Karat Packaging Inc. (NASDAQ:KRT) Q1 2022 Results Conference Call May 12, 2022 5:00 PM ET Company Participants Roger Pondel - IR, PondelWilkinson Alan Yu - CEO Jian Guo - CFO Conference Call Participants Jake Bartlett - Truist Securities Brian Butler - Stifel Paul Dircks - William Blair Michael Hoffman - Stifel Operator Good day, and welcome to the Karat Packaging Inc. First Quarter 2022 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the ...

Table of Contents 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 March 31, 2022 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 ...

Risks and Challenges - The company faces significant risks related to changes in laws and regulations affecting food and beverage products, which could negatively impact customer demand [75]. - Supply chain disruptions have already affected the company, with increased freight costs and delays leading to diminished margins in 2021, and expectations of continued impacts in 2022 [78]. - Raw material inflation and shortages, particularly of polyethylene terephthalate (PET) plastic resin, could adversely affect the company's financial condition and results of operations [79]. - The competitive landscape is challenging, with larger companies potentially offering superior products or lower prices, which could hinder the company's ability to maintain or grow net sales [80]. - Economic conditions, including consumer spending trends and discretionary income, significantly influence the company's sales, with potential declines in demand due to economic uncertainty [84]. - Changes in freight carrier costs could materially impact the company's results of operations, affecting timely delivery and cost-effectiveness [83]. - The ongoing effects of COVID-19 remain unpredictable, potentially leading to increased operating costs and supply chain disruptions [90]. - The company relies on a non-exclusive supplier network, which poses risks related to timely delivery and compliance with quality standards, potentially harming margins [86]. - Labor cost inflation and the unavailability of skilled workers could disrupt the company's operations, leading to significant losses [103]. - The company may face significant risks due to potential delays or disruptions in the shipment of goods through operational ports, which could harm its business and financial condition [99]. - Inaccurate demand forecasting could lead to excess inventory or shortages, negatively impacting sales and financial performance [95]. - The company may face legal and regulatory proceedings that could harm its financial condition and results of operations, including compliance with various laws and regulations [119]. - Credit risk is a concern for the company, particularly regarding accounts receivable, which could be impacted by customers' ability to meet payment obligations during economic downturns [121]. - The company is subject to payment-related risks, including evolving regulations and potential increases in processing fees, which could affect its operations [120]. - The company may experience difficulties in managing growth, which could lead to operational challenges and impact its profitability if sales do not increase sufficiently [116]. - The company faces risks related to international operations, including potential tariffs and trade restrictions that could materially harm its business and results of operations [125]. - Tariffs could significantly raise product costs, leading to margin erosion or the need to increase prices, which may result in customer loss [126]. - The company relies on overseas manufacturers for product shipments, making it vulnerable to delays and increased costs associated with international logistics [127]. - Foreign exchange rate fluctuations, particularly with the New Taiwan Dollar, could adversely impact the company's financial condition and results of operations [130]. Financial Condition and Capital Structure - The company plans to incur significant capital expenditures for leasing additional warehouse space and investing in its E-commerce platform, which may affect its ability to service existing debt obligations [102]. - The company has identified material weaknesses in its internal control over financial reporting, which could harm its business and lead to a decline in stock price if not remediated effectively [122]. - As of December 31, 2021, the company's disclosure controls and procedures were deemed ineffective due to these material weaknesses [123]. - The company is undertaking steps to improve its internal controls, but there is no assurance that these improvements will be successful or timely [124]. - The company may pursue acquisitions, which could result in operating difficulties and adversely affect its financial condition and growth prospects [133]. - The company does not intend to pay dividends in the foreseeable future, relying on stock price appreciation for investor returns [144]. - Karat Packaging Inc. has approximately $36.7 million in outstanding indebtedness as of December 31, 2021, secured by the company's property and equipment [147]. - The company relies on cash generated from its wholly-owned subsidiary, Lollicup, for funding operations and future dividend payments [145]. - The ability of subsidiaries to distribute cash is subject to restrictions in subsidiary agreements and applicable laws, which could impact the company's operations [145]. - The company may face significant operating and financial restrictions due to its debt agreements, potentially limiting its ability to incur additional debt or transfer assets [148]. - If the company fails to comply with debt covenants, it could trigger defaults, leading to acceleration of debt repayment [148]. Corporate Governance and Compliance - As of March 1, 2022, directors and significant stockholders own 73.1% of the company's common stock, which could limit changes in corporate control [131]. - The company is classified as an "emerging growth company," allowing it to delay adopting new financial accounting standards, which may affect investor attractiveness [153]. - The company intends to take advantage of exemptions from certain reporting requirements, which could result in a less active trading market for its common stock [154]. - The company must comply with various laws and regulations as a public entity, increasing legal and financial compliance costs [157]. - Effective internal controls over financial reporting are crucial; any failure could adversely affect the company's financial position and results [159]. - The success of new product designs and developments is critical for maintaining and increasing sales, with potential costs and risks associated with product quality and market acceptance [107].

Table of Contents 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 cha ...

