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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, 20222023
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)
Delaware83-2237832
(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 classTrading Symbol(s)Name of each exchange on which registered
Common Stock, $0.001 par valueKRTThe 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 4, 20226, 2023 was 19,908,01219,964,413 shares.


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PART II - OTHER INFORMATION
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KARAT PACKAGING INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share and per share data)
PART I - FINANCIAL INFORMATION


September 30,
2022		December 31,
2021		September 30, 2023December 31, 2022
AssetsAssetsAssets
Current assetsCurrent assetsCurrent assets
Cash and cash equivalents (including $1,568 and $1,163 associated with variable interest entity at September 30, 2022 and December 31, 2021, respectively)$7,531 $6,483 
Accounts receivable, net of allowances of $1,695 and $583 at September 30, 2022 and December 31, 2021, respectively (including $3 and $24 associated with variable interest entity at September 30, 2022 and December 31, 2021, respectively)36,732 32,776 
Cash and cash equivalents (including $7,770 and $2,022 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)Cash and cash equivalents (including $7,770 and $2,022 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)$28,162 $16,041 
Short-term investments (including $8,000 and $0 associated with variable interest entity at September 30, 2023, and December 31, 2022, respectively)Short-term investments (including $8,000 and $0 associated with variable interest entity at September 30, 2023, and December 31, 2022, respectively)18,063 — 
Accounts receivable, net of allowance for doubtful accounts of $430 and $1,260 at September 30, 2023 and December 31, 2022, respectively (including $0 and $6 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)Accounts receivable, net of allowance for doubtful accounts of $430 and $1,260 at September 30, 2023 and December 31, 2022, respectively (including $0 and $6 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)33,984 29,912 
InventoriesInventories73,286 58,472 Inventories71,657 71,206 
Prepaid expenses and other current assets (including $187 and $63 associated with variable interest entity at September 30, 2022 and December 31, 2021, respectively)7,258 5,141 
Prepaid expenses and other current assets (including $25 and $191 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)Prepaid expenses and other current assets (including $25 and $191 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)6,823 6,641 
Total current assetsTotal current assets124,807 102,872 Total current assets158,689 123,800 
Property and equipment, net (including $45,702 and $46,612 associated with variable interest entity at September 30, 2022 and December 31, 2021, respectively)94,346 93,475 
Property and equipment, net (including $44,489 and $45,399 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)Property and equipment, net (including $44,489 and $45,399 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)96,690 95,568 
DepositsDeposits15,610 6,885 Deposits1,672 12,413 
GoodwillGoodwill3,510 3,510 Goodwill3,510 3,510 
Intangible assets, netIntangible assets, net360 380 Intangible assets, net333 353 
Other assets (including $47 and $65 associated with variable interest entity at September 30, 2022 and December 31, 2021, respectively)827 477 
Operating right-of-use assetsOperating right-of-use assets17,068 15,713 
Other assets (including $55 and $38 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)Other assets (including $55 and $38 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)2,002 818 
Total assetsTotal assets$239,460 $207,599 Total assets$279,964 $252,175 
Liabilities and Stockholders’ EquityLiabilities and Stockholders’ EquityLiabilities and Stockholders’ Equity
Current liabilitiesCurrent liabilitiesCurrent liabilities
Accounts payable (including $27 and $136 associated with variable interest entity at September 30, 2022 and December 31, 2021, respectively)$18,929 $18,470 
Accrued expenses (including $480 and $68 associated with variable interest entity at September 30, 2022 and December 31, 2021, respectively)8,469 7,813 
Accounts payable (including $60 and $2 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)Accounts payable (including $60 and $2 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)$19,384 $18,559 
Accrued expenses (including $461 and $625 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)Accrued expenses (including $461 and $625 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)8,858 9,005 
Related party payableRelated party payable4,858 2,003 Related party payable2,555 4,940 
Income taxes payable (including $0 and $9 associated with variable interest entity at September 30, 2022 and December 31, 2021, respectively)196 85 
Customer deposits (including $244 and $88 associated with variable interest entity as of September 30, 2022 and December 31, 2021, respectively)1,186 1,215 
Debt, current portion (including $948 and $1,178 associated with variable interest entity at September 30, 2022 and December 31, 2021, respectively)948 1,178 
Income taxes payableIncome taxes payable8,010 — 
Customer deposits (including $116 and $165 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)Customer deposits (including $116 and $165 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)803 1,281 
Long-term debt, current portion (including $1,111 and $957 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)Long-term debt, current portion (including $1,111 and $957 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)1,111 957 
Operating lease liabilities, current portionOperating lease liabilities, current portion4,927 4,511 
Other payablesOther payables242 — Other payables49 — 
Total current liabilitiesTotal current liabilities34,828 30,764 Total current liabilities45,697 39,253 

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September 30,
2022		December 31,
2021		September 30, 2023December 31, 2022
Deferred tax liabilityDeferred tax liability5,634 5,634 Deferred tax liability5,156 5,156 
Long-term debt, net of current portion and debt discount of $229 and $200 as of September 30, 2022 and December 31, 2021, respectively (including $41,789 and $35,339 associated with variable interest entity at September 30, 2022 and December 31, 2021, respectively, and debt discount of $229 and $200 associated with variable interest entity as of September 30, 2022 and December 31, 2021, respectively)41,789 35,339 
Other liabilities (including $1,302 and $2,637 associated with variable interest entity at September 30, 2022 and December 31, 2021, respectively)3,127 3,837 
Long-term debt, net of current portion and debt discount of $219 and $216 at September 30, 2023 and December 31, 2022, respectively (including $48,668 and $41,558 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively, and debt discount of $219 and $216 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)Long-term debt, net of current portion and debt discount of $219 and $216 at September 30, 2023 and December 31, 2022, respectively (including $48,668 and $41,558 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively, and debt discount of $219 and $216 associated with variable interest entity at September 30, 2023 and December 31, 2022, respectively)48,668 41,558 
Operating lease liabilities, net of current portionOperating lease liabilities, net of current portion12,866 11,623 
Other liabilities (including $1,302 associated with variable interest entity at both September 30, 2023 and December 31, 2022)Other liabilities (including $1,302 associated with variable interest entity at both September 30, 2023 and December 31, 2022)2,824 2,652 
Total liabilitiesTotal liabilities85,378 75,574 Total liabilities115,211 100,242 
Commitments and Contingencies (Note 13)— — 
Commitments and Contingencies (Note 17)Commitments and Contingencies (Note 17)
Karat Packaging Inc. stockholders’ equityKarat Packaging Inc. stockholders’ equityKarat Packaging Inc. stockholders’ equity
Common stock, $0.001 par value, 100,000,000 shares authorized, 19,832,417 and 19,809,417 shares issued and outstanding, respectively, at September 30, 2022; 19,827,417 and 19,804,417 shares issued and outstanding, respectively, at December 31, 202120 20 
Preferred stock, $0.001 par value, 10,000,000 shares authorized, no shares issued and outstanding, at both September 30, 2023 and December 31, 2022Preferred stock, $0.001 par value, 10,000,000 shares authorized, no shares issued and outstanding, at both September 30, 2023 and December 31, 2022— — 
Common stock, $0.001 par value, 100,000,000 shares authorized, 19,916,839 and 19,893,839 shares issued and outstanding, respectively, as of September 30, 2023 and 19,908,005 and 19,885,005 shares issued and outstanding, respectively, as of December 31, 2022Common stock, $0.001 par value, 100,000,000 shares authorized, 19,916,839 and 19,893,839 shares issued and outstanding, respectively, as of September 30, 2023 and 19,908,005 and 19,885,005 shares issued and outstanding, respectively, as of December 31, 202220 20 
Additional paid in capitalAdditional paid in capital85,519 83,694 Additional paid in capital86,620 85,792 
Treasury stock, $0.001 par value, 23,000 shares at both September 30, 2022 and December 31, 2021(248)(248)
Treasury stock, $0.001 par value, 23,000 shares at both September 30, 2023 and December 31, 2022Treasury stock, $0.001 par value, 23,000 shares at both September 30, 2023 and December 31, 2022(248)(248)
Retained earningsRetained earnings58,541 39,434 Retained earnings67,773 56,118 
Total Karat Packaging Inc. stockholders’ equityTotal Karat Packaging Inc. stockholders’ equity143,832 122,900 Total Karat Packaging Inc. stockholders’ equity154,165 141,682 
Noncontrolling interestNoncontrolling interest10,250 9,125 Noncontrolling interest10,588 10,251 
Total stockholders’ equityTotal stockholders’ equity154,082 132,025 Total stockholders’ equity164,753 151,933 
Total liabilities and stockholders’ equityTotal liabilities and stockholders’ equity$239,460 $207,599 Total liabilities and stockholders’ equity$279,964 $252,175 
The accompanying notes to the condensed consolidated financial statements are an integral part of these statements.

