithful observance of contracts, which will be refunded to the Company upon expiration or termination of the contract.

Impairment of Long-lived Assets: The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. An impairment exists if the undiscounted cash flows generated by the Company’s long-lived assets are less than the net book value of the related assets. If the long-lived assets are impaired, an impairment loss is recognized and measured as the amount by which the carrying value exceeds the estimated fair value of those assets. For the periods ended September 30, 2021 and September 30, 2020, management concluded that an impairment write-down was not required.

Business Combination and Goodwill: The Company applies the acquisition method of accounting for business combinations in accordance with U.S. GAAP, which requires the Company to make use of estimates and judgments to allocate the purchase price paid for acquisitions to the fair value of the assets, including identifiable intangible assets, and liabilities acquired. Such estimates may be based on significant unobservable inputs. The Company’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Fair values are subject to refinement for up to one year after the closing date of an acquisition as information relative to closing date fair values becomes available. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.

Goodwill is the excess of the acquisition price over the fair value of the tangible and identifiable intangible net assets acquired. The Company does not amortize goodwill, but performs an impairment test of goodwill annually or whenever events and circumstances indicate that the carrying amount of goodwill may exceed its fair value. The Company operates as a single operating segment with one reporting unit and consequently evaluates goodwill for impairment based on an evaluation of the fair value of the Company as a whole. Goodwill is evaluated for impairment at least annually on October 1, or more frequently if events or changes in circumstances would more likely than not reduce the fair value of its single reporting unit below its carrying value. As of September 30, 2021, goodwill recorded in the accompanying condensed consolidated balance sheets is related to the Company’s acquisition of Pacific Cup, Inc. and Lollicup Franchising (see Note 3). Through September 30, 2021, the Company determined no impairments have occurred.

The following table displays a roll-forward of the carrying amount of goodwill from December 31, 2020 to September 30, 2021:

Gross carrying amount
Balance at December 31, 2020	$	3,113,000
Acquired through business combination	397,000
Balance at September 30, 2021	3,510,000
Accumulated impairment
Balance at December 31, 2020	—
Impairment loss recognized	—
Balance at September 30, 2021	—
Carrying amount at September 30, 2021	$	3,510,000

Government Grants: Government grants are not recognized unless there is reasonable assurance that the Company and Global Wells will comply with the grants’ conditions and that the grants will be received. As of September 30, 2021 and December 31, 2020, the Company received cumulative grants of $1,200,000 and $900,000, respectively. As of September 30, 2021 and

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KARAT PACKAGING INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

December 31, 2020, Global Wells received cumulative grants of $1,302,000. These grants are reported as deferred income within other liabilities in the accompanying condensed consolidated balance sheets as there are conditions attached to the grants that the Company and Global Wells have not met. These conditions include requiring its facility in Rockwall, Texas to maintain a certain minimum tax value for five calendar years (the “Required Period”), continue operations in the facility for the Required Period, have a minimum number of full time equivalent employees with a minimum average annual gross wage employed in the operation of the facility in the Required Period, and promise to not engage in a pattern or practice of unlawful employment of aliens during the Required Period. 

Derivative Instruments: Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) Topic No. 815, Derivatives and Hedging, requires companies to recognize all of its derivative instruments as either assets or liabilities in the statement of financial position at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in the statement of income during the current period.

The Company and Global Wells are exposed to certain risks relating to its ongoing business operations. The primary risks managed by using derivative instruments applicable to the Company and Global Wells is interest rate risk. Interest rate swaps are entered into to manage interest rate risk associated with the Company and Global Wells’ fixed and floating-rate borrowings. As of September 30, 2021 and December 31, 2020, Global Wells had interest rate swaps that are accounted for as a derivative instrument under ASC 815. The Company and Global Wells did not designate interest rate swaps for hedge accounting and as such, the change in fair value of interest rate swaps is recognized as interest expense in the accompanying condensed consolidated statements of income.

Variable Interest Entities: The Company has a variable interest in two entities, Global Wells and Lollicup Franchising, LLC (prior to September 30, 2020, the acquisition date, see Note 3).