Financial Data and Key Metrics Changes - For Q3 2021, net sales increased by 35% year-over-year to $103 million, with adjusted EBITDA at $8.2 million, down from $9.1 million a year ago [15][24] - Gross margin for Q3 2021 was 29%, a decline of 120 basis points compared to 30.2% in the same period last year, primarily due to increased freight costs [19][23] - Operating income decreased by 24% to $5 million, with an operating margin of 5.2% compared to 9.2% for the same period last year [22] Business Line Data and Key Metrics Changes - Sales from distributors, the largest channel, grew by 44%, while sales from national chains expanded by 24% [16] - Online sales rose by 64% year-over-year, reflecting strong demand and continued investment in this channel [11][17] - Retail channel sales fell by 14% as some sales shifted to online channels [17] Market Data and Key Metrics Changes - The company experienced inventory shortages due to tight labor conditions and port delays, impacting sales capacity [11] - Gross margin was negatively affected by increased landed costs, including freight and duty fees of approximately $1.8 million [12][19] Company Strategy and Development Direction - The company is targeting net sales in the range of $93 million to $96 million for Q4 2021, representing a 34% increase at the midpoint compared to the same period last year [14] - To mitigate supply constraints, the company is increasing imports from overseas and finding new vendors [34][55] - The company is investing in additional manufacturing capacity, including new machines and hiring more staff to meet demand [63] Management's Comments on Operating Environment and Future Outlook - Management noted that demand remains strong, particularly for environmentally friendly products, and expects continued growth despite supply constraints [8][26] - The company anticipates improvements in gross margins in Q4 due to price increases and lower landed costs from inventory [13][40] - Management expressed concerns about ongoing supply chain challenges and inflationary pressures impacting costs [46][68] Other Important Information - Net income for Q3 2021 was $4.1 million, down from $4.6 million in the same period last year, with diluted earnings per share of $0.19 compared to $0.26 [23] - The effective tax rate was 24% for both periods, with expectations to remain in the mid-20% range for 2021 [22] Q&A Session Summary Question: Supply constraints and seasonality impact - Management confirmed that demand is currently higher than supply, which may lessen the typical seasonal decline in Q4 [30][31] Question: Future supply improvements - Management indicated that supply constraints are expected to persist into 2022, particularly for paper products, but they are working to increase inventory from overseas [33][34] Question: Gross margin expectations - Management expects gross margins to improve in Q4 due to price increases and lower costs from inventory [40][41] Question: Restaurant customer insights - Management reported strong demand for takeout and delivery, with some customers seeing a 30% to 40% increase in holiday season takeout [43][44] Question: Year-over-year price inflation - Management noted significant price increases due to rising labor and freight costs, with no signs of price stability [45][46] Question: EBITDA margin guidance - Management reaffirmed the target of 9% to 11% EBITDA margin for the year-end, expecting strong performance in Q4 [50][51] Question: Manufacturing capacity expansion - Management is actively adding manufacturing capacity and hiring more staff to meet increased demand [63] Question: Impact of port penalties - Management estimated that potential penalties from the Port of Los Angeles could add significant costs, impacting overall inflation [65][68]

Financial Performance - Net sales for the three months ended June 30, 2021, were $94.5 million, an increase of $9.8 million or 12% compared to $84.7 million for the same period in 2020[158]. - Gross profit decreased by $0.8 million or 3% to $28.1 million, with a gross profit margin of 29.7%, down from 34.1% in the prior year[162]. - Operating income for the three months ended June 30, 2021, was $6.9 million, a decrease of $7.6 million or 53% compared to $14.5 million in the same period in 2020[164]. - Net income for the three months ended June 30, 2021, was $9.3 million, a decrease of $0.6 million or 6% from $9.9 million in the prior year[166]. - Adjusted EBITDA for the three months ended June 30, 2021, was $10.1 million, a decrease of $6.4 million or 39% compared to $16.5 million in the same period in 2020[168]. - Net sales increased by $21.4 million, or 14%, to $170.2 million for the six months ended June 30, 2021, compared to $148.8 million for the same period in 2020[171]. - Adjusted EBITDA decreased by $5.5 million, or 25%, to $16.9 million for the six months ended June 30, 2021, compared to $22.4 million for the same period in 2020[180]. - Gross profit increased by $2.9 million, or 6%, to $49.7 million for the six months ended June 30, 2021, with a gross profit margin of 29.2%, down from 31.4% in the prior year[175]. - Net income increased by $1.9 million, or 18%, to $12.4 million for the six months ended June 30, 2021, compared to $10.5 million for the same period in 2020[179]. Expenses and Costs - Cost of goods sold increased by $10.6 million or 19% to $66.4 million for the three months ended June 30, 2021, primarily due to an increase in product costs and freight expenses[159]. - Operating expenses rose by $6.8 million or 47% to $21.2 million, driven by increased shipping costs, payroll-related costs, and rent expenses[163]. - Operating expenses rose by $10.9 million, or 39%, to $39.1 million for the six months ended June 30, 2021, primarily due to increased shipping and payroll-related costs[176]. Customer Acquisition and Market Trends - The company acquired more than 9,000 new customers in the three months ended June 30, 2021, contributing to increased product sales[158]. - The company anticipates a positive impact on operations from the growing trend towards eco-friendly and compostable single-use products due to environmental concerns[184]. - Personal protective equipment sales have declined to under 1% of net sales for the first two fiscal quarters of 2021, indicating a shift in product focus[186]. Capital Expenditures and Investments - Cash and cash equivalents were approximately $7.7 million as of June 30, 2021, with expected capital expenditures of $6.3 million for the next twelve months[189]. - The company has commitments for capital expenditures not expected to exceed $6.3 million, primarily for manufacturing equipment in Texas[193]. - The Company acquired a warehouse building in Summerville, SC for $1.1 million, adding an additional distribution facility expected to be operational by September 2021[232]. - The company anticipates future capital expenditures of up to $3.2 million for manufacturing equipment in Texas[205]. Debt and Financing - Total enforceable and legally binding obligations as of June 30, 2021 amounted to $122.3 million, with long-term debt accounting for $37.2 million[206][209]. - The line of credit had approximately $3.2 million outstanding as of June 30, 2021, down from $33.2 million at December 31, 2020[199]. - Net cash provided by financing activities for the six months ended June 30, 2021 was $14.8 million, compared to $24.0 million in the same period of 2020[194]. - The company received $5.0 million under the Paycheck Protection Program, which was fully forgiven on June 10, 2021[202][203]. - The company maintains a minimum debt service coverage ratio of 1.20 to 1.00 as per its loan agreements[195][200]. - The company recorded a gain of $5.0 million from the forgiveness of the PPP loan in its income statement for the six months ended June 30, 2021[203]. Compliance and Accounting - As of June 30, 2021, the company was in compliance with all covenants included in its business loan agreements[198][201]. - The Company is an emerging growth company and has elected to take advantage of reduced public company reporting requirements under the JOBS Act[224]. - The Company plans to adopt new accounting standards in the annual reporting period beginning after December 15, 2021, and is currently assessing the impact on its consolidated financial statements[230]. - The FASB issued ASU 2016-02, requiring lessees to recognize operating leases on their balance sheet as a right-of-use asset and corresponding lease liability[225]. - The Company is currently considered a smaller reporting company, which affects its market risk disclosures[233]. - The Company periodically reviews the recoverability of deferred tax assets and provides valuation allowances as deemed necessary by management[219]. - Adequate provisions for income taxes have been made for all years, with management making judgments on tax law interpretations that may be challenged upon audit[220]. - The Company adopted ASU 2018-07 as of January 1, 2020, which did not have a material impact on its financial position or results of operations[228].

Karat Packaging, Inc. (NASDAQ:KRT) Q2 2021 Earnings Conference Call August 12, 2021 5:00 PM ET Company Participants Roger Pondel - PondelWilkinson Alan Yu - Chairman & CEO Ann Sabahat - CFO Conference Call Participants Jake Bartlett - Truist Securities Michael Hoffman - Stifel, Nicolaus & Company Ryan Merkel - William Blair & Company Operator Good afternoon, and welcome to the Karat Packaging Second Quarter 2021 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over ...