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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,
2022202120222021
Net sales$109,996 $102,711 $330,290 $272,910 
Cost of goods sold75,828 72,918 227,869 193,393 
Gross profit34,168 29,793 102,421 79,517 
Operating expenses
Selling expense9,413 9,855 28,218 24,026 
General and administrative expense (including $665 and $683 associated with variable interest entity for the three months ended September 30, 2022 and 2021, respectively; $1,899 and $1,983 associated with variable interest entity for the nine months ended September 30, 2022 and 2021, respectively)16,845 14,573 49,000 39,485 
Total operating expenses26,258 24,428 77,218 63,511 
Operating income7,910 5,365 25,203 16,006 
Other income (expense)
Rental income (including $239 and $246 associated with variable interest entity for the three months ended September 30, 2022 and 2021, respectively; and $715 and $738 associated with variable interest entity for the nine months ended September 30, 2022 and 2021, respectively)239 246 715 738 
Other income (expense)28 101 (235)223 
Gain (Loss) on foreign currency transactions369 (63)1,352 (347)
Interest (expense) income (including $470 interest expense and $273 interest expense associated with variable interest entity for the three months ended September 30, 2022 and 2021, respectively; and $781 interest income and $283 interest expense associated with variable interest entity for the nine months ended September 30, 2022 and 2021, respectively)(493)(308)584 (1,158)
Gain on forgiveness of debt— — — 5,000 
Total other income (expense)143 (24)2,416 4,456 
Income before provision for income taxes8,053 5,341 27,619 20,462 
Provision for income taxes1,900 1,268 6,323 4,001 
Net income6,153 4,073 21,296 16,461 
Net income attributable to noncontrolling interest57 287 2,189 1,312 
Net income attributable to Karat Packaging Inc.$6,096 $3,786 $19,107 $15,149 
Basic and diluted earnings per share:
Basic$0.31 $0.19 $0.96 $0.84 
Diluted$0.31 $0.19 $0.96 $0.84 
Weighted average common shares outstanding, basic19,809,417 19,710,043 19,808,813 17,945,205 
Weighted average common shares outstanding, diluted19,938,042 19,881,295 19,922,047 18,110,127 

Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
Net sales$105,528 $109,996 $310,069 $330,290 
Cost of goods sold66,584 75,828 191,120 227,869 
Gross profit38,944 34,168 118,949 102,421 
Operating expenses
Selling expense8,004 9,413 25,500 28,218 
General and administrative expense (including $702 and $665 associated with variable interest entity for the three months ended September 30, 2023 and 2022, respectively; $2,020 and $1,899 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)19,870 16,861 53,767 49,033 
Impairment expense and (gain) loss, net, on disposal of machinery(310)(16)2,231 (33)
Total operating expenses27,564 26,258 81,498 77,218 
Operating income11,380 7,910 37,451 25,203 
Other income (expense)
Rental income (including $235 and $239 associated with variable interest entity for the three months ended September 30, 2023 and 2022, respectively; and $721 and $715 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)259 239 781 715 
Other income (expense), net32 28 (58)(235)
Gain on foreign currency transactions455 369 350 1,352 
Interest income (including $80 and $0 interest income associated with variable interest entity for the three months ended September 30, 2023 and 2022, respectively; and $278 and $2,160 interest income associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)454 — 1,040 2,160 
Interest expense (including $528 and $470 interest expense associated with variable interest entity for the three months ended September 30, 2023 and 2022, respectively; and $1,499 and $1,379 interest expense associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)(536)(493)(1,516)(1,576)
Total other income, net664 143 597 2,416 
Income before provision for income taxes12,044 8,053 38,048 27,619 
Provision for income taxes2,904 1,900 9,045 6,323 
Net income9,140 6,153 29,003 21,296 
Net income attributable to noncontrolling interest75 57 431 2,189 
Net income attributable to Karat Packaging Inc.$9,065 $6,096 $28,572 $19,107 
Basic and diluted earnings per share:
Basic$0.46 $0.31 $1.44 $0.96 
Diluted$0.45 $0.31 $1.43 $0.96 
Weighted average common shares outstanding, basic19,890,646 19,809,417 19,888,244 19,808,813 
Weighted average common shares outstanding, diluted19,994,648 19,938,042 19,962,999 19,922,047 
The accompanying notes to the condensed consolidated financial statements are an integral part of these statements.

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KARAT PACKAGING INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)
(In thousands, except share and per share data)
Common StockTreasury StockAdditional
Paid-in
Capital		Retained
Earnings		Total
Stockholders’
Equity attributable
to Karat
Packaging Inc.		Noncontrolling
Interest		Total
Stockholders’
Equity
SharesAmountSharesAmount
Balance, January 1, 202115,190,000 $15 (23,000)$(248)$13,981 $18,656 $32,404 $7,464 $39,868 
Net income— — — — — 1,780 1,780 1,270 3,050 
Balance, March 31, 202115,190,000 $15 (23,000)$(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 $5,0884,542,500 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, 202119,732,500 $20 (23,000)$(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 units5,000 — — — — — — — — 
Net income— — — — — 3,786 3,786 287 4,073 
Balance, September 30, 202119,737,500 $20 (23,000)$(248)$82,656 $33,805 $116,233 $8,776 $125,009 

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Common StockTreasury StockAdditional
Paid-in
Capital		Retained
Earnings		Total
Stockholders’
Equity attributable
to Karat
Packaging Inc.		Noncontrolling
Interest		Total
Stockholders’
Equity
SharesAmountSharesAmount
Balance, January 1, 202219,827,417 $20 (23,000)$(248)$83,694 $39,434 $122,900 $9,125 $132,025 
Stock-based compensation— — — — 611 — 611 — 611 
Exercise of common stock options5,000 — — — 51 — 51 — 51 
Noncontrolling interest tax withholding— — — — — — — (387)(387)
Net income— — — — — 6,667 6,667 1,276 7,943 
Balance, March 31, 202219,832,417 $20 (23,000)$(248)$84,356 $46,101 $130,229 $10,014 $140,243 
Stock-based compensation— — — — 565 — 565 — 565 
Noncontrolling interest tax withholding— — — — — — — (487)(487)
Net income— — — — — 6,344 6,344 856 7,200 
Balance, June 30, 202219,832,417 $20 (23,000)$(248)$84,921 $52,445 $137,138 $10,383 $147,521 
Stock-based compensation— — — — 598 — 598 — 598 
Noncontrolling interest tax withholding— — — — — — — (190)(190)
Net income— — — — — 6,096 6,096 57 6,153 
Balance, September 30, 202219,832,417 $20 (23,000)$(248)$85,519 $58,541 $143,832 $10,250 $154,082 


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

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KARAT PACKAGING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)

Nine Months Ended
September 30,
20222021
Cash flows from operating activities
Net income$21,296 $16,461 
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization7,752 7,477 
Adjustments to accounts receivable reserves1,112 — 
Adjustments to inventory reserves441 133 
Gain on sale of asset(33)— 
Change in fair value of interest rate swap(2,159)(1,298)
Amortization of loan fees28 9 
Stock-based compensation1,774 1,088 
Gain on forgiveness of debt— (5,000)
(Increase) decrease in operating assets
Accounts receivable(5,068)(9,438)
Inventories(15,255)(11,226)
Prepaid expenses and other current assets(2,264)840 
Deposits(143)(64)
Other assets100 (238)
Increase (decrease) in operating liabilities
Accounts payable459 (1,041)
Accrued expenses1,130 3,202 
Related party payable2,855 (2,427)
Income taxes payable111 65 
Customer deposits(29)574 
Other liabilities150 — 
Other payable242 (363)
Net cash provided by (used in) operating activities$12,499 $(1,246)
Cash flows from investing activities
Purchases of property and equipment(2,007)(3,947)
    Proceeds from disposal of property and equipment76 — 
Deposits paid for property and equipment(11,471)(3,792)
Deposits paid for joint venture investment(4,000)— 
    Proceeds from settlement of interest rate swap825 — 
    Acquisition of Pacific Cup, Inc., net of cash acquired— (900)
Net cash used in investing activities$(16,577)$(8,639)
Cash flows from financing activities
Proceeds from line of credit21,100 1,470 
Payments on line of credit(21,100)(34,639)
Proceeds from long-term debt27,477 15,997 
Payments on long-term debt(21,338)(38,985)
Proceeds from exercise of stock options51 67,592 
Payments on capital lease obligations— (319)
Payments of noncontrolling interest tax withholding(1,064)— 
Net cash provided by financing activities$5,126 $11,116 
Net increase in cash and cash equivalents1,048 1,231 
Cash and cash equivalents
Beginning of year$6,483 448
End of year$7,531 $1,679 