Global Wells

In 2017, Lollicup along with three other unrelated parties formed Global Wells. Lollicup has a 13.5% ownership interest and a 25% voting interest in Global Wells, located in Rockwall, Texas. The purpose of this entity is to own, construct, and manage a warehouse and manufacturing facility. Global Wells’ operating agreement may require its members to make additional contributions only upon the unanimous decision of the members or where the cash in Global Wells’ bank account falls below $50,000. In the event that a member is unable to make an additional capital contribution, the other members will be required to make contributions to offset the amount that member cannot contribute, up to $25,000.

Global Wells was determined to be a variable interest entity in accordance with ASC Topic 810, Consolidations, however, at the time the investment was made, it was determined that Lollicup was not the primary beneficiary. In 2018, Lollicup entered into an operating lease with Global Wells (“Texas Lease”). The lease term for the Texas Lease is for 10 years beginning October 1, 2018 and called for a monthly lease payment of $214,500. The lease agreement was subsequently amended for the lease term to begin in May 1, 2019 and calls for a monthly lease payment of $196,000. In June 2020, the Company entered into another operating lease with Global Wells (“New Jersey Lease”). The lease term for the New Jersey Lease is for 5 years beginning July 1, 2020 and calls for a monthly lease payment of $90,128.

Upon entering into the Texas Lease with Lollicup on March 23, 2018, it was determined that Lollicup holds current and potential rights that give it the power to direct activities of Global Wells that most significantly impact Global Wells’ economic performance, receive significant benefits, or the obligation to absorb potentially significant losses, resulting in Lollicup having a controlling financial interest in Global Wells. As a result, Lollicup was deemed to be the primary beneficiary of Global Wells and has consolidated Global Wells under the risk and reward model of ASC Topic 810, for the period from March 23, 2018. The monthly lease payments for the Texas Lease and New Jersey Lease are eliminated upon consolidation.

Assets recognized as a result of consolidating Global Wells do not represent additional assets that could be used to satisfy claims against the Company’s general assets. Conversely, liabilities recognized as a result of consolidating Global Wells do not represent additional claims of the Company’s general assets; they represent claims against the specific assets of Global Wells, except for the Company’s guarantee of Global Wells’ term loans. The Company was a guarantor for Global Wells’ construction

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loan, which provided for advances up to $21,640,000 and expired in May 2019. In May 2019, Global Wells entered into a loan agreement with a financial institution and used the proceeds from the new term loan to pay off the principal balance and accrued interest related to the construction loan. In June 2020, Global Wells entered into a loan agreement with a financial institution to purchase land and building in Branchburg, New Jersey, which was also guaranteed by the Company. The Company entered into an operating lease with Global Wells to utilize the facility in Branchburg, New Jersey. As of September 30, 2021 and December 31, 2020, total loan guaranteed by the Company related to Global Wells amounted to $37,005,000 and $37,491,000, respectively. The term loans are also guaranteed by the Company’s two significant stockholders.

The following financial information includes assets and liabilities of Global Wells and are included in the accompanying condensed consolidated balance sheets, except for those that eliminate upon consolidation:

	September 30, 2021		December 31, 2020
Cash	$	689,000	$	81,000
Accounts receivable	396,000		343,000
Prepaid expenses and other current assets	87,000		98,000
Property and equipment, net	46,916,000		47,826,000
Other assets	4,882,000		5,260,000
Total assets	$	52,970,000	$	53,608,000
Accounts payable	$	29,000	$	564,000
Accrued expenses	447,000		128,000
Customer deposits	82,000		—
Due to Lollicup USA Inc.	2,620,000		2,990,000
Long-term debt, current portion	1,166,000		694,000
Long-term debt, net of current portion	35,629,000		36,697,000
Other liabilities	2,851,000		3,906,000
Total liabilities	$	42,824,000	$	44,979,000

Lollicup Franchising, LLC

Prior to the acquisition, on September 30, 2020 (see Note 3), the Company’s two major shareholders share common ownership with Lollicup Franchising. Lollicup Franchising owns and operates one store and also licenses its name to third party store owners and operators. The Company sells inventory to Lollicup Franchising and to the licensed third-party stores. In connection with the sales to third-party stores, the Company has an incentive program with Lollicup Franchising where a certain percentage of the sales to the third-party stores are paid to Lollicup Franchising. The Company has determined that the Company held a variable interest in Lollicup Franchising, however, it was determined that the Company is not the primary beneficiary.