Financial Data and Key Metrics Changes - Net sales for Q1 2021 increased by 18% to $76 million compared to the same period last year [13] - Gross profit rose by 21% to $22 million, with a gross margin increase of 70 basis points despite higher freight costs [14] - Operating income declined by 8% due to increased operating expenses, with operating margin decreasing by 140 basis points [14][15] - Net income amounted to $3 million, up from less than $1 million in Q1 2020, with net income attributable to Karat Packaging at $1.8 million or $0.12 per diluted share [16] - Adjusted EBITDA increased slightly to $6.8 million, with a consolidated adjusted EBITDA margin declining by 30 basis points to 9% [17] Business Line Data and Key Metrics Changes - Sales to distributors, the largest channel, grew by 18%, while online sales surged by 82% [13] - Sales to national chains also increased by 18%, but retail channel sales fell by 29% due to a shift towards online ordering [13][14] - The take-out container segment grew to $11 million, representing 15% of revenue, while cup-related products accounted for approximately $20 million or 25% of total revenue [51] Market Data and Key Metrics Changes - The online channel's growth was attributed to a shift in consumer preference towards food delivery, with significant investments made in this area [13][14] - The company experienced a significant increase in freight costs, with ocean freight rates more than doubling compared to the previous year [11][14] - The demand for environmentally friendly products increased as restaurants reopened, contributing to the growth in online sales [10][20] Company Strategy and Development Direction - The company aims to be a leading single-source provider for a broad set of customers in disposable foodservice products, focusing on expanding its customer base and increasing online sales [9][10] - The acquisition of Pacific Cup expanded the company's manufacturing and distribution footprint, with plans to manufacture paper straws among other products [12] - The company is evaluating other acquisition targets to further enhance its market position [12] Management's Comments on Operating Environment and Future Outlook - Management expressed confidence in the ability to protect near-term margins despite cost pressures from freight and raw materials [11][20] - The company anticipates strong demand to continue in the upcoming months as the economy reopens [21] - Management noted that the competitive landscape is challenging, but the company's nimble operations provide a significant advantage [20] Other Important Information - The company completed its IPO on April 15, 2021, raising approximately $73 million in gross proceeds [18] - Capital expenditures declined year-over-year due to prior investments in manufacturing equipment and facility construction [18] Q&A Session Summary Question: Demand and Fulfillment Capabilities - Management indicated that they anticipated increased demand as the economy reopened and had proactively ordered more products to meet this demand [26][28] Question: Cost Increases and Pricing Strategy - Management confirmed that they are passing through cost increases to customers while also increasing margins through online sales [30] Question: PPE Revenue Comparison - PPE revenue in Q1 2021 was $800,000 compared to $2.5 million in Q1 2020, with expectations of minimal impact moving forward [33] Question: Revenue and EBITDA Expectations for Q2 - Management expects growth to exceed 18% in Q2 2021, excluding PPE, with organic growth projected above 30% [36] Question: Freight Costs and Online Sales Drivers - Freight costs increased significantly, but management is implementing price increases to offset these costs while also benefiting from a shift to online sales [40][44] Question: Retail Channel Weakness - Management expects the retail channel to improve as more stores reopen, despite current labor shortages affecting operations [45] Question: Product Mix and Manufacturing Capabilities - The company continues to manufacture approximately 15% of its products, with plans to increase domestic manufacturing to reduce reliance on imports [53][55] Question: Eco-Friendly Product Sales - Eco-friendly products comprised roughly 20% of total revenue in Q1 2021, showing an increase from previous quarters [62]

```markdown [PART I - FINANCIAL INFORMATION](index=4&type=section&id=PART%20I%20-%20FINANCIAL%20INFORMATION) [Item 1. Financial Statements](index=4&type=section&id=Item%201.%20Financial%20Statements) Presents Karat Packaging Inc.'s unaudited condensed consolidated financial statements and notes for Q1 2021 and Q4 2020 [Condensed Consolidated Balance Sheets (Unaudited)](index=4&type=section&id=Condensed%20Consolidated%20Balance%20Sheets%20(Unaudited)) Condensed Consolidated Balance Sheet Highlights (in thousands) | Metric | March 31, 2021 | December 31, 2020 | | :-------------------------------- | :------------- | :---------------- | | Total current assets | $76,027 | $79,777 | | Total assets | $176,870 | $181,104 | | Total current liabilities | $39,551 | $43,137 | | Total liabilities | $133,952 | $141,236 | | Total stockholders' equity | $42,918 | $39,868 | - Total assets decreased by **$4.234 million** from December 31, 2020, to March 31, 2021, primarily due to a decrease in total current assets[9](index=9&type=chunk) - Total liabilities decreased by **$7.284 million**, while total stockholders' equity increased by **$3.050 million** during the same period[9](index=9&type=chunk)[10](index=10&type=chunk) [Condensed Consolidated Statements of Income (Unaudited)](index=6&type=section&id=Condensed%20Consolidated%20Statements%20of%20Income%20(Unaudited)) Condensed Consolidated Statements of Income Highlights (in thousands) | Metric | Three months ended March 31, 2021 | Three months ended March 31, 2020 | | :-------------------------------- | :-------------------------------- | :-------------------------------- | | Net sales | $75,673 | $64,083 | | Cost of goods sold | $54,047 | $46,192 | | Gross profit | $21,626 | $17,891 | | Operating income | $3,771 | $4,088 | | Net income | $3,050 | $567 | | Net income attributable to Karat Packaging Inc. | $1,780 | $2,451 | | Basic EPS | $0.12 | $0.16 | | Diluted EPS | $0.12 | $0.16 | - Net sales increased by **18%** to **$75.673 million** in Q1 2021 from **$64.083 million** in Q1 2020[11](index=11&type=chunk) - Net income saw a significant increase of **438%** to **$3.050 million** in Q1 2021 from **$0.567 million** in Q1 2020, primarily driven by a positive shift in other income (expense)[11](index=11&type=chunk) - Despite the overall net income increase, net income attributable to Karat Packaging Inc. decreased by **27.3%** to **$1.780 million** in Q1 2021 from **$2.451 million** in Q1 2020, and basic/diluted EPS also decreased from **$0.16** to **$0.12**[11](index=11&type=chunk) [Condensed Consolidated Statements of Stockholders' Equity (Unaudited)](index=7&type=section&id=Condensed%20Consolidated%20Statements%20of%20Stockholders'%20Equity%20(Unaudited)) Condensed Consolidated Statements of Stockholders' Equity Highlights (in thousands) | Metric | March 31, 2021 | December 31, 2020 | | :-------------------------------- | :------------- | :---------------- | | Total Karat Packaging Inc. stockholders' equity | $34,184 | $32,404 | | Noncontrolling interest | $8,734 | $7,464 | | Total stockholders' equity | $42,918 | $39,868 | - Total stockholders' equity increased by **$3.050 million** from December 31, 2020, to March 31, 2021, driven by net income[13](index=13&type=chunk) - Retained earnings increased from **$18.656 million** to **$20.436 million**, reflecting the net income attributable to Karat Packaging Inc. during the period[13](index=13&type=chunk) [Condensed Consolidated Statements of Cash Flows (Unaudited)](index=8&type=section&id=Condensed%20Consolidated%20Statements%20of%20Cash%20Flows%20(Unaudited)) Condensed Consolidated Statements of Cash Flows Highlights (in thousands) | Metric | Three months ended March 31, 2021 | Three months ended March 31, 2020 | | :-------------------------------- | :-------------------------------- | :-------------------------------- | | Net cash provided by operating activities | $4,504 | $1,501 | | Net cash used in investing activities | $(2,094) | $(3,011) | | Net cash (used in) provided by financing activities | $(1,897) | $2,974 | | Net increase in cash and cash equivalents | $513 | $1,464 | | Cash and cash equivalents, end of year | $961 | $2,266 | - Net cash provided by operating activities significantly increased to **$4.504 million** in Q1 2021 from **$1.501 million** in Q1 2020[15](index=15&type=chunk) - Net cash used in investing activities decreased to **$2.094 million** in Q1 2021 from **$3.011 million** in Q1 2020, despite the acquisition of Pacific Cup, Inc[15](index=15&type=chunk) - Financing activities shifted from providing **$2.974 million** in Q1 2020 to using **$1.897 million** in Q1 2021, primarily due to payments on long-term debt[15](index=15&type=chunk) [Notes to Condensed Consolidated Financial Statements (Unaudited)](index=9&type=section&id=Notes%20to%20Condensed%20Consolidated%20Financial%20Statements%20(Unaudited)) [Note 1. Nature of Operations](index=9&type=section&id=Note%201.%20Nature%20of%20Operations) - Karat Packaging Inc. (formerly Lollicup USA Inc.) is a manufacturer and distributor of environmentally friendly, single-use disposable products for the foodservice industry, including food containers, tableware, cups, lids, cutlery, and straws, available in various materials[16](index=16&type=chunk)[17](index=17&type=chunk) - The company expanded its product offerings in 2020 to include personal protective equipment (PPE) such as face shields and masks[17](index=17&type=chunk) - Karat Packaging operates manufacturing facilities and distribution centers in California, Texas, New Jersey, Washington, and South Carolina, and acquired Pacific Cup Inc., a paper cup manufacturer in Hawaii, on March 1, 2021[19](index=19&type=chunk) [Note 2. Summary of Significant Accounting Policies](index=9&type=section&id=Note%202.%20Summary%20of%20Significant%20Accounting%20Policies) - The financial statements are unaudited and prepared in accordance with US GAAP for interim financial information, with all necessary adjustments included[20](index=20&type=chunk) - The company consolidates Karat Packaging, its wholly-owned subsidiaries (Lollicup, Lollicup Franchising, Pacific Cup), and Global Wells, a variable interest entity where the Company is the primary beneficiary[22](index=22&type=chunk) - Revenue is recognized at a point in time upon transfer of control of products to customers, with variable consideration estimated based on contract terms and historical experience[54](index=54&type=chunk)[57](index=57&type=chunk) - As an emerging growth company, Karat Packaging has elected to use the extended transition period for complying with new or revised accounting standards, including ASU 2016-02 (Leases) and ASU 2016-13 (Credit Losses), which will be adopted in annual reporting periods beginning after December 15, 2021, and January 1, 2023, respectively[89](index=89&type=chunk)[90](index=90&type=chunk)[91](index=91&type=chunk) [Note 3. Acquisitions](index=20&type=section&id=Note%203.%20Acquisitions) - On March 1, 2021, Lollicup acquired assets of Pacific Cup, Inc., a disposable product manufacturer in Hawaii, for **$1.0 million** cash, recognizing **$397,000** in goodwill[96](index=96&type=chunk)[100](index=100&type=chunk) - On September 1, 2020, Lollicup acquired **100%** membership interest in Lollicup Franchising, LLC for **$900,000** cash, recognizing **$3.113 million** in goodwill[101](index=101&type=chunk)[105](index=105&type=chunk) Preliminary Assets Acquired - Pacific Cup, Inc. (March 1, 2021) | Asset | Amount | | :-------------------- | :------- | | Inventories | $153,000 | | Property and equipment | $50,000 | | Customer relationships | $400,000 | | Goodwill | $397,000 | | **Total purchase consideration** | **$1,000,000** | Assets Acquired and Liabilities Assumed - Lollicup Franchising, LLC (September 1, 2020) | Item | Amount | | :-------------------- | :------- | | Cash | $7,000 | | Accounts receivable | $103,000 | | Inventories | $21,000 | | Property and equipment | $257,000 | | Accounts payable | $(42,000) | | Accrued expenses | $(104,000) | | Related party payable | $(2,455,000) | | Goodwill | $3,113,000 | | **Total purchase consideration** | **$900,000** | [Note 4. Inventories](index=22&type=section&id=Note%204.%20Inventories) Inventories (in thousands) | Category | March 31, 2021 | December 31, 2020 | | :--------------- | :------------- | :---------------- | | Raw materials | $4,251 | $4,336 | | Work in progress | $133 | $132 | | Finished goods | $45,252 | $42,272 | | Less inventory reserve | $(675) | $(675) | | **Total inventories** | **$48,961** | **$46,065** | - Total inventories increased by **$2.896 million** from December 31, 2020, to March 31, 2021, primarily driven by an increase in finished goods[106](index=106&type=chunk) [Note 5. Property and Equipment](index=23&type=section&id=Note%205.%20Property%20and%20Equipment) Property and Equipment, Net (in thousands) | Category | March 31, 2021 | December 31, 2020 | | :-------------------------- | :------------- | :---------------- | | Machinery and equipment | $56,278 | $55,528 | | Building | $34,134 | $34,134 | | Land | $11,907 | $11,907 | | Less accumulated depreciation | $(32,783) | $(30,319) | | **Total property and equipment, net** | **$93,865** | **$95,533** | - Total property and equipment, net, decreased by **$1.668 million** from December 31, 2020, to March 31, 2021[107](index=107&type=chunk) - Depreciation and amortization expense increased to **$2.464 million** for Q1 2021 from **$1.892 million** for Q1 2020[107](index=107&type=chunk) [Note 6. Line of Credit](index=23&type=section&id=Note%206.%20Line%20of%20Credit) - The Company has a line of credit with a maximum borrowing of **$40 million**, maturing in May 2022, with an interest rate of prime less **0.25%** (minimum **3.75%**)[108](index=108&type=chunk) - Outstanding borrowings were **$33.239 million** as of March 31, 2021, and **$33.169 million** as of December 31, 2020[108](index=108&type=chunk) - The Company was in compliance with all financial covenants (minimum current ratio, tangible net worth, debt service coverage ratio, debt to EBITDA ratio) as of March 31, 2021, and December 31, 2020[108](index=108&type=chunk) [Note 7. Accrued Expenses](index=24&type=section&id=Note%207.%20Accrued%20Expenses) Accrued Expenses (in thousands) | Category | March 31, 2021 | December 31, 2020 | | :---------------------- | :------------- | :---------------- | | Accrued expenses | $1,987 | $2,085 | | Accrued interest | $209 | $199 | | Accrued payroll | $1,339 | $1,253 | | Accrued vacation and sick pay | $631 | $496 | | Accrued shipping expenses | $478 | $433 | | Accrued legal fees | $541 | $192 | | Deferred rent liability | $325 | $301 | | **Total accrued expenses** | **$5,510** | **$4,959** | - Total accrued expenses increased by **$0.551 million** from December 31, 2020, to March 31, 2021, primarily due to increases in accrued legal fees, payroll, and vacation/sick pay[110](index=110&type=chunk) [Note 8. Long-Term Debt](index=25&type=section&id=Note%208.