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Nine Months Ended
September 30,
20222021
Supplemental disclosures of non-cash investing and financing activities:
Transfers from deposit to property and equipment$6,639 $3,215 
Acquisition price of Pacific Cup, Inc. included within deposits$— $100 
Gain on forgiveness of debt$— $5,000 
Supplemental disclosures of cash flow information:
Cash paid for income taxes$7,069 $3,324 
Cash paid for interest$1,541 $2,472 
Common StockTreasury StockAdditional Paid-in CapitalRetained EarningsTotal Stockholders’ Equity Attributable to Karat Packaging Inc.Noncontrolling InterestTotal Stockholders’ Equity
SharesAmountSharesAmount
Balance, January 1, 202219,827,417$20 (23,000)$(248)$83,694 $39,434 $122,900 $9,125 $132,025 
Stock-based compensation————611— 611 —611 
Exercise of common stock options5,000— — — 51 — 51— 51
Noncontrolling interest tax withholding—————— — (387)(387)
Net income—————6,667 6,667 1,276 7,943 
Balance, March 31, 202219,832,417 $20 (23,000)$(248)$84,356 $46,101 $130,229 $10,014 $140,243 
Stock-based compensation————565—565—565
Noncontrolling interest tax withholding———————(487)(487)
Net income—————6,3446,3448567,200
Balance, June 30, 202219,832,417 $20 (23,000)$(248)$84,921 $52,445 $137,138 $10,383 $147,521 
Issuance of common stock upon vesting of restricted stock units, net shares withheld to cover taxes————598—598—598
Stock-based compensation———————(190)(190)
Net income—————6,096 6,096 57 6,153 
Balance, September 30, 202219,832,417$20 (23,000)$(248)$85,519 $58,541 $143,832 $10,250 $154,082 
Common StockTreasury StockAdditional Paid-in CapitalRetained EarningsTotal Stockholders’ Equity Attributable to Karat Packaging Inc.Noncontrolling InterestTotal Stockholders’ Equity
SharesAmountSharesAmount
Balance, January 1, 202319,908,005$20 (23,000)$(248)$85,792 $56,118 $141,682 $10,251 $151,933 
Issuance of common stock upon vesting of restricted stock units, net shares withheld to cover taxes2,452 — — — (14)— (14)— (14)
Stock-based compensation—— — — 277— 277— 277
Net income—— — — — 9,005 9,005 181 9,186 
Balance, March 31, 202319,910,457$20 (23,000)$(248)$86,055 $65,123 $150,950 $10,432 $161,382 
Cash dividends declared ($0.35 per share)—— —— — (6,965)(6,965)— (6,965)
Issuance of common stock upon vesting of restricted stock units, net shares withheld to cover taxes582 — — — (4)— (4)— (4)
Stock-based compensation—— — — 216 — 216 — 216 
Net income—— — — — 10,502 10,502 175 10,677 
Balance, June 30, 202319,911,039$20 (23,000)$(248)$86,267 $68,660 $154,699 $10,607 $165,306 
Cash dividends declared ($0.50 per share)—————(9,952)(9,952)—(9,952)
Stock-based compensation————250250—250
Exercise of stock options5,800 ———103—103—103
Noncontrolling interest tax withholding———————(94)(94)
Net income—————9,0659,065759,140
Balance, September 30, 202319,916,839$20 (23,000)$(248)$86,620 $67,773 $154,165 $10,588 $164,753 
The accompanying notes to the condensed consolidated financial statements are an integral part of these statements.

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KARAT PACKAGING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Nine Months Ended September 30,
20232022
Cash flows from operating activities
Net income$29,003 $21,296 
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization (including $910 associated with variable interest entity for both the nine months ended September 30, 2023 and 2022)8,058 7,752 
Adjustments to allowance for doubtful accounts(673)1,112 
Adjustments to inventory reserve(27)441 
Write-off of inventory3,225 — 
Impairment of deposits523 — 
Loss (gain), net, on disposal of machinery and equipment1,708 (33)
Change in fair value of interest rate swap (including $0 and $2,159 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)— (2,159)
Amortization of loan fees (including $41 and $28 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)57 28 
Accrued interest on certificates of deposit(63)— 
Stock-based compensation743 1,774 
Amortization of operating right-of-use assets3,617 2,897 
(Increase) decrease in operating assets
Accounts receivable (including $6 and $21 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)(3,399)(5,068)
Inventories(3,649)(15,255)
Prepaid expenses and other current assets (including $22 and $396 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)431 (2,264)
Other assets (including $34 and $458 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)(75)(43)
Increase (decrease) in operating liabilities
Accounts payable (including $57 and $470 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)1,701 459 
Accrued expenses (including $163 and $414 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)(147)1,130 
Related party payable(2,385)2,855 
Income taxes payable8,010 111 
Customer deposits (including $49 and $156 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)(478)(29)
Operating lease liability(3,313)(2,897)
Other liabilities (including $0 and $1 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)172 150 
Other payables49 242 
Net cash provided by operating activities$43,088 $12,499 
6

Nine Months Ended September 30,
20232022
Cash flows from investing activities
Purchases of property and equipment(2,870)(2,007)
Proceeds from disposal of property and equipment605 76 
Payments for costs incurred from sale of machinery and equipment(189)— 
Deposits paid for joint venture investment(2,900)(4,000)
Deposits refunded from joint venture investment6,900 — 
Deposit refund from cancelled property and equipment purchase503 — 
Deposits paid for property and equipment(5,390)(11,471)
Proceeds from settlement of interest rate swap (including $0 and $825 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)— 825 
Purchase of short-term investments (including $8,000 and $0 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)(28,000)— 
Redemption of short-term investments10,000 — 
Net cash used in investing activities$(21,341)$(16,577)
Cash flows from financing activities
Proceeds from line of credit— 21,100 
Payments on line of credit— (21,100)
Proceeds from long-term debt (including $8,000 and $27,477 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)8,000 27,477 
Payments for lender fees(61)— 
Payments on long-term debt (including $733 and $21,338 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)(733)(21,338)
Tax withholding on vesting of restricted stock units(18)— 
Proceeds from exercise of common stock options103 51 
Dividends paid to shareholders(16,917)— 
Payments of noncontrolling interest tax withholding (including $0 and $1,064 associated with variable interest entity for the nine months ended September 30, 2023 and 2022, respectively)— (1,064)
Net cash (used in) provided by financing activities$(9,626)$5,126 
Net increase in cash and cash equivalents12,1211,048
Cash and cash equivalents
Beginning of period$16,041 $6,483 
End of period$28,162 $7,531 
Supplemental disclosures of non-cash investing and financing activities:
Transfers from deposit to property and equipment$8,953 $6,639 
Non-cash purchases of property and equipment$71 $— 
Supplemental disclosures of cash flow information:
Cash paid for income tax$309 $7,069 
Cash paid for interest$1,493 $1,541 
The accompanying notes to the condensed consolidated financial statements are an integral part of Contentsthese statements. 
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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, includingsuch as food containers, tableware, cups, lids, cutlery, and straws. The products are available in plastic, paper, biopolymer-based and other compostable forms. In addition to manufacturing and distribution, the Company offers customized solutions to customers, including new product development, design, printing, and logistics services, and distributes certain specialty food and beverages products, such as boba and coffee drinks.
The Company supplies products to national and regional distributors, supermarkets, restaurants, and convenience stores as well as to smaller chains and businesses including boutique coffee houses, bubble tea cafes, pizza parlors and frozen yogurt shops, as well as to distributors and national and regional supermarkets, restaurants and convenience stores.shops.
The Company currently operates manufacturing facilities and distribution and fulfillment centers in Chino, California; Rockwall, Texas and Kapolei, Hawaii. In addition, the Company operates fiveseven other distribution centers located in Branchburg, New Jersey; Sumner, Washington; Summerville, South Carolina andCarolina; Branchburg, New Jersey; Kapolei, Hawaii; City of Industry, California.California, Aurora, Illinois; and Sugar Land, Texas.
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 8-03 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, 20222023 and for the three and nine months ended September 30, 20222023 and 20212022 is unaudited; however, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair statement have been included. Operating results for the three and nine months ended September 30, 20222023 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2022.2023.
The condensed consolidated balance sheet at December 31, 20212022 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, 2021,2022, as included in ourthe Company's Annual Report on Form 10-K filed on March 31, 2022, as amended.16, 2023.
Principles of Consolidation:The condensed consolidated financial statements include the accounts of Karat Packaging and its wholly-owned and controlled operating subsidiaries, Lollicup, Lollicup Franchising, LLC (“Lollicup Franchising”) 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. 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 attributable to noncontrolling interests is disclosed in the condensed consolidated statements of income. Tax payments made by the Company on behalf of the noncontrolling interests are deducted from their equity balances, as shown in the condensed consolidated statement of stockholders’ equity.
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

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KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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 and reserve for slow-moving and obsolete inventory.
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 certain specialty food and beverages products, such as boba and coffee drinks.
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, 2022 and December 31, 2021, cash and cash equivalents were comprised of cash held in money market, cash on hand and cash deposited with banks.
Accounts Receivable and Allowances: 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. The Company also maintains a sales allowance primarily related to potential billing adjustments to customers. The amount of the sales allowance is determined based on a historical transaction analysis and any additions to the sales allowance are recorded as a reduction to net revenue.
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 a reserve for excess and obsolete inventory and carries its inventory at net realizable value, taking into account 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 15 years

Leasehold improvementsLesser of useful life or lease term
Vehicles5 years
Furniture and fixtures7 years
Building28 years to 40 years
Property held under capital leases3 years to 5 years
Computer hardware and software3 years
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 are payments made for machinery and equipment, and construction and improvement for the Company’s facilities. Included in deposits are also payments made to 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. The impairment test comprises

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KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
of two steps. The first step compares the carrying amount of the asset to the sum of expected undiscounted future cash flows. If the sum of expected undiscounted future cash flows exceeds the carrying amount of the asset, no impairment is taken. If the sum of expected undiscounted future cash flows is less than the carrying amount of the asset, a second step is warranted and an impairment loss is measured as the amount by which the carrying amount of the asset exceeds its fair value calculated using the present value of estimated net future cash flows. For the periods ended September 30, 2022 and September 30, 2021, 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 US 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 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, 2022, goodwill recorded in the accompanying condensed consolidated balance sheets is related to the Company’s acquisition of Pacific Cup, Inc. and Lollicup Franchising. For the periods ended September 30, 2022 and September 30, 2021, the Company determined no impairments have occurred.
The following table summarizes the activity in the Company’s goodwill balance:
(in thousands)
Balance at December 31, 2021$3,510 
Goodwill acquired— 
Balance at September 30, 2022$3,510
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 both September 30, 2022 and December 31, 2021, the Company received cumulative grants of $1,350,000. As of both September 30, 2022 and December 31, 2021, 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 the facility in Rockwall, Texas to maintain a certain minimum tax value for the next five calendar years through 2024 (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 balance sheet 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 entered into certain interest rate swaps to manage the interest rate risk, and accounted for such interest rate swaps as a derivative instrument under ASC 815. The interest rate swaps were not designated for hedge