The Company incurred incentive program expenses of $21,000 and $79,000 for the three and nine months ended September 30, 2020, respectively, which are reported as a contra to net sales in the accompanying condensed consolidated statements of income.

The Company does not have any explicit arrangements and implicit variable interest where the Company is required to provide financial support to Lollicup Franchising. The Company has determined that the maximum exposure to loss as a result of its involvement with Lollicup Franchising is zero.

Stockholder’s Equity: The Company’s Certificate of Incorporation authorizes both common and preferred stock. The total number of shares of all classes of stock authorized for issuance is 110,000,000 shares, par value of $0.001, with 10,000,000 designed as preferred stock and 100,000,000 designated as common stock. Each holder of common stock and preferred stock shall be entitled to one vote per share held.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

In June 2020, a $0.04 cents per qualifying share of dividend was declared by the Company. The Company recorded $607,000 of cash dividends as of December 31, 2020.

In June 2020, the Company re-acquired 10,000 of its own shares from an existing shareholder. The total amount paid to acquire the shares was $107,000 and has been deducted from shareholders’ equity.

In July 2020, the Company re-acquired 13,000 of its own shares from an existing shareholder. The total amount paid to acquire the shares was $141,000 and has been deducted from shareholders’ equity.

Revenue Recognition: As the Company generates revenues from customers that include national distributors, fast food restaurants with multiple locations, small businesses, and those that purchase for individual consumption, the Company considers revenue disaggregated by customer type to most accurately reflect the nature and uncertainty of its revenue and cash flows that are affected by economic factors. For the three months and nine months ended September 30, 2021 and 2020, net sales disaggregated by customer type consists of the amounts shown below.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
National	$	22,894,000	$	18,426,000	$	63,493,000	$	50,092,000
Distributors	57,317,000		39,862,000		148,294,000		118,322,000
Online	14,644,000		8,928,000		39,790,000		26,472,000
Retail	7,856,000		9,101,000		21,333,000		30,251,000
Total Revenue	$	102,711,000	$	76,317,000	$	272,910,000	$	225,137,000

•National chains revenue: National chains revenue is derived from fast food restaurants with locations across multiple states. Revenue from transactions with national chains is recognized at a point in time upon transfer of control of promised products to customers. Transfer of control typically occurs when the title and risk of loss passes to the customer. Shipping terms generally indicate when the title and risk of loss have passed, which is generally when the products are shipped from our manufacturing facility to the customers.

•Distributors revenue: Distributors revenues are derived from national and regional distributors across the U.S. that purchase the Company’s products for restaurants, offices, schools, and government entities. Revenue from national distributions is recognized at a point in time upon transfer of control of promised products to customers. Transfer of control typically occurs when the title and risk of loss passes to the customer. Shipping terms generally indicate when the title and risk of loss have passed, which is generally when the products are shipped from our manufacturing facility to the customers.

•Online revenue: Online revenue is derived from small businesses such as small restaurants, bubble tea shops, coffee shops, juice bars and smoothie shops. Revenue from wholesale transactions is recognized at a point in time upon transfer of control of promised products to customers. Transfer of control typically occurs when the title and risk of loss passes to the customer. Shipping terms generally indicate when the title and risk of loss have passed, which is generally when the products are shipped from our manufacturing facility to the customers.

•Retail revenue: Retail revenue is derived primarily from regional bubble tea shops, boutique coffee shops and frozen yogurt shops. Revenue from retail transactions is recognized at a point in time upon transfer of control of promised products to customers. Transfer of control typically occurs when the title and risk of loss passes to the customer. Shipping terms generally indicate when the title and risk of loss have passed, which is generally when the products are shipped from our manufacturing facility to the customers.