%20Long-Term%20Debt) Long-Term Debt Summary (in thousands) | Metric | March 31, 2021 | December 31, 2020 | | :-------------------------------- | :------------- | :---------------- | | Total long-term debt | $62,987 | $64,876 | | Less: current portion | $(11,841) | $(11,364) | | **Long-term debt, net of current portion** | **$51,048** | **$53,410** | - The Company has various term loans with maturities ranging from 2021 to 2029, secured by company assets and guaranteed by stockholders, with interest rates from **1.00%** to **5.75%**[111](index=111&type=chunk)[112](index=112&type=chunk) - A **$5.0 million** Paycheck Protection Program (PPP) loan was received in April 2020, accruing interest at **1.00%** and potentially forgivable, with payments deferred until September 2021[115](index=115&type=chunk)[116](index=116&type=chunk) - Future maturities of long-term debt as of March 31, 2021, include **$9.479 million** for the remainder of 2021 and **$19.329 million** thereafter[114](index=114&type=chunk) [Note 9. Interest Rate Swaps](index=28&type=section&id=Note%209.%20Interest%20Rate%20Swaps) - Global Wells has a **ten-year** floating-to-fixed interest-rate swap (prime vs. **5.05%** fixed) with a notional value of **$21.580 million**, maturing May 2029[118](index=118&type=chunk) - The Company has a **five-year** floating-to-fixed interest-rate swap (prime vs. **5.19%** fixed) with a notional value of **$10.000 million**, maturing May 2024[119](index=119&type=chunk) Interest Rate Swap Fair Values (in thousands) | Entity | March 31, 2021 | December 31, 2020 | | :-------------------- | :------------- | :---------------- | | Global Wells swap | $1,322 | $2,604 | | Company swap | $201 | $243 | | **Total fair value (liability)** | **$1,523** | **$2,847** | - Changes in fair value of these swaps are recognized as interest income/expense, resulting in **$1.282 million** interest income for Global Wells and **$41,000** for the Company in Q1 2021[118](index=118&type=chunk)[119](index=119&type=chunk) [Note 10. Obligations under Capital Leases](index=28&type=section&id=Note%2010.%20Obligations%20under%20Capital%20Leases) - The Company leases warehouse vehicles under capital leases expiring through 2024, with interest rates varying from **3.55%** to **6.50%**[120](index=120&type=chunk)[121](index=121&type=chunk) - Assets and liabilities under capital leases are recorded at the lower of present value of minimum lease payments or fair value, and are depreciated over their estimated useful lives[120](index=120&type=chunk) [Note 11. Stock-based Compensation](index=28&type=section&id=Note%2011.%20Stock-based%20Compensation) - The 2019 Stock Incentive Plan authorizes **2,000,000 shares** for incentive or nonqualified stock options and stock awards to employees, directors, and consultants[123](index=123&type=chunk) Stock Option Activity (March 31, 2021) | Metric | Number of Options | Weighted Average Exercise Price | | :-------------------------- | :---------------- | :------------------------------ | | Outstanding at Dec 31, 2020 | 15,000 | $10.00 | | Outstanding at Mar 31, 2021 | 15,000 | $10.00 | | Expected to vest at Mar 31, 2021 | 15,000 | $10.00 | Restricted Stock Units Activity (March 31, 2021) | Metric | Number of Shares Outstanding | Weighted Average Grant Date Fair Value | | :-------------------------- | :--------------------------- | :------------------------------------- | | Unvested at Dec 31, 2020 | 256,000 | $10.00 | | Forfeited | (35,000) | - | | Unvested at Mar 31, 2021 | 221,000 | $10.00 | - Stock-based compensation expense was not recognized for Q1 2021 and Q1 2020 as vesting was contingent upon the closing of an initial public offering, which occurred on April 15, 2021. Total remaining compensation expense for unvested restricted stock units is approximately **$2.2 million**[128](index=128&type=chunk) [Note 12. Earnings Per Share](index=30&type=section&id=Note%2012.%20Earnings%20Per%20Share) Basic and Diluted Earnings Per Share | Metric | Three months ended March 31, 2021 | Three months ended March 31, 2020 | | :-------------------------------- | :-------------------------------- | :-------------------------------- | | Net income attributable to Karat Packaging Inc. | $1,780,000 | $2,451,000 | | Weighted average common shares outstanding, basic | 15,167,000 | 15,190,000 | | Basic earnings per share | $0.12 | $0.16 | | Dilutive shares (stock options and restricted stock units) | 236,000 | 271,000 | | Adjusted weighted average number of common shares | 15,403,000 | 15,461,000 | | Diluted earnings per share | $0.12 | $0.16 | - Basic and diluted EPS decreased from **$0.16** in Q1 2020 to **$0.12** in Q1 2021, despite an increase in overall net income, due to a decrease in net income attributable to Karat Packaging Inc[130](index=130&type=chunk)[131](index=131&type=chunk) [Note 13. Commitments and Contingencies](index=31&type=section&id=Note%2013.%20Commitments%20and%20Contingencies) - The Company leases facilities and automobiles under various operating leases, including agreements with Global Wells for its Texas and New Jersey facilities, expiring through 2031 and 2024, respectively[133](index=133&type=chunk)[134](index=134&type=chunk)[135](index=135&type=chunk) Approximate Future Minimum Lease Obligations (in thousands) | Period | Amount | | :--------------- | :------- | | 2021 (remainder) | $4,890 | | 2022 | $6,515 | | 2023 | $6,595 | | 2024 | $5,470 | | 2025 | $3,743 | | Thereafter | $10,731 | | **Total** | **$37,944** | - Management believes that the outcome of any legal actions and claims arising in the ordinary course of business is not likely to have a material effect on the Company's financial position or results of operations[136](index=136&type=chunk) [Note 14. Related Party Transactions](index=31&type=section&id=Note%2014.%20Related%20Party%20Transactions) - Lollicup Franchising was a related party until its acquisition by the Company in September 2020. Sales to Lollicup Franchising for Q1 2020 were **$14,000**, with incentive program expenses of **$32,000**[137](index=137&type=chunk) - Keary Global and its affiliate, Keary International, are related parties (minority stockholder, owned by a family member of a Company stockholder/employee) and serve as inventory suppliers and purchasing agents[138](index=138&type=chunk) Related Party Transactions with Keary Global/International (in thousands) | Metric | March 31, 2021 | December 31, 2020 | | :-------------------- | :------------- | :---------------- | | Accounts payable | $3,420 | $5,038 | | Purchases (Q1) | $5,055 | $7,782 | [Note 15. Income Taxes](index=32&type=section&id=Note%2015.%20Income%20Taxes) - The Company's income tax expense for Q1 2021 was **$1.2 million** with an effective tax rate of **28.0%**, compared to **$0.2 million** and **26.1%** for Q1 2020[140](index=140&type=chunk) - The effective tax rate differs from the U.S. federal statutory rate of **21%** primarily due to non-controlling interest income exclusion, state taxes, permanent book-tax differences, and income tax credits[140](index=140&type=chunk) - The Company has no uncertain tax positions as of March 31, 2021, and has evaluated the impacts of the CARES Act, Taxpayer Certainty and Disaster Relief Act of 2020, and American Rescue Plan Act of 2021, determining no material impact to its consolidated financial statements[143](index=143&type=chunk)[144](index=144&type=chunk)[145](index=145&type=chunk)[146](index=146&type=chunk) [Note 16. COVID-19](index=33&type=section&id=Note%2016.