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KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
accounting and as such, the change in the fair value of interest rate swaps was recognized as interest income/expense in the accompanying condensed consolidated statements of income.
Variable Interest Entity: Entities:The Company has a variable interest in 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, which is located in Rockwall, Texas. The purpose of this entity is to own, construct, and manage a warehousewarehouses and manufacturing facility.facilities. Global Wells’ operating agreement may require its members to make additional contributions only upon the unanimous decision of the members or wherewhen 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”). In 2020,for a facility in Rockwall, Texas. Upon the Company entered into another operatingexecution of this lease, with Global Wells (“New Jersey Lease”).
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
8
KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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.Consolidations.
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. See Note 9 — — Long TermLong-Term Debt for a description of the two term loans that Global Wells hashad with financial institutions as of September 30, 2022.2023.
Noncontrolling Interests:The following financial information includes assets and liabilities ofCompany consolidates its variable interest entity, Global Wells, and are included in the accompanying condensed consolidated balance sheets, except for those that eliminate upon consolidation:
September 30,
2022		December 31,
2021
(in thousands)
Cash$1,568 $1,163 
Accounts receivable255 384 
Prepaid expenses and other current assets187 63 
Due from Lollicup USA Inc.4,700 — 
Property and equipment, net45,702 46,612 
Other assets4,395 4,762 
Total assets$56,807 $52,984 
Accounts payable$27 $497 
Accrued expenses48068 
Income tax payable— 9 
Customer deposits24488 
Due to Lollicup USA Inc.— 2,620 
Long-term debt, current portion9481,178 
Long-term debt, net of current portion41,789 35,339 
Other liabilities1,302 2,636 
Total liabilities$44,790 $42,435 

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KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Revenue Recognition: The Company generates revenues from customers that include national and regional distributors, chain restaurants and supermarkets, 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. Forthe three and nine months ended September 30, 2022 and 2021, net sales disaggregated by customer type consists of the amounts shown below.
Three Months Ended September 30,Nine Months Ended September 30,
2022202120222021
(in thousands)
National and regional chains$23,956 $22,894 $73,943 $63,493 
Distributors63,555 57,317 189,078 148,294 
Online14,044 14,644 43,084 39,790 
Retail8,441 7,856 24,185 21,333 
$109,996 $102,711 $330,290 $272,910 
•National and regional chains revenue: National and regional chains revenue is derived from chain restaurants and supermarkets with locations across multiple states. Revenue from transactions with national and regional 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 the Company’s 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 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 the Company’s 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 online 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 the Company’s 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 the Company’s manufacturing facility to the customers.
The transaction price is the amount of consideration to which the Company expects to be entitled tois the primary beneficiary. Noncontrolling interests represent third-party equity ownership interests 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.Global Wells. The Company estimates its variable consideration based on contract terms and historical experience of actual results using the expected value method. The performance obligations are generally satisfied shortly after manufacturing and shipmentrecognizes noncontrolling interests as purchases made by the Company’s customers are manufactured and shipped with minimal lead time.
The Company’s contract liabilities consist primarily of rebates, sales incentives, customer deposits and consideration payable to customers for cooperative advertising. As of September 30, 2022 and December 31, 2021, the rebates, sales incentives and cooperative advertising were not significant to the financial statements. Customer deposits are included in the current liabilitiesequity in the condensed consolidated balance sheets.

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KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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 consolidatedfinancial statements of income. Shipping and handling fees billed to a customer are not deemed to be separate performance obligations for all offrom the Company’s product sales, as these activities occur before the customer receives the products. Shipping and handling costs included within selling expensesstockholders’ equity. The amount of net income attributable to noncontrolling interests is disclosed in the condensed consolidated statements of income forincome. Tax payments made by the three months ended September 30, 2022 and 2021 were $8,625,000 and $8,794,000, respectively. Shipping and handling costs included within selling expensesCompany on behalf of the noncontrolling interests are deducted from their equity balances, as shown in the condensed consolidated statements of income forstockholders’ equity.
Estimates and Assumptions: Management uses estimates and assumptions in preparing financial statements in accordance with US GAAP. Those estimates and assumptions affect the nine months ended September 30, 2022reported amounts of assets and 2021liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could differ materially from the estimates that were $25,653,000 and $21,285,000, respectively.
Sales taxes collected concurrently with revenue-producing activities and remitted to governmental authoritiesassumed in preparing the condensed consolidated financial statements. Estimates that are excluded from revenue. Sales commissions are expensed as incurred duesignificant to the amortization period being less than one yearcondensed consolidated financial statements include stock-based compensation, allowance for doubtful accounts and are recorded in selling expense on the accompanying consolidated statements of income.reserve for slow-moving and obsolete inventory.
Advertising Costs:Reporting Segments: The Company expenses costsmanages and evaluates its operations in one reportable segment. This segment consists of print production, trade show, online marketing,manufacturing and other advertisementssupply 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 certain specialty food and beverage products, such as boba and coffee drinks, and certain restaurant and warehouse supplies. The Company’s long-lived assets are all located in the period in which the expenditure is incurred. Advertising costs included in operating expensesUnited States, and its revenues are all generated in the condensed consolidated statements of income were $599,000 and $823,000 for the three months ended September 30, 2022 and 2021, respectively. Advertising costs included in operating expenses in the condensed consolidated statements of income were $1,732,000 and $1,843,000 for the nine months ended September 30, 2022 and 2021, respectively.United States.
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 recognizes 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, 2022 and December 31, 2021.
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, 2022 and 2021, 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,
2022202120222021
Keary Global Ltd. ("Keary Global") and its affiliate, Keary International, Ltd.- related parties*13.7 %10.9 %14.3 %
*Amount purchased represented less than 10% of total purchases.







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KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Amounts due to vendors that exceed 10 percent of total accounts payable at September 30, 2022 and December 31, 2021 are as follows:
September 30,
2022		December 31,
2021
Keary Global and its affiliate, Keary International - related parties21 %10 %
Wen Ho Industrial Co., Ltd*11 %
Fuling Technology Co., Ltd.15 %21 %
*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, 2022 and 2021, respectively. No customer accounted for more than 10 percent of accounts receivable as of September 30, 2022 and December 31, 2021.
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 three levels of inputs are as follows:
Level 1 — Quoted prices in active markets for identical assets or liabilities that the Company 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.
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. 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 Company has financial instruments classified within the fair value hierarchy, which consist of the following:
•At September 30, 20222023, the Company had money market accounts and short-term investments classified as Level 1 within the fair value hierarchy. The short-term investments comprise of certificates of deposits with an original maturity of longer than 90 days and are reported at their carrying value as current assets on the condensed consolidated balance sheet. The carrying value of these short-term investments approximates fair value as they were purchased near or on September 30, 2023. At December 31, 2021,2022, the Company has ahad money market account,accounts classified as Level 1 within the fair value hierarchy, and reported as a current assetassets on the condensed consolidated balance sheets.

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•At December 31, 2021, the Company had an interest rate swap that met the definition of a derivative, classified as Level 2 within the fair value hierarchy, and reported as other liabilities on the condensed consolidated balance sheet. The fair value of interest rate swap was calculated using pricing models that will use volatility to quantify the probability of changes around interest rate trends. This interest rate swap was terminated in June 2022, as further discussed in Note 10 — Interest Rate Swaps.
The following table summarizes the Company’s fair value measurements by level at September 30, 2022 for the assets measured at fair value on a recurring basis (in thousands):2023:
Level 1Level 2Level 3
(in thousands)
Cash equivalents$4,05019,024 $— $— 
Short-term investments18,063 — — 
Fair value, September 30, 20222023$4,05037,087 $— $— 
The following table summarizessummarize the Company’s fair value measurements by level at December 31, 2021 for the assets and liabilities measured at fair value on a recurring basis (in thousands):2022:
Level 1Level 2Level 3
Cash equivalents$2,000 $— $— 
Interest rate swap— (1,334)— 
Fair value, December 31, 2021$2,000 $(1,334)$— 
Level 1Level 2Level 3
(in thousands)
Cash equivalents$10,609 $— $— 
Fair value, December 31, 2022$10,609$—$—
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, related-party payable, accrued and other liabilities, other payable and borrowings under promissory notes and Line of Credit (as defined below), are reported at their carrying value.
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, related-party payable, accrued and other liabilities and other payablepayables at September 30, 20222023 and December 31, 2021, approximate2022, approximated fair value
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because of the short maturity of these instruments. The carrying amount of the Company's Line of Credit approximates fair value because the interest rate is variable in nature. For the $21,580,000 term loan that the Company refinanced in June 2022, the carrying amount as of December 31, 2021 approximated fair value because the interest rate was variable in nature. The following is a summary of the carrying amount and estimated fair value of the $23,000,000 and $28,700,000 term loans that mature in September 2026 and July 2027, respectively (in thousands)(the "2026 Term Loan" and "2027 Term Loan," respectively):
September 30, 2022
Carrying AmountEstimated Fair Value
(in thousands)
$23,000,000 term loan maturing in September 2026$22,318 $19,993 
$28,700,000 term loan maturing in July 202720,648 20,184 
$42,966 $40,177 
September 30, 2023
Carrying AmountEstimated Fair Value
(in thousands)
2026 Term Loan$21,640 $19,496 
2027 Term Loan28,139 27,090 
$49,779 $46,586 
December 31, 2022
Carrying AmountEstimated Fair Value
(in thousands)
2026 Term Loan$22,079 $20,115 
2027 Term Loan20,436 18,918 
$42,515 $39,033 
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 income. The Company recorded a gain on foreign currency transactions of $369,000 and a loss $63,000 for the three months ended September 30, 2022 and 2021, respectively. The Company recorded a gain on foreign currency transactions of $1,352,000 and a loss $347,000 for the nine months ended September 30, 2022 and 2021, respectively.