The transaction price is the amount of consideration to which the Company expects to be entitled to in exchange for transferring goods to the customer. Revenue is recorded based on the total estimated transaction price, which includes fixed consideration and estimates of variable consideration. Variable consideration includes estimates of rebates and other sales incentives, cash discounts for prompt payment, consideration payable to customers for cooperative advertising and other program incentives, and sales returns. The Company estimates its variable consideration based on contract terms and historical experience of actual

13

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

results using the expected value method. The performance obligations are generally satisfied shortly after manufacturing and shipment as purchases made by the Company’s customers are manufactured and shipped with minimal lead time.

The Company’s contract liabilities consist of rebates and other sales incentives, consideration payable to customers for cooperative advertising and other program incentives, and sales return. As of September 30, 2021 and December 31, 2020, the contract liabilities were not considered significant to the financial statements.

Shipping and handling fees billed to a customer are recorded within net sales, with corresponding shipping and handling costs recorded in selling expense on the accompanying condensed consolidated statements of income. Shipping and handling fees billed to a customer are not deemed to be separate performance obligations as these activities occur before the customer receives the products. Shipping and handling costs included within selling expenses in the condensed consolidated statements of income for the three months ended September 30, 2021 and 2020 were $8,794,000 and $5,099,000, respectively. Shipping and handling costs included within selling expenses in the condensed consolidated statements of income for the nine months ended September 30, 2021 and 2020 were $21,285,000 and $13,164,000, respectively.

Sales taxes collected concurrently with revenue-producing activities and remitted to governmental authorities are excluded from revenue.

Sales commissions are expensed as incurred due to the amortization period being less than one year and are recorded in selling expense on the accompanying consolidated statements of income.

Advertising Costs: The Company expenses costs of print production, trade show, online marketing, and other advertisements in the period in which the expenditure is incurred. Advertising costs included in operating expenses in the condensed consolidated statements of income were $823,000 and $336,000 for the three months ended September 30, 2021 and 2020, respectively. Advertising costs included in operating expenses in the condensed consolidated statements of income were $1,843,000 and $1,126,000 for the nine months ended September 30, 2021 and 2020, respectively.

Income Taxes: The Company applies the asset and liability approach for financial accounting and reporting for income taxes. Deferred income taxes arise from temporary differences between income tax and financial reporting and principally relate to recognition of revenue and expenses in different periods for financial and tax accounting purposes and are measured using currently enacted tax rates and laws. In addition, a deferred tax asset can be generated by net operating loss carryforwards. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized. 

The Company applies ASC 740, Income Taxes, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.

The Company’s practice is to recognize potential interest and/or penalties related to income tax matters as income tax expense in the accompanying condensed consolidated statements of income. Accrued interest and penalties are included on the related tax liability in the condensed consolidated balance sheets. The Company had no uncertain tax positions as of September 30, 2021 and December 31, 2020.

Concentration of Credit Risk: Cash is maintained at financial institutions and, at times, balances exceed federally insured limits. Management believes that the credit risk related to such deposits is minimal.

The Company extends credit based on the valuation of the customers’ financial condition and general collateral is not required. Management believes the Company is not exposed to any material credit risk on these accounts.

For the three and nine months ended September 30, 2021 and 2020, respectively, purchases from the following vendor makes up greater than 10 percent of total purchases:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Keary Global Ltd. ("Keary Global") and its affiliate, Keary International, Ltd.- related parties	13.7	%	13.3	%	14.3	%	11	%

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Amounts due to the following vendors at September 30, 2021 and December 31, 2020 that exceed 10 percent of total accounts payable are as follows:

	September 30, 2021		December 31, 2020
Keary Global and its affiliate, Keary International - related parties	*		18	%
Taizhou Fuling Plastics Co., Ltd	*		11	%
Fuling Technology Co., Ltd.	24	%	*
Wen Ho Industrial Co.	12	%	*

*Amounts payable represented less than 10% of total accounts payable

No customer accounted for more than 10 percent of sales for the three and nine months ended September 30, 2021 and 2020, respectively. No customer accounted for more than 10 percent of accounts receivable as of September 30, 2021 and December 31, 2020.

Fair Value Measurements: The Company follows ASC 820, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under ASC 820 as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants.

ASC 820 establishes a hierarchy of valuation inputs based on the extent to which the inputs are observable in the marketplace. Observable inputs reflect market data obtained from sources independent of the reporting entity and unobservable inputs reflect the entity’s own assumptions about how market participants would value an asset or liability based on the best information available.