%20COVID-19) - The Company is actively monitoring the impact of the COVID-19 pandemic on its financial condition, liquidity, operations, suppliers, industry, and workforce[149](index=149&type=chunk) - In response to the pandemic, the Company began supplying personal protective equipment (PPE) related products, which positively impacted operations in 2020[149](index=149&type=chunk) - While the full magnitude is uncertain, the Company does not believe it will be adversely affected, but acknowledges that a continued pandemic could materially impact future operations, financial position, and liquidity in fiscal year 2021[149](index=149&type=chunk)[150](index=150&type=chunk) [Note 17. Subsequent Events](index=33&type=section&id=Note%2017.%20Subsequent%20Events) - On April 15, 2021, the Company completed an initial public offering (IPO), issuing **3,950,000 shares** at **$16.00** per share, generating gross proceeds of **$63.2 million**. An overallotment exercise on April 23, 2021, added **$9.48 million**, totaling **$72.68 million** in gross IPO proceeds[151](index=151&type=chunk) - A portion of the IPO proceeds, totaling **$50.2 million**, was used in April and early May 2021 to pay down various loan obligations, including **$30 million** of the existing line of credit and several term loans, resulting in the extinguishment of multiple term loans[151](index=151&type=chunk)[152](index=152&type=chunk) - On May 18, 2021, the Company granted **35,000 restricted stock units** to employees under the 2019 Stock Incentive Plan, with a **3-year** vesting period[152](index=152&type=chunk) [Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations](index=34&type=section&id=Item%202.%20Management's%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations) Management's discussion and analysis of Karat Packaging Inc.'s financial condition and operations for Q1 2021 vs Q1 2020 [Forward-Looking and Cautionary Statements](index=34&type=section&id=Forward-Looking%20and%20Cautionary%20Statements) - The report contains forward-looking statements based on current beliefs, expectations, and assumptions, identifiable by words like 'anticipate,' 'believe,' 'expect,' etc[154](index=154&type=chunk) - These statements are subject to risks and uncertainties, including fluctuations in demand, competition, freight costs, COVID-19 impact, raw material prices, and trade policies, which could cause actual results to differ materially[154](index=154&type=chunk)[156](index=156&type=chunk) [Overview](index=35&type=section&id=Overview) - Karat Packaging is a rapidly-growing specialty distributor and manufacturer of environmentally-friendly disposable foodservice products, offering a wide range of items in plastic, paper, and biopolymer-based forms, including the Karat Earth® line[157](index=157&type=chunk) - The company provides customized solutions such as new product development, design, printing, and logistics services, aiming to be a single-source provider for customers[157](index=157&type=chunk) - Operations include large distribution centers in California and Texas with manufacturing capabilities, additional distribution centers in Washington, South Carolina, and New Jersey, and the recent acquisition of Pacific Cup Inc. in Hawaii to expand manufacturing of Karat Earth products[158](index=158&type=chunk) [Results of Operations](index=35&type=section&id=Results%20of%20Operations) [Net Sales](index=36&type=section&id=Net%20Sales) Net Sales (in thousands) | Period | Amount | | :-------------------------- | :------- | | Three months ended Mar 31, 2021 | $75,673 | | Three months ended Mar 31, 2020 | $64,083 | | **Increase** | **$11,590 (18%)** | - The **18% increase** in net sales was primarily driven by a **$9.3 million** increase in product sales to existing customers, the acquisition of over **6,300 new customers**, growth in direct-to-consumer online sales, and a **$1.6 million** increase in logistic service and shipping revenue[161](index=161&type=chunk) - Sales of personal protective equipment (PPE) related products declined to under **1%** of net sales for Q1 2021, down from their peak in April 2020[161](index=161&type=chunk) [Cost of goods sold](index=36&type=section&id=Cost%20of%20goods%20sold) Cost of Goods Sold (in thousands) | Period | Amount | | :-------------------------- | :------- | | Three months ended Mar 31, 2021 | $54,047 | | Three months ended Mar 31, 2020 | $46,192 | | **Increase** | **$7,855 (17%)** | - The **17% increase** in cost of goods sold was mainly due to a **$4.9 million** rise in product costs in line with sales growth, a **$2.8 million** increase in freight and duty costs for overseas inventory, and a **$0.3 million** increase in depreciation expense for manufacturing equipment[162](index=162&type=chunk) [Gross profit](index=36&type=section&id=Gross%20profit) Gross Profit (in thousands) | Period | Amount | Margin | | :-------------------------- | :------- | :----- | | Three months ended Mar 31, 2021 | $21,626 | 29% | | Three months ended Mar 31, 2020 | $17,891 | 28% | | **Increase** | **$3,735 (21%)** | **1%** | - Gross profit increased by **21%**, and gross profit margin improved by **1%** to **29%** in Q1 2021, driven by increased product sales and higher margins from direct-to-consumer online sales[163](index=163&type=chunk) [Operating expenses](index=36&type=section&id=Operating%20expenses) Operating Expenses (in thousands) | Period | Amount | | :-------------------------- | :------- | | Three months ended Mar 31, 2021 | $17,855 | | Three months ended Mar 31, 2020 | $13,803 | | **Increase** | **$4,052 (29%)** | - Operating expenses increased by **29%**, primarily due to a **$1.7 million** rise in shipping costs, a **$0.7 million** increase in payroll-related costs from workforce expansion, a **$0.6 million** increase in rent for new facilities, and a **$0.3 million** increase in professional services fees[164](index=164&type=chunk) [Operating income](index=36&type=section&id=Operating%20income) Operating Income (in thousands) | Period | Amount | | :-------------------------- | :------- | | Three months ended Mar 31, 2021 | $3,771 | | Three months ended Mar 31, 2020 | $4,088 | | **Decrease** | **$(317) (8%)** | - Operating income decreased by **8%**, as the **$3.7 million** increase in gross profit was offset by a **$4.1 million** increase in operating expenses[165](index=165&type=chunk) [Other income (expenses)](index=36&type=section&id=Other%20income%20(expenses)) Other Income (Expenses) (in thousands) | Period | Amount | | :-------------------------- | :------- | | Three months ended Mar 31, 2021 | $465 | | Three months ended Mar 31, 2020 | $(3,321) | | **Increase** | **$3,786 (114%)** | - Other income (expenses) saw a significant positive shift of **$3.8 million**, primarily due to a **$3.6 million** decrease in interest expense, driven by a **$1.3 million** gain on interest rate swap fair value in Q1 2021 compared to a **$2.4 million** loss in Q1 2020, and a **$0.2 million** increase in rental income[166](index=166&type=chunk) [Net income](index=36&type=section&id=Net%20income) Net Income (in thousands) | Period | Amount | | :-------------------------- | :------- | | Three months ended Mar 31, 2021 | $3,050 | | Three months ended Mar 31, 2020 | $567 | | **Increase** | **$2,483 (438%)** | - Net income increased by **438%**, primarily driven by the **$3.8 million** increase in other income, partially offset by a **$0.3 million** decrease in operating income and a **$1.0 million** increase in income tax expense[167](index=167&type=chunk) - The effective tax rate was **28%** for Q1 2021, up from **26%** in Q1 2020[167](index=167&type=chunk) [Adjusted