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Stock-Based Compensation: The Company recognizes stock-based compensation expense related to employee stock options and restricted stock units 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 for stock options, and the closing price of the Company's common stock on the trading day immediately prior to the grant date for restricted stock units. Key input assumptions used in the Black-Scholes option pricing model to estimate the grant date fair value of stock options include 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 (the "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 determines 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 income 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 will adopt the new standard in annual reporting period beginning after December 15, 2021. The Company expects to adopt this guidance using the package of transitional practical expedients relating to the identification, classification and initial direct costs of leases commencing before the effective date of Topic 842, and the expedient to combine the lease and non-lease components; however, the Company does not expect to elect the hindsight

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transitional practical expedient. Although the Company continues to evaluate the effect on its Condensed Consolidated Financial Statements and disclosures, the Company currently estimates total consolidated assets and liabilities will increase approximately $8,000,000 to $11,000,000 upon adoption. This estimate could change as the Company continues to progress with implementation and will also fluctuate based on the lease portfolio and discount rates. Management does not expect a material impact to the Company’s Condensed Consolidated Statements of Income or Cash Flows.
In June 2016, the FASB issued ASU 2016-13, ““Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial InstrumentsInstruments"”, which adds to U.S.US GAAP an impairment model known as the current expected credit loss (CECL)("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.US 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, including interim periods within those fiscal years. The FASB subsequently issued ASU 2019-10 (Topic 326), ““Financial Instruments-Credit Losses: Effective Dates”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 forThe Company adopted this new standard using the deferral, the effective date is January 1,modified retrospective adoption method beginning with its first quarter in 2023. The Company will adopt theapplication of this new standard in annual reporting period beginning after January 1, 2023, and is currently assessing thedid not have a material impact of this standard on the Company’sits 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 Cup Agreement, Lollicup paid cash consideration of $1,000,000 to acquire certain assets of Pacific Cup. Acquisition-related costs were immaterial. The amounts of revenue and earnings of the acquiree since the acquisition date is included in the condensed consolidated statement of income for the reporting periods, and is not significant for the period from March 1, 2021 to September 30, 2021.

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 final valuation of assets acquired as a result of this acquisition:activity in the Company's goodwill from December 31, 2022 to September 30, 2023:
(in thousands)
InventoriesBalance at December 31, 2022$153 3,510
Property and equipment50 
Customer relationships400 
Goodwill acquired397 —
Total assets acquiredBalance at September 30, 2023$1,0003,510 

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4. Joint Venture

On April 6, 2022, Lollicupthe Company entered into a definitive joint venture agreement (the “JV Agreement”"JV Agreement") with Happiness Moon Co., Ltd., a Taiwanese company, to jointly establish Green Earth Technology (“Green Earth”), a new Taiwanese corporation, for the manufacturing of compostable foodservice products from bagasse.Bio Earth, to build a bagasse factory in Taiwan. The JV Agreement stipulated an investment by the Company of approximately $5,876,000$6,500,000 for a 49% interest in GreenBio Earth.

As of September 30, Through December 31, 2022, the incorporationCompany made net
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
payments totaling $4,000,000 under the JV Agreement. During the three months ended March 31, 2023, the Company made additional payments of Green$2,900,000 and received a refund of $900,000 under the JV Agreement.
On May 8 2023, the Company entered into a Share Transfer Agreement (the "Share Transfer Agreement"), with approval of the Board of Directors, to sell all of its equity interest in Bio Earth had not been completed. Lollicup had investedto Keary Global for a total consideration of $4,000,000 pursuant toapproximately $6,100,000 (the "Share Transfer"), representing the total net deposits made by the Company of $6,000,000 under the JV Agreement as discussed above and interest accruing at 5% per annum. Keary Global and its affiliate, Keary International are both owned or controlled by Jeff Yu, brother of September 30, 2022our Chief Executive Officer, Alan Yu. Concurrent with the Share Transfer Agreement, the Company also entered into an agreement with Keary Global, Bio Earth and Happiness Moon Co., Ltd. (“Happiness Moon”) pursuant to which was included(i) Lollicup agreed to transfer all Bio Earth shares, as well as its rights and obligations under the JV Agreement to Keary Global, (ii) Happiness Moon and Bio Earth agree to foregoing and (iii) Bio Earth shall manage the regulatory and registration requirements related to the Share Transfer.
As of the end of the second quarter of 2023, the Company had completed the Share Transfer to Keary Global and received the total consideration of $6,100,000 in deposits on the accompanying condensed consolidated balance sheet. As discussed infull.
See Note 1715 — Subsequent EventsRelated Party Transactions, Lollicup made its final remaining investment payment of $1,876,000 for further discussion on November 9, 2022.our business activities with Keary Global.
5. InventoryInventories
Inventories consist of the following:
September 30,
2022		December 31,
2021		September 30, 2023December 31, 2022
(in thousands)(in thousands)
Raw materialsRaw materials$21,870 $14,075 Raw materials$9,427 $18,061 
Semi-finished goodsSemi-finished goods2,413 1,850 
Finished goodsFinished goods52,599 45,140Finished goods60,539 52,044 
SubtotalSubtotal74,469 59,215Subtotal72,379 71,955 
Less: Inventory reserves(1,183)(743)
Less inventory reserveLess inventory reserve(722)(749)
Total inventoriesTotal inventories$73,286 $58,472 Total inventories$71,657 $71,206 
The Company incurred inventory adjustments and write-off of $281,000 and $3,225,000 for the three and nine months ended September 30, 2023, respectively. There were no inventory adjustments and write-offs for the three and nine months ended September 30, 2022. Included within the amount for the nine months ended September 30, 2023, was a $1,710,000 write-off of raw materials, as the Company disposed of certain machinery and equipment in executing the strategy to scale back production in certain locations. Inventory adjustments and write-offs are included in cost of goods sold on the accompanying condensed consolidated statements of income. See Note 14 — Impairment Expense and (Gain) Loss, Net, on Disposal of Machinery for further discussion about the disposal of machinery.
6. Property and Equipment
Property and equipment, net consist of the following:
September 30, 2023December 31, 2022
(in thousands)
Machinery and equipment$70,150 $70,234 
Leasehold improvements19,070 19,063 
Vehicles7,480 6,725 
Furniture and fixtures1,141 1,016 
Building38,505 36,599 
Land11,907 11,907 
Computer hardware and software593 593 
148,846 146,137 
Less: accumulated depreciation and amortization(52,156)(50,569)
Total property and equipment, net$96,690 $95,568 
September 30,
2022		December 31,
2021
(in thousands)
Machinery and equipment$67,540 $60,935 
Leasehold improvements19,919 18,655 
Vehicles5,993 5,384 
Furniture and fixtures974 936 
Building35,387 35,387 
Land11,907 11,907 
Computer hardware and software568 553 
142,288 133,757 
Less: Accumulated depreciation and amortization(47,942)(40,282)
Total property and equipment, net$94,346 $93,475 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Depreciation and amortization expense wereon property and equipment was $2,701,000 and $2,597,000 and $2,528,000 for the three months ended September 30, 20222023 and 2021,2022, respectively. Depreciation and amortization expense wereon property and equipment was $8,038,000 and $7,732,000 and $7,464,000 for the nine months ended September 30, 20222023 and 2021,2022, respectively. Depreciation and amortization expense areis reported within general and administrative expense except for depreciation and amortization expense related to manufacturing facilities and equipment, which is included in cost of goods sold on the accompanying condensed consolidated statements of income.
7. Line of Credit
Pursuant to the terms of the Business Loan Agreement, dated February 23, 2018, between Lollicup, as borrower, and Hanmi Bank, as lender (as amended, the “Loan Agreement”), the Company has a line of credit with a maximum borrowing

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capacity of $40,000,000 (the “Line of Credit”) secured by the Company’s assets. The Line of Credit also includes a standby letter of credit sublimit, which was amended and increased to $2,000,000 on August 18, 2022. The Company is not required to pay a commitment (unused) fee on the undrawn portion of the Line of Credit and interest is payable monthly.
On October 6, 2021, the The Company amended the Loan Agreement. Prior to October 6, 2021, interest accrued at an annual rate of prime less 0.25% with a minimum floor of 3.75%, and the amount that could be borrowed was subject to a borrowing base that was calculated as a percentage of the accounts receivable and inventory balances measured monthly. Additionally, the Company wasis required to comply with certain financial covenants, including a minimum current ratio, minimum tangible net worth, minimum debt service coverage ratio, and minimum debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”("EBITDA") ratio and a minimum fixed charge coverage ratio.
On March 14, 2023, the Company amended the Line of Credit. Prior to March 14, 2023, interest accrued at the annual rate of prime less 0.25% with a minimum floor of 3.25%. The amendment on October 6, 2021,March 14, 2023, among other things, (1) extended the maturity date to October 6, 2023,March 14, 2025, and (2) revised the interest on any lineLine of creditCredit borrowings to an annual rate of prime less 0.25%one month term Secured Overnight Financing Rate ("SOFR") plus 2.50%, with a minimumSOFR floor of 3.25%, (3) removed1.0%.
The Line of Credit also includes a standby letter of credit sublimit, which was amended and increased to $5,000,000 from $2,000,000 on June 20, 2023.
The Company had no borrowings outstanding under the requirement forLine of Credit as of both September 30, 2023 and December 31, 2022. The amount issued under the maximum amountstandby letter of borrowings to be subject to a borrowing base requirement thatcredit was calculated$3,736,000 and $1,070,000 as a percentage of accounts receivableSeptember 30, 2023 and inventory balances, (4) removed the minimum tangible net worth and minimum debt service coverage ratio from the financial covenant requirement, and (5) added a minimum fixed charge coverage ratio in the financial covenant requirement.
December 31, 2022, respectively. As of September 30, 2022,2023, the maximum remaining amount that could be borrowed under the Line of Credit was $38,930,000. The Company had $0 of borrowings outstanding under the Line of Credit as of both September 30, 2022 and December 31, 2021. The amount issued under the standby letter of credit was $1,070,000 and $0 as of September 30, 2022 and December 31, 2021, respectively.$36,264,000. As of both September 30, 20222023 and December 31, 2021,2022, the Company was in compliance with the financial covenants under the Line of Credit.
8. Accrued Expenses
The following table summarizes information related to accrued expense liabilities:
September 30,
2022		December 31,
2021
(in thousands)
Accrued and other expenses$3,310 $2,363 
Accrued interest104 68 
Accrued payroll1,617 1,456 
Accrued vacation and sick pay685 416 
Accrued shipping expenses2,214 2,868 
Accrued professional services fees539 642 
Total accrued expenses$8,469 $7,813 