Valuation techniques used to measure fair value under ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value.

The following describes the hierarchy of inputs used to measure fair value and the primary valuation methodologies used by the Center for financial instruments measured at fair value on a recurring basis. The three levels of inputs are as follows:

Level 1 — Quoted prices in active markets for identical assets or liabilities that the Center has the ability to access as of the measurement date.

Level 2 — Inputs that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the same term of the assets or liabilities.

Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Financial assets are considered Level 3 when their fair values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable.

The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

At September 30, 2021 and December 31, 2020, the Company has financial instruments classified within the fair value hierarchy, which consist of the following:

•Interest rate swaps that meets the definition of a derivative, classified as Level 2 within the fair value hierarchy, and reported as an asset or liability depending on its fair value on the condensed consolidated balance sheet. The fair value of interest rate swaps is calculated using pricing models that will use volatility to quantify the probability of changes around interest rate trends.

•Money market account, classified as Level 1 within the fair value hierarchy, and reported as a current asset on the condensed consolidated balance sheets.

The following table summarizes the Company’s fair value measurements by level at September 30, 2021 for the assets and liabilities measured at fair value on a recurring basis:

	Level 1		Level 2			Level 3
Cash equivalents	$	699,000	$	—		$	—
Interest rate swaps	—		(1,549,000)		*	—
Fair value, September 30, 2021	$	699,000	$	(1,549,000)		$	—

*See Note 9 for further discussion on interest rate swaps.

The following table summarizes the Company’s fair value measurements by level at December 31, 2020 for the assets and liabilities measured at fair value on a recurring basis:

	Level 1		Level 2		Level 3
Cash equivalents	$	448,000	$	—	$	—
Interest rate swaps	—		(2,847,000)		—
Fair value, December 31, 2020	$	448,000	$	(2,847,000)	$	—

The Company has not elected the fair value option as presented by ASC 825, Fair Value Option for Financial Assets and Financial Liabilities, for the financial assets and liabilities that are not otherwise required to be carried at fair value. Under ASC 820, material financial assets and liabilities not carried at fair value, including accounts receivable, accounts payable, and borrowing under promissory notes, are reported at their carrying value.

The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, and accrued and other liabilities approximate fair value because of the short maturity of these instruments. The carrying amounts of long-term debt and line of credit at September 30, 2021 and December 31, 2020 approximates fair value because the interest rate approximates the current market interest rate. The fair value of these financial instruments was determined using level 2 inputs.

Foreign Currency: The Company includes gains or losses from foreign currency transactions, such as those resulting from the settlement of foreign receivables or payables, in the consolidated statements of operations. The Company recorded a loss on foreign currency transactions of $63,000 and $268,000 for the three months ended September 30, 2021 and 2020, respectively. The Company recorded a loss on foreign currency transactions of $347,000 and $377,000 for the nine months ended September 30, 2021 and 2020, respectively.

Stock-Based Compensation: The Company recognizes stock-based compensation expense related to employee stock options in accordance with ASC 718, Compensation — Stock Compensation. This standard requires the Company to record compensation expense equal to the fair value of awards granted to employees and non-employees.

The fair value of share-based payment awards is estimated on the grant-date using the Black-Scholes option pricing model. Key input assumptions used in the Black-Scholes option pricing model to estimate the grant date fair value of stock options include

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

the fair value of the Company’s common stock, the expected option term, the expected volatility of the Company’s stock over the option’s expected term, the risk-free interest rate, and the Company’s expected annual dividend yield.

The risk-free interest rate assumption for options granted under the 2019 Stock Incentive Plan is based upon observed interest rates on the United States government securities appropriate for the expected term of the Company’s stock options.

The expected term of employee stock options under the Plan represents the weighted-average period that the stock options are expected to remain outstanding. The expected term of options granted is calculated based on the “simplified method,” which estimates the expected term based on the average of the vesting period and contractual term of the stock option.

The Company determined the expected volatility assumption using the frequency of daily historical prices of comparable public company’s common stock for a period equal to the expected term of the options.

The dividend yield assumption for options granted under the Plan is based on the Company’s history and expectation of dividend payouts.