EBITDA](index=37&type=section&id=Adjusted%20EBITDA) Adjusted EBITDA (in thousands) | Period | Amount | | :-------------------------- | :------- | | Three months ended Mar 31, 2021 | $6,818 | | Three months ended Mar 31, 2020 | $5,965 | | **Increase** | **$853 (14%)** | - Adjusted EBITDA increased by **14%**, driven by the increase in net income, a decrease in interest expense add-back, an increase in income tax provision, higher depreciation and amortization, and IPO-related expenses[168](index=168&type=chunk) - Adjusted EBITDA is a non-GAAP financial measure used to assess operating performance and should not be considered in isolation from GAAP measures[168](index=168&type=chunk) [Liquidity and Capital Resources](index=37&type=section&id=Liquidity%20and%20Capital%20Resources) [Trends in Our Business](index=37&type=section&id=Trends%20in%20Our%20Business) - The Company anticipates positive impacts from growing trends in at-home dining, e-commerce, food delivery, and take-out, increasing demand for packaging[170](index=170&type=chunk) - Environmental concerns are expected to drive increased demand for eco-friendly and compostable single-use disposable products, benefiting the Karat Earth® line[170](index=170&type=chunk) - Fluctuations in freight carrier costs, U.S. foreign trade policy (tariffs), and raw material costs (e.g., PET plastic resin) are identified as factors that could positively or negatively impact results[170](index=170&type=chunk) - While the supply of personal protective equipment (PPE) initially had a positive impact, its contribution to net sales and gross profit is expected to decrease, falling to under **1%** of net sales in Q1 2021[171](index=171&type=chunk) [Working Capital](index=38&type=section&id=Working%20Capital) Working Capital (in thousands) | Metric | March 31, 2021 | December 31, 2020 | | :---------------- | :------------- | :---------------- | | Current assets | $76,027 | $79,777 | | Current liabilities | $39,551 | $43,137 | | **Working capital** | **$36,476** | **$36,640** | | **Decrease** | **$(164) (0.4%)** | | - Working capital decreased slightly by **$0.1 million** (**0.4%**) from December 31, 2020, to March 31, 2021, remaining consistent with the prior year due to no significant changes in customer payment terms, inventory, or current maturities of long-term debt[172](index=172&type=chunk) [Cash Flows](index=38&type=section&id=Cash%20Flows) Cash Flows Data (in thousands) | Activity | Three Months Ended March 31, 2021 | Three Months Ended March 31, 2020 | | :-------------------------------- | :-------------------------------- | :-------------------------------- | | Net cash provided by operating activities | $4,504 | $1,501 | | Net cash used in investing activities | $(2,094) | $(3,011) | | Net cash (used in) provided by financing activities | $(1,897) | $2,974 | | Net change in cash and cash equivalents | $513 | $1,464 | - Operating cash flow increased significantly to **$4.5 million** in Q1 2021, driven by net income and non-cash adjustments, compared to **$1.5 million** in Q1 2020[177](index=177&type=chunk) - Investing activities used **$2.1 million** in Q1 2021, primarily for manufacturing equipment purchases, deposits, and the Pacific Cup acquisition, a decrease from **$3.0 million** used in Q1 2020[178](index=178&type=chunk) - Financing activities shifted from providing **$3.0 million** in Q1 2020 to using **$1.9 million** in Q1 2021, mainly due to long-term debt payments[180](index=180&type=chunk) [Financing Arrangements](index=39&type=section&id=Financing%20Arrangements) - The Company has various business loan agreements, including a **$3.0 million** term loan (matures June 2025, **3.50%** interest) and a **$16.5 million** term loan (matures June 2025, **4.5%** fixed interest) for its variable interest entity[182](index=182&type=chunk)[183](index=183&type=chunk) - A line of credit with a maximum borrowing of **$40 million**, maturing May 2022, had **$33.2 million** outstanding as of March 31, 2021, and is subject to financial covenants[185](index=185&type=chunk) - The Company received a **$5.0 million** Paycheck Protection Program (PPP) loan in April 2020, with a **1%** interest rate and potential for forgiveness, used for eligible purposes[188](index=188&type=chunk)[189](index=189&type=chunk) - As of March 31, 2021, the Company was in compliance with all covenants for its business loan agreements and line of credit[184](index=184&type=chunk)[187](index=187&type=chunk) [Commitments and Contractual Obligation](index=41&type=section&id=Commitments%20and%20Contractual%20Obligation) Commitments and Contractual Obligations (in thousands) as of March 31, 2021 | Obligation | Total | Less than 1 year | 1 – 3 years | 3 – 5 years | More than 5 years | | :-------------------------------- | :------ | :--------------- | :---------- | :---------- | :---------------- | | Long-term debt | $62,992 | $11,841 | $13,493 | $18,425 | $19,233 | | Line of credit | $33,239 | — | $33,239 | — | — | | Interest on long-term debt and line of credit | $14,787 | $4,008 | $4,862 | $2,900 | $3,017 | | Operating leases | $37,944 | $6,507 | $13,094 | $8,348 | $9,995 | | Capital lease obligations including interest | $569 | $346 | $206 | $17 | — | | Capital expenditures | $34,425 | $5,100 | $12,615 | $16,710 | — | | **Total** | **$183,956** | **$27,802** | **$77,509** | **$46,400** | **$32,245** | - Total contractual obligations amount to **$183.956 million**, with **$27.802 million** due within one year[193](index=193&type=chunk) - Operating lease obligations include **$3.5 million**, **$7.2 million**, **$6.8 million**, and **$8.0 million** to the variable interest entity for respective periods, which are eliminated upon consolidation[194](index=194&type=chunk) - Capital expenditures include a maximum commitment of **$5.1 million** primarily for manufacturing equipment for the Texas facility[194](index=194&type=chunk) [Effect on Inflation](index=41&type=section&id=Effect%20on%20Inflation) - Inflation rates have had no material impact on the Company's financial statements in recent years[194](index=194&type=chunk) - The Company mitigates increased costs by adjusting product prices and diversifying supplier purchases[194](index=194&type=chunk) [Off-Balance Sheet Arrangements](index=42&type=section&id=Off-Balance%20Sheet%20Arrangements) - The Company currently has no off-balance sheet arrangements as of March 31, 2021, and December 31, 2020[195](index=195&type=chunk) - Letters of credit outstanding amounted to **$900,000** as of both March 31, 2021, and December 31, 2020[195](index=195&type=chunk) [Critical Accounting Policies and Estimates](index=42&type=section&id=Critical%20Accounting%20Policies%20and%20Estimates) [Use of Estimates](index=42&type=section&id=Use%20of%20Estimates) - The preparation of financial statements requires management to make estimates and assumptions, which include stock-based compensation, allowance for doubtful accounts, inventory reserves, deferred taxes, and estimated useful lives of property and equipment[196](index=196&type=chunk) [Inventory Reserve](index=42&type=section&id=Inventory%20Reserve) - The Company maintains reserves for excess and obsolete inventory based on factors such as historical usage, expected demand, anticipated sales price, and product obsolescence[198](index=198&type=chunk) [Allowance for Doubtful Accounts](index=43&type=section&id=Allowance%20for%20Doubtful%20Accounts) - An allowance for bad debt on accounts receivable is recognized based on estimated probable losses, historical write-offs, current past-due accounts, and assessment of specific at-risk customer accounts[200](index=200&type=chunk) [Stock-Based Compensation](index=43&type=section&id=Stock-Based%20Compensation) - Stock-based compensation expense is recorded at the fair value of awards granted, estimated using the Black-Scholes option pricing model with inputs like common stock fair value, expected option term, volatility, risk-free interest rate, and dividend yield[201](index=201&type=chunk) [Property and Equipment](index=43&type=section&id=Property%20and%20Equipment) - Property and equipment are recorded at historical cost less accumulated depreciation and amortization, computed on a straight-line basis over estimated useful lives ranging from **three** to **40 years**[202](index=202&type=chunk) [Income Taxes](index=43&type=section&id=Income%20Taxes) - Income taxes are accounted for under ASC 740, using the asset and liability approach for deferred taxes, which are measured using enacted tax rates[203](index=203&type=chunk)[204](index=204&type=chunk) - Deferred tax assets are reduced by a valuation allowance if their realization is not more likely than not. Tax benefits from uncertain positions are recognized only if sustained on examination[204](index=204&type=chunk)[205](index=205&type=chunk) [Revenue Recognition](index=44&type=section&id=Revenue%20Recognition) - Revenue from sales transactions is recognized at a point in time when control of products transfers to customers, typically upon shipment from the manufacturing facility[209](index=209&type=chunk)[210](index=210&type=chunk) - The transaction price includes fixed and estimated variable consideration (rebates, sales incentives, discounts, returns), estimated using contract terms and historical experience[211](index=211&type=chunk) [Recent Accounting Pronouncements](index=44&type=section&id=Recent%20Accounting%20Pronouncements) - As an emerging growth company, Karat Packaging has elected to adopt new accounting standards on the timeline required for private companies[212](index=212&type=chunk) - The Company plans to adopt ASU 2016-02 (Leases) in the annual reporting period beginning after December 15, 2021, and ASU 2016-13 (Credit Losses) in the annual reporting period beginning after January 1, 2023, and is currently assessing their impact[213](index=213&type=chunk)[214](index=214&type=chunk) - ASU 2018-07 (Stock Compensation) and ASU 2018-13 (Fair Value Measurement) were adopted as of January 1, 2020, with no material impact on financial position, results of operations, or cash flow[216](index=216&type=chunk)[217](index=217&type=chunk) [Subsequent Events](index=45&type=section&id=Subsequent%20Events) - On April 15, 2021, the Company completed its IPO, raising **$72.68 million** in gross proceeds after an overallotment exercise[220](index=220&type=chunk) - Approximately **$50.2 million** of the IPO proceeds were used to pay down various loan obligations in April and early May 2021, including **$30 million** of the line of credit and several term loans, leading to the extinguishment of multiple term loans[220](index=220&type=chunk)[221](index=221&type=chunk)[227](index=227&type=chunk) - On May 18, 2021, **35,000 restricted stock units** were granted to employees with a **3-year** vesting period[222](index=222&type=chunk) [Item 3. Quantitative and Qualitative Disclosure About Market Risk](index=46&type=section&id=Item%203.%20Quantitative%20and%20Qualitative%20Disclosure%20About%20Market%20Risk) This item is not applicable to Karat Packaging Inc. as a smaller reporting company - The Company is a smaller reporting company, making this disclosure item not applicable[223](index=223&type=chunk) [Item 4. Controls and Procedures](index=46&type=section&id=Item%204.%20Controls%20and%20Procedures) Details management's evaluation of disclosure controls and internal control over financial reporting [Evaluation of Disclosure Controls and Procedures](index=46&type=section&id=Evaluation%20of%20Disclosure%20Controls%20and%20Procedures) - Management, with CEO and CFO participation, concluded that the Company's disclosure controls and procedures were effective as of March 31, 2021[225](index=225&type=chunk) - Disclosure controls are designed to provide reasonable assurance that required information is recorded, processed, summarized, and reported timely[224](index=224&type=chunk) [Changes in Internal Control Over Financial Reporting](index=46&type=section&id=Changes%20in%20Internal%20Control%20Over%20Financial%20Reporting) - There were no changes in internal control over financial reporting during the most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting[226](index=226&type=chunk) [Limitations on Effectiveness of Controls and Procedures](index=46&type=section&id=Limitations%20on%20Effectiveness%20of%20Controls%20and%20Procedures) - Management acknowledges that any controls and procedures, regardless of design, can only provide reasonable assurance of achieving control objectives due to inherent limitations and resource constraints[227](index=227&type=chunk) [PART II - OTHER INFORMATION](index=47&type=section&id=PART%20II%20-%20OTHER%20INFORMATION) [Item 1. Legal Proceedings](index=47&type=section&id=Item%201.%20Legal%20Proceedings) Karat Packaging Inc. is not currently a party to any material legal proceedings - The Company is not a party to any material legal proceedings[229](index=229&type=chunk) [Item 1A. Risk Factors](index=47&type=section&id=Item%201A.%20Risk%20Factors) No material changes to Risk Factors previously disclosed in Form S-1 - No material changes to the Risk Factors previously disclosed in the Company's Registration Statement on Form S-1[230](index=230&type=chunk) [Item 2. Unregistered Sales of Equity Securities and Use of Proceeds](index=47&type=section&id=Item%202.%20Unregistered%20Sales%20of%20Equity%20Securities%20and%20Use%20of%20Proceeds) Karat Packaging Inc. reports no unregistered sales of equity securities or use of proceeds - There were no unregistered sales of equity securities and no use of proceeds to report[231](index=231&type=chunk) [Item 3. Defaults Upon Senior Securities](index=47&type=section&id=Item%203.%20Defaults%20Upon%20Senior%20Securities) Karat Packaging Inc. has not defaulted upon any senior securities - There were no defaults upon senior securities[232](index=232&type=chunk) [Item 4. Mine Safety Disclosures](index=47&type=section&id=Item%204.%20Mine%20Safety%20Disclosures) This item is not applicable to Karat Packaging Inc. - This item is not applicable[233](index=233&type=chunk) [Item 5. Other Information](index=47&type=section&id=Item%205.%20Other%20Information) Karat Packaging Inc. has no other information to report - There is no other information to report[234](index=234&type=chunk) [Item 6. Exhibits](index=47&type=section&id=Item%206.%20Exhibits) Lists all exhibits filed with Form 10-Q, including organizational documents, plans, and agreements - Exhibits include the Certificate of Incorporation, By-Laws, 2019 Stock Incentive Plan, various lease agreements, business loan agreements, and certifications[235](index=235&type=chunk)[236](index=236&type=chunk) - Many exhibits are incorporated by reference from the Company's Registration Statement on Form S-1[235](index=235&type=chunk)[236](index=236&type=chunk) - Certifications from the Principal Executive Officer and Principal Financial Officer are filed herewith, including XBRL Instance and Taxonomy Extension Documents[236](index=236&type=chunk) [SIGNATURES](index=49&type=section&id=SIGNATURES) - The report is signed by Alan Yu, Chief Executive Officer (Principal Executive Officer), and Ann T. Sabahat, Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer), on May 27, 2021[239](index=239&type=chunk) ```