September 30, 2023December 31, 2022
(in thousands)
Accrued miscellaneous expenses$2,368 $1,646 
Accrued interest73 108 
Accrued payroll1,180 1,586 
Accrued vacation and sick pay834 543 
Accrued shipping expenses1,478 1,918 
Accrued professional services fees499 600 
Accrued property tax876 1,164 
Accrued sale taxes and use taxes1,021 992 
Accrued sales discount529 448 
Total accrued expenses$8,858 $9,005 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
9. Long-Term Debt
Long-term debt consists of the following:
September 30, 2022December 31, 2021September 30, 2023December 31, 2022
(in thousands)(in thousands)
A $23,000,000 term loan that matures September 30, 2026, with an initial balance of $16,115,000 and an option to request for additional advances up to a maximum of $6,885,000 through September 2022, which the Company exercised in February 2022. Interest accrues at a fixed rate of 3.5% per annum. Principal and interest payments of $116,000 are due monthly throughout the term of the loan, with the remaining principal balance due at maturity. The loan is collateralized by substantially all of Global Wells’ assets and is guaranteed by Global Wells and one of the Company’s stockholders. In accordance with the loan agreement, Global Wells is required to comply with certain financial covenants, including a minimum debt service coverage ratio.$22,318 $15,909 
A $21,580,000 term loan ("2029 Loan") that was set to mature in May 2029. Interest accrued at prime rate less 0.25% (3.00% at December 31, 2021) and principal payments ranging from $24,000 to $40,000 along with interest were due monthly throughout the term of the loan, with the remaining principal balance due at maturity. The loan was collateralized by substantially all of the Company’s and Global Well’s assets and was guaranteed by the Company and its stockholders. The Company incurred debt issuance costs of approximately $119,000, which was reported as a reduction of the carrying value of debt on the accompanying consolidated balance sheet. This loan was refinanced in June 2022 (see below).— $20,808 
A $28,700,000 term loan ("2027 Loan") that matures July 1, 2027, with an initial balance of $20,700,000 and an option to request for additional advances up to a maximum of $8,000,000 through June 30, 2023. Interest accrues at a fixed rate of 4.375% per annum. Principal and interest payments of $104,000 are due monthly throughout the term of the loan, with the remaining principal balance due at maturity. The loan is collateralized by substantially all of Global Wells’ assets and is guaranteed by one of the Company’s stockholders. In accordance with the loan agreement, Global Wells is required to comply with certain financial covenants, including a minimum debt coverage ratio.20,648 — 
The 2026 Term Loan, with an initial balance of $16,115,000 and an option to request for additional advances up to a maximum of $6,885,000 through September 2022, which the Company exercised in February 2022. Interest accrues at a fixed rate of 3.5% per annum. Principal and interest payments of $116,000 are due monthly throughout the term of the loan, with the remaining principal balance due at maturity. The loan is collateralized by substantially all of Global Wells’ assets and is guaranteed by Global Wells and one of the Company’s stockholders. In accordance with the loan agreement, Global Wells is required to comply with certain financial covenants, including a minimum debt service coverage ratio.The 2026 Term Loan, with an initial balance of $16,115,000 and an option to request for additional advances up to a maximum of $6,885,000 through September 2022, which the Company exercised in February 2022. Interest accrues at a fixed rate of 3.5% per annum. Principal and interest payments of $116,000 are due monthly throughout the term of the loan, with the remaining principal balance due at maturity. The loan is collateralized by substantially all of Global Wells’ assets and is guaranteed by Global Wells and one of the Company’s stockholders. In accordance with the loan agreement, Global Wells is required to comply with certain financial covenants, including a minimum debt service coverage ratio.$21,711 $22,168 
The 2027 Term Loan, with an initial balance of $20,700,000 and an option to request for additional advances up to a maximum of $8,000,000 through June 30, 2023, which the Company exercised in March 2023. Interest accrues at a fixed rate of 4.375% per annum. Prior to August 1, 2023, principal and interest payments of $104,000 are due monthly. Beginning August 1, 2023, monthly principal and interest payments increased to $144,000 for the remainder of the loan term, with the remaining principal balance due at maturity. The loan is collateralized by substantially all of Global Wells’ assets and is guaranteed by one of the Company’s stockholders. In accordance with the loan agreement, Global Wells is required to comply with certain financial covenants, including a minimum debt coverage ratio.The 2027 Term Loan, with an initial balance of $20,700,000 and an option to request for additional advances up to a maximum of $8,000,000 through June 30, 2023, which the Company exercised in March 2023. Interest accrues at a fixed rate of 4.375% per annum. Prior to August 1, 2023, principal and interest payments of $104,000 are due monthly. Beginning August 1, 2023, monthly principal and interest payments increased to $144,000 for the remainder of the loan term, with the remaining principal balance due at maturity. The loan is collateralized by substantially all of Global Wells’ assets and is guaranteed by one of the Company’s stockholders. In accordance with the loan agreement, Global Wells is required to comply with certain financial covenants, including a minimum debt coverage ratio.$28,287 $20,563 
Long-term debtLong-term debt42,966 36,717 Long-term debt49,998 42,731 
Less: unamortized loan feesLess: unamortized loan fees(229)(200)Less: unamortized loan fees(219)(216)
Less: current portionLess: current portion(948)(1,178)Less: current portion(1,111)(957)
Long-term debt, net of current portionLong-term debt, net of current portion$41,789 $35,339 Long-term debt, net of current portion$48,668 $41,558 
At September 30, 2022,2023, future maturities are (in thousands):are:
2022 (remainder)$235 
2023957 
2024990 
20251,040 
202620,653 
Thereafter19,091 
Total$42,966 
(in thousands)
2023 (remainder)$277 
20241,122 
20251,179 
202620,798 
202726,622 
$49,998 

The Company's refinance of the 2029 Loan with the 2027 Loan was a refinance in June 2022 from a previous $21,580,000 term loan, and was accounted for as a debt modification. The Company was in compliance with all of its financial covenants as of both September 30, 20222023 and December 31, 2021.2022.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
10. Interest Rate SwapsSwap
In June 2022, Global Wells terminated its ten-year floating-to-fixed interest rate swap, and recognized cash proceeds of $825,000 as gain on the settlement, which was included in interest income in the accompanying condensed consolidated statements of income. This interest rate swap had a notional value of $21,580,000 as of the effective date of June 13, 2019 based on the prime rate versus a 5.05%5.0% fixed rate. As of December 31, 2021, the fair value of the interest rate swap was $1,334,000, which is reported as other liabilities in the accompanying condensed consolidated balance sheet. For the three months ended September 30, 2021, Global Wells recognized $155,000 as interest income related to change in fair value of his interest rate swap.
For the nine months ended September 30, 2022, and 2021, Global Wells recognized $2,159,000 (including the gain on settlement) and $1,055,000 as interest income related to change in fair value of thisthe interest rate swap, respectively.swap.
13

In June 2019, the Company also entered into a five-year floating-to-fixed interest-rate swap, with an effective date of June 3, 2019, that was based on the prime rate versus 5.19% fixed rate. The notional was $10,000,000 as of June 2019. For the nine months ended September 30, 2021, the Company recognized approximately $47,000 in interest income related to change in fair value of this interest rate swap. In April 2021, the Company terminated this interest rate swap, recognizing $196,000 in swap termination fee, which was included in interest income in the condensed consolidated statements of income for the nine months ended September 30, 2021.
11. Stock-basedStock-Based Compensation
In January 2019, the Company’s Board of Directors adopted the 2019 Stock Incentive Plan (the “Plan”). A total of 2,000,000 shares of common stock were authorized and reserved for issuance under the Plan in the form of incentive or nonqualified stock options and stock awards. A compensation committee appointed by the Board of Directors of the Company determines the terms and conditions of each grant under the Plan. Employees, directors, and consultants are eligible to receive stock options and stock awards under the Plan. The aggregate number of shares available under the Plan and the number of shares subject to outstanding options may be increased or decreased by the Plan administrator to reflect any changes in the outstanding common stock by reason of any recapitalization, reorganization, reclassification, stock split, reverse split, combination of shares, exchange of shares, stock dividend or other distribution payable in capital stock or similar transaction.
The exercise price of incentive stock options may not be less than the fair market value of the common stock at the date of grant. The exercise price of incentive stock options granted to individuals that own greater than 10% of the voting stock may not be less than 110% of the fair market value of the common stock at the date of grant.
The term of each incentive and nonqualified option is based upon conditions as determined by the option agreement; however, the term can be no more than ten years from the date of the grant. In the case of an incentive stock option granted to an optionee who, at the time the option is granted, owns stock representing more than 10% of the voting power of all classes of stock of the Company or any parent or subsidiary, the term of the option will be a shorter term as provided in the option agreement, but not more than five years from the date of the grant.