Stock-based compensation expense is based on awards that ultimately vest. Forfeitures are accounted for as they occur. The Company has elected to treat stock-based payment awards with graded vesting schedules and time-based service conditions as separate awards and recognizes stock-based compensation expense over the requisite service period using the graded vesting attribution method. 

The determination of stock-based compensation is inherently uncertain and subjective and involves the application of valuation models and assumptions requiring the use of judgment. If the Company had made different assumptions, its stock-based compensation expense, and its net loss could have been significantly different.

New and Recently Adopted Accounting Standards: The Company is an emerging growth company as that term is used in the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act"), and as such, the Company have elected to take advantage of certain reduced public company reporting requirements. In addition, Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, or the Securities Act, for complying with new or revised accounting standards, as a result, the Company will adopt new or revised accounting standards on the relevant dates in which adoption of such standards is required for private companies.

In February 2016, the FASB issued ASU 2016-2 (Topic 842), “Leases”. This ASU amends a number of aspects of lease accounting, including requiring lessees to recognize operating leases with a term greater than one year on their balance sheet as a right-of-use asset and corresponding lease liability, measured at the present value of the lease payments. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and early adoption is permitted. The FASB subsequently issued ASU 2018-11 (Topic 842), “Leases: Targeted Improvements” which amends ASC 842 in two important areas, including (i) allowing lessors to combine lease and associated nonlease components by class of underlying asset in contracts that meet certain criteria and, (ii) provides entities with an optional method for adopting the new leasing guidance by recognizing a cumulative-effect adjustment to the opening balance of the retained earnings, and not to restate the comparative periods presented at the adoption date. The effective date for ASC 842 for public business entities is annual reporting periods beginning after December 15, 2018. The effective date for all other entities is annual reporting periods beginning after December 15, 2021. The Company elects to adopt the new standard in annual reporting period beginning after December 15, 2021, and is currently assessing the impact of this standard on the Company’s consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13 “Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” which adds to U.S. GAAP an impairment model known as the current expected credit loss (CECL) model that is based on expected losses rather than incurred losses. Under the new guidance, an entity recognizes as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of such losses. The ASU is also intended to reduce the complexity of U.S. GAAP by decreasing the number of credit impairment models that entities use to account for debt instruments. The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years for public business entities that are U.S. Securities and Exchange Commission (SEC) filers. For all other public business entities, the ASU is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. For all other entities, the ASU is effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. Early adoption is permitted beginning after December 15, 2018,

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including interim periods within those fiscal years. The FASB subsequently issued ASU 2019-10 (Topic 326), “Financial Instruments-Credit Losses: Effective Dates” which amends the effective date for SEC filers that are eligible to be ‘smaller reporting companies’, non-SEC filers and all other companies, including not-for-profit companies and employee benefit plans. For calendar-year end companies that are eligible for the deferral, the effective date is January 1, 2023. The Company elects to adopt the new standard in annual reporting period beginning after January 1, 2023, and is currently assessing the impact of this standard on the Company’s consolidated financial statements.

In June 2018, the FASB issued ASU 2018-7 (Topic 718), “Compensation — Stock Compensation: Improvements to Non-employee Share based Payment Accounting”, which supersedes Subtopic 505-50 and expands the scope of ASC Topic 718 to include share-based payments issued to nonemployees for goods and services. The amendments also clarify that Topic 718 does not apply to share-based payments used to effectively provide financing to the issuer or awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under ASC Topic 606. The FASB subsequently issued ASU 2019-8 (Topic 718), “Compensation — Stock Compensation” which clarifies guidance in Topic 718 on measurement and classification of share-based payments to customers. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. For all other entities, the ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted, but no earlier than a company’s adoption date of Topic 606. The Company adopted this ASU as of January 1, 2020 and adoption of this guidance did not have a material impact on the Company’s financial position, results of operations and cash flow.

In August 2018, the FASB issued ASU 2018-13 “Fair Value Measurement (Topic 820) Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement”. The guidance in this ASU eliminates certain disclosure requirements for fair value measurements for all entities, requires public entities to disclose certain new information and modifies some disclosure requirements. Entities are no longer required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy but require public companies to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. Certain provisions are applied prospectively while others are applied retrospectively. This ASU is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. The Company adopted this ASU as of January 1, 2020 and adoption of this guidance did not have a material impact on the Company’s financial position, results of operations and cash flow.

In December 2019, the FASB issued ASU 2019-12 “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes”. The guidance in this ASU eliminates certain exceptions for recognizing deferred taxes for investments, performing intraperiod allocation and calculating income taxes in interim periods. The ASU also adds guidance to reduce complexity in certain areas, including recognizing deferred taxes for tax goodwill and allocating taxes to members of a consolidated group. For public entities, the amendments in this Update are effective for fiscal years, beginning after December 15, 2020. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Early adoption of the amendment is permitted. As part of the IPO relief provided to emerging growth companies ("EGC"), an EGC may elect to adopt new standards on the timeline afforded a private company. The Company elects to adopt the new standard in annual reporting period beginning after December 15, 2021, and is currently assessing the impact of this standard on the Company’s consolidated financial statements.

In March 2020, the FASB issued ASU 2020-3 “Codification Improvements to Financial Instruments”. The guidance in this ASU clarifies the requirement for all entities to provide the fair value option disclosures in paragraphs 825-10-50-24 through 50-32 of the FASB’s ASC. The guidance also clarifies that the contractual term of a net investment in a lease determined in accordance with ASC 842, “Leases”, should be the contractual term used to measure expected credit losses under ASC 326, “Financial Instruments — Credit Losses”. This ASU is effective upon adoption of the amendments in ASU 2016-13. Early adoption is not permitted before an entity’s adoption of ASU 2016-13.

3.Acquisitions

Pacific Cup, Inc.

On March 1, 2021, Lollicup entered into an asset purchase agreement (“the Pacific Cup Agreement”) with Pacific Cup, Inc. (“Pacific Cup”), a manufacturer and distributor of disposable products operating in Kapolei, Hawaii. Pursuant to the Pacific

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KARAT PACKAGING INC.

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Cup Agreement, Lollicup paid cash consideration of $1,000,000 to acquire certain assets of Pacific Cup. Acquisition-related costs were immaterial.

The acquisition of Pacific Cup has been accounted for as a business combination pursuant to ASC 805, Business Combinations, using the acquisition method of accounting. The acquisition method requires, among other things, that assets acquired and liabilities assumed to be recognized at their fair values as of the acquisition date. The initial estimated fair value of assets acquired has been recognized based on management’s estimates and assumptions using information about facts and circumstances that existed at the acquisition date. The excess of the purchase price over the tangible assets is preliminarily recorded as goodwill.  

The goodwill recognized in this transaction was derived from expected opportunities to leverage Pacific Cup’s customer base, manufacturing facility, and sales force to expand the Company’s footprint. Goodwill recognized as a result of this acquisition is deductible for income tax purposes, and subject to annual impairment testing, which may give rise to deferred taxes in future periods.

The following table summarizes the assets acquired as a result of this acquisition:

Inventories	$	153,000
Property and equipment	50,000
Customer relationships	400,000
Goodwill	397,000
Total assets acquired	$	1,000,000

4.Inventories

Inventories consist of the following:

	September 30, 2021		December 31, 2020
Raw materials	$	17,092,000	$	4,251,000
Work in progress	—		133,000
Finished goods	43,790,000		45,252,000
Subtotal	60,882,000		49,636,000
Less inventory reserve	(675,000)		(675,000)
Total inventories	$	60,207,000	$	48,961,000

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KARAT PACKAGING INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

5.Property and Equipment

Property and equipment, net consist of the following:

	September 30, 2021		December 31, 2020
Machinery and equipment	$	59,975,000	$	55,528,000
Leasehold improvements	17,955,000		17,832,000
Vehicles	4,471,000		3,447,000
Furniture and fixtures	903,000		851,000
Building	35,237,000		34,134,000
Land	11,907,000		11,907,000
Property held under capital leases	828,000		1,607,000
Computer hardware and software	548,000		546,000
	131,824,000		125,852,000
Less accumulated depreciation	(37,783,000)		(30,319,000)
Total property and equipment, net	$	94,041,000	$