As of September 30, 2022,2023, a total of 1,308,1831,334,017 shares of common stock waswere available for further award grants under the Plan. For the three months ended September 30, 20222023 and 2021,2022, the Company recognized a total of $598,000$250,000 and $830,000$598,000 in stock-based compensation expense, respectively. For the nine months ended September 30, 20222023 and 2021,2022, the Company recognized a total of $1,774,000$743,000 and $1,060,000$1,774,000 in stock-based compensation expense, respectively. The restricted stock units and stock options granted prior to April 15, 2021 were subjected to vesting conditions contingent upon the closing of an initial public offering of the Company. Such awards began vesting on April 15, 2021 when the Company completed its initial public

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KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
offering. The Company recognizes stock-based compensation over the vesting period, which is generally 3three (3) years for both the restricted stock units and stock options.

Stock Options
A summary of the Company’s stock option activity under the Plan for the period ended September 30, 20222023 is as follows:
Number of
Options		Weighted-
Average
Exercise
Price		Weighted-
Average
Remaining
Contract
Life
(In Years)		Aggregate
Intrinsic
Value
Outstanding at December 31, 2021435,000 $18.76$— 
Granted50,000 16.53 
Exercised(5,000)10.00 
Canceled/forfeited(50,000)18.86 
Outstanding at September 30, 2022430,000 $18.599.1$— 
Expected to vest at September 30, 2022430,000 $18.599.1$— 
Exercisable at September 30, 2022— — — $— 
Number of OptionsWeighted-Average Exercise PriceWeighted-Average Remaining Contract Life (In Years)Aggregate Intrinsic Value
(in thousands)
Outstanding at December 31, 2022420,000 $18.6 8.8$— 
Exercised(5,800)$17.7 
Forfeited(10,000)$18.9 
Outstanding at September 30, 2023404,200 $18.6 8.1$1,807 
Vested and expected to vest at September 30, 2023404,200 $18.6 8.1$1,807 
Exercisable at September 30, 2023130,867 $18.6 8.1$581 

The weighted-average grant date fair-value of theThere were no stock options granted forduring the nine months ended September 30, 2022 was $16.53 per share.2023. At September 30, 2022,2023, total remaining stock-based compensation expensecost for unvested stock options isunder the Plan was approximately $1,001,000. $282,000. The cost is expected to be recognized over a weighted-average period of 1.6 years.

1.0 year.
The aggregate intrinsic value is calculated by subtracting the exercise price of the option from the closing price of the Company’s common stock on September 30, 2022,2023, multiplied by the number of shares per each option.

The assumptions that were used to calculate the grant date fair value of the Company’s stock option grants for the nine months ended September 30, 2022 were as follows:

Nine Months Ended September 30, 2022
Risk-free interest rate1.70 %
Expected term (years)6.25 years
Volatility30 %
Dividend yield0.40 %
KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Restricted Stock Units
The Company issued restricted stock units to employees of the Company.its employees. The following table summarizes the unvested restricted stock units for the periodnine months ended September 30, 2022:2023:
Number of
Shares
Outstanding		Weighted
Average
Grant Date
Fair Value
Unvested at December 31, 2021159,000 $11.08 
Granted9,900 16.69 
Forfeited(7,000)17.90 
Unvested at September 30, 2022161,900 $11.12 
Number of Shares OutstandingWeighted Average Grant Date Fair Value
Unvested at December 31, 202282,146 11.47
Vested(4,550)16.64
Forfeited(1,667)10.00
Unvested at September 30, 202375,929 11.19


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KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
There were no restricted stock units granted during the nine months ended September 30, 2023. At September 30, 2022,2023, total remaining stock-based compensation expensecost for unvested restricted stock units iswas approximately $478,000.$39,000. The cost is expected to be recognized over a weighted-average period of 1.0 year.0.6 years.
12. Earnings Per Share
(a)Basic
Basic earnings per share is calculated by dividing the net income attributable to equity holders of the Company for the period by the weighted average number of common shares outstanding during the related period.
Three Months Ended September 30,Nine Months Ended September 30,Three Months Ended September 30,Nine Months Ended September 30,
20222021202220212023202220232022
(in thousands, except per share data)(in thousands, except per share data)
Net income attributable to Karat Packaging Inc.Net income attributable to Karat Packaging Inc.$6,096 $3,786 $19,107 $15,149 Net income attributable to Karat Packaging Inc.$9,065$6,096$28,572$19,107
Weighted average number of common shares in issueWeighted average number of common shares in issue19,809 19,710 19,809 17,945 Weighted average number of common shares in issue19,891 19,809 19,888 19,809 
Basic earnings per shareBasic earnings per share$0.31 $0.19 $0.96 $0.84 Basic earnings per share$0.46 $0.31 $1.44 $0.96 
(b)Diluted

Diluted earnings per share is calculated based upon the weighted average number of common shares and common equivalent shares outstanding during the period, calculated using the treasury stock method. Under the treasury stock method, exercise proceeds include the amount the employee must pay for exercising stock options and the amount of compensation cost related to stock awards for future services that the Company has not yet recognized. Common equivalent shares are excluded from the computation in periods in which they have an anti-dilutive effect.

The following table summarizes the calculation of diluted earnings per share:
Three Months Ended September 30,Nine Months Ended September 30,Three Months Ended September 30,Nine Months Ended September 30,
20222021202220212023202220232022
(in thousands, except per share data)(in thousands, except per share data)
Net income attributable to Karat Packaging Inc.Net income attributable to Karat Packaging Inc.$6,096 $3,786 $19,107 $15,149 Net income attributable to Karat Packaging Inc.$9,065 $6,096 $28,572 $19,107 
Weighted average number of common shares in issueWeighted average number of common shares in issue19,809 19,710 19,809 17,945 Weighted average number of common shares in issue19,891 19,809 19,888 19,809 
Dilutive sharesDilutive sharesDilutive shares
Stock options and restricted stock unitsStock options and restricted stock units129 171 113 165 Stock options and restricted stock units104 129 75 113 
Adjusted weighted average number of common sharesAdjusted weighted average number of common shares19,938 19,881 19,922 18,110 Adjusted weighted average number of common shares19,995 19,938 19,963 19,922 
Diluted earnings per shareDiluted earnings per share$0.31 $0.19 $0.96 $0.84 Diluted earnings per share$0.45 $0.31 $1.43 $0.96 
For the three months ended September 30, 20222023 and 2021,2022, a total of 434,0000 and 90,000434,000 shares of potentially dilutive shares, respectively, have been excluded in the diluted earnings per share calculation due to itstheir anti-dilutive impact on earnings per share. For the nine months ended September 30, 20222023 and 2021,2022, a total of 452,000285,000 and 157,000452,000 shares of
15
KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
potentially dilutive shares, respectively, have been excluded in the diluted earnings per share calculation due to itstheir anti-dilutive impact on earnings per share.
13. Commitments and Contingencies
Lease CommitmentsLeases
The Company primarily leases certainmanufacturing facilities, distribution centers and vehicles under various operating leasesoffice spaces with lease terms expiring through 2031. The Company recognized the following lease costs in the accompanying condensed consolidated statement of income:

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KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
At September 30, 2022, approximate future minimum lease obligations are as follows:
(in thousands)
2022 (remainder)$1,362 
20235,413 
20244,287 
20252,927 
20263,006 
Thereafter2,614 
Total$19,609 
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
(in thousands)(in thousands)
Operating lease expense$1,606 $1,336 $4,454 $3,256 
Short-term lease expense106 4 143 14 
Variable lease expense260 212 750 501 
Total lease expense$1,972 $1,552 $5,347 $3,771 
For the three months ended September 30, 20222023 and 2021,2022, rent expense included in operating expenses was $1,260,000$1,653,000 and $931,000,$1,260,000, respectively, and rent expensesexpense included in cost of goods sold was $292,000$319,000 and $192,000,$292,000, respectively. For the nine months ended September 30, 20222023 and 2021,2022, rent expense included in operating expenses was $2,974,000$4,542,000 and $2,383,000,$2,974,000, respectively, and rent expensesexpense included in cost of goods sold was $805,000 and $797,000, and $609,000, respectively.
The following table presents supplemental information related to operating leases:
September 30, 2023December 31, 2022
Weighted average remaining lease term4.41 years4.27 years
Weighted average discount rate5.8 %5.3 %
Nine Months Ended September 30,
20232022
(in thousands)
Cash paid for amounts included in measurement of lease obligations:
Operating cash flows from operating leases$4,129 $3,120 
As of September 30, 2023, future lease payments under operating leases were as follows:
(in thousands)
2023 (remainder)$1,544 
20245,254
20253,928
20264,044
20272,711
Thereafter2,885
Total future lease payments20,366
Less: imputed interest2,573
Total lease liability balance$17,793 
In September 2020, Global Wells entered into an operating lease with an unrelated party as the landlord. The lease generates monthly rental payments from $58,000 to $61,000 over the lease term of 38 months beginning September 9,
16
KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
2020. Rental incomeThe lease was extended for the three months ended September 30, 2022a period of two additional years beginning November 1, 2023, and 2021 was $239,000 and $246,000, respectively. Rental income for the nine months ended September 30, 2022 and 2021 was $715,000 and $738,000, respectively.will generate monthly rental payments from $62,000 to $65,000. The expected rental income is $182,000 and $611,000$185,000 for the remaining three months of the year ended December 31, 2022 and for the year endedending December 31, 2023, and $739,000 and $616,000 for the years ending December 31, 2024, and 2025, respectively.
Contingencies
14. Impairment Expense and (Gain) Loss, Net, on Disposal of Machinery and Equipment
In February 2023, the Company started to execute a strategy to increase imports and scale back manufacturing in certain locations. The Company subsequently reached an agreement with two unrelated third-party vendors in Taiwan to sell them certain of its manufacturing machinery and equipment. The sale of these assets occurred in the second and third quarter of 2023. During the same period, the Company also cancelled certain equipment purchase commitments that it had previously paid deposits towards, and disposed of certain machinery and equipment through abandonment.
The Company is involved from timerecognized the following amounts related to time in certain legal actionsimpairment expense and claims arising in the ordinary course(gain) loss, net, on disposal of business. Management believes that the outcome of such litigation and claims, should they arise in the future, is not likely to have a material effect on the Company’s financial position or results of operations.machinery:
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
(in thousands)(in thousands)
(Gain) loss, net, on disposal of machinery in scaling back manufacturing$(310)$— $1,612 $— 
(Gain) loss, net, on disposal of machinery within normal course of business— (16)96 (33)
(Gain) Loss, net, on disposal(310)(16)1,708 (33)
Impairment of deposits— — 523 — 
Impairment expense and (gain) loss, net, on disposal of machinery$(310)$(16)$2,231 $(33)
14.15. Related Party Transactions
Keary Global Ltd. ("Keary Global") owns 250,004 shares of the Company's common stock as of September 30, 2022,2023, which Keary Global acquired upon exercise of two convertible notes during the third quarter of 2018. Keary Global and its affiliate, Keary International, are owned by one of the Company’s stockholders’ family member. In addition to being a stockholder, Keary Global and Keary International are inventory suppliers and purchasing agents for the Company overseas. The Company has entered into ongoing purchase and supply agreements with Keary Global. At September 30, 20222023 and December 31, 2021,2022, the Company has accounts payable due to Keary Global and Keary InternationalInternational of $4,858,000$2,555,000 and $2,003,000, respectively.$4,940,000, respectively. Purchases for the three months ended September 30, 20222023 and 20212022 from this related party werewere $7,371,000 and $7,336,000, and $12,248,000, respectively. Purchases for the nine months ended September 30, 20222023 and 20212022 from this related party wwere $32,384,000 and $33,051,000, respectively.
See Note 4 — ere $33,051,000Joint Venture and $25,780,000, respectively.for discussion on our share transfer agreement with Keary Global.
15.16. Income Taxes
In determining the interim provision for income taxes, the Company uses the annual estimated effective tax rate applied to the actual year-to-date income and adds the tax effects of any discrete items in the reporting period in which they occur.
For the three months ended September 30, 20222023 and 2021,2022, the Company's income tax expense was $1,900,000$2,904,000 and $1,268,000,$1,900,000, with effective tax rate of 23.6%24.1% and 23.7%23.6%, respectively. For the nine months ended September 30, 20222023 and 2021,2022, the Company's income tax expense was $6,323,000$9,045,000 and $4,001,000,$6,323,000, with effective tax rate of 22.9%23.8% and 19.6%22.9%, respectively. For both the three and nine months ended September 30, 2023 and 2022, the Company's effective tax rate differed from the United States federal statutory rate of 21% primarily due to state taxes.
ASC 740, Income Taxes, provides for the recognition of deferred tax assets if realization of these assets is more-likely-than-not. In evaluating the Company’s ability to recover its deferred tax assets, the Company considers all available positive and negative evidence, including its operating results, ongoing tax planning and forecasts of future taxable income on a

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KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
jurisdiction-by-jurisdiction basis. Based upon the level of historical taxable income, at this time, the Company determined that sufficient positive evidence existed to conclude that it is more likely than not there will be full utilization of the deferred tax assets in each jurisdiction. As such, as of September 30, 2023, based on the available evidence, the Company did not record any valuation allowance.
17
KARAT PACKAGING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Company remains subject to IRSthe Internal Revenue Services ("IRS") examination for the 20162019 through 20212022 tax years, and has received notice in February 2019 that it is under examination for years 2016 and 2017. Additionally, the Company files multiple state and local income tax returns and remains subject to examination in various of these jurisdictions including California for the 20172018 through 2021 tax years and South Carolina for the 2017 through 2020 tax years.
The Company accounts for uncertainties in income tax in accordance with ASC 740-10 — Accounting for Uncertainty in Income Taxes. ASC 740-10 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. This accounting standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company recognizes interest and penalties related to unrecognized tax benefits on the income tax expense line in the accompanying consolidated statement of income. Accrued interest and penalties are included on the related tax liability line in the consolidated balance sheet. As of September 30, 2022,2023, and December 31, 2021,2022, the Company did not have any unrecognized tax benefit.
On March 27, 2020,In August 2022, the CARESInflation Reduction Act of 2022 (the "Act") was signed into law. The Act, among other things, imposes a nondeductible 1% excise tax on the fair market value of certain stock that is "repurchased" during the taxable year by publicly traded U.S. corporations or acquired by certain of its subsidiaries. The taxable amount is reduced by the fair market value of certain issuances of stock throughout the year. The Act also imposes a 15% corporate minimum tax on the adjusted financial statement income of large corporations for taxable years beginning after December 31, 2022. We do not expect these tax law changes to have a material impact on our condensed consolidated financial statements; however, we will continue to evaluate their impact.
In March 2023, the IRS announced the Winter Storm Relief that allowed for taxpayers in California affected by severe winter storms, flooding, landslides, and provided several favorablemudslides to have until November 15, 2023, to file various individual and business tax provisions.returns and make tax payments. The Company evaluatedtook advantage of this tax relief in the impactscurrent year.
17. Commitments and Contingencies
The Company is a party to, and certain of CARES Actits property is the subject of, various pending claims and determined it currently has nolegal proceedings that routinely arise in the ordinary course of its business. Management believes that the outcome of such litigation and claims, should they arise in the future, is not likely to have a material impact toeffect on the Company’s consolidated financial statements.
The Taxpayer Certainty and Disaster Relief Actposition or results of 2020, enacted on December 27, 2020, added a temporary exception to the 50% limit (TCJA) on the amount that businesses may deduct for food or beverages. Beginning January 1, 2021, through December 31, 2022, the temporary exception allows a 100% deduction for food or beverages from restaurants. The Company evaluated the impacts and does not believe the Act has material impact to the income tax provision.
On March 10, 2021, the “American Rescue Plan Act of 2021” was signed into law by the president. The American Rescue Plan Act of 2021 provides several tax provisions. The Company evaluated the impacts of the American Rescue Plan Act of 2021 and determined it has no material impact to the income tax provision.
16. COVID-19income.

Since Coronavirus Disease 2019 ("COVID-19") was declared
18. Secondary Offering
On September 12, 2023, certain selling stockholders completed a global pandemicsecondary public offering of shares of the Company's common stock. The Company did not receive any of the proceeds from the sale of these shares by the World Health Organization,selling stockholders. The Company incurred offering transaction costs of $453,000, which were recognized in general and administrative expense in the Company’s business, operations and financial performance have been, and may continue to be, impacted by macroeconomic factors resulting from the efforts to control the spreadcondensed consolidated statement of COVID-19 including raw material and labor shortage, supply chain disruptions and inflationary pressures.income.

19. Subsequent Events
Given the recent positive effects of vaccines on the United States and global populations along with relaxed restrictions on travel and social gatherings,In October 2023, the Company currently expects that such impacts of COVID-19 will be less significant going forwardmade tax payments totaling approximately $9,600,000 related to the Company's future business, operationscurrent year quarterly estimate tax payments that were previously deferred under the Winter Storm Relief declared by the IRS. See Note 16 — Income Taxes for details on this tax relief.
In October 2023, Global Wells made a pro rata distribution of approximately $3,956,000, net of all applicable withholding taxes, to its four members.
In October 2023, the Company received deposit refund of $1,272,000 related to the cancellation of a machinery purchase.
In October 2023, the Company signed an amended and financial performance. However, if global economic conditions worsenrestated lease agreement for a 98,000 square-foot distribution facility in Puyallup, Washington for a term of 64-months, which amended, restated and superseded the lease dated June 15, 2023. The lease term is expected to commence in November 2023 pending completion of certain landlord work or an earlier date as a result ofmutually agreed-upon between the pandemic, it could materially impactCompany and the Company’s liquidity position and capital needs.
17. Subsequent Events
Declaration of Dividend

landlord. Under the lease agreement, monthly base lease payments range from $94,000 to $115,000 after an initial rent abatement period.
On November 8, 2022,6, 2023, the Company's Board of Directors declared a specialquarterly cash dividend of $0.35$0.20 per share on the Company's common stock, which will be paid on or around November 30, 20222023 to shareholders of record at the close of business on November 21, 2022.

On November 9, 2022, Lollicup made its final remaining investment payment of $1,876,000 pursuant to the JV Agreement as discussed in Note 4 — Joint Venture.20, 2023.

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ItemITEM 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and accompanying notes. This discussion and analysis contains “forward-looking statements,” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements relate to expectations concerning matters that are not historical facts. For example, statements discussing, among other things, business strategies, growth strategies and initiatives, future revenues and future performance and expected costs and liabilities are forward-looking statements. Such forward-looking statements may be identified by words such as “anticipates,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” ��intends,“intends,” “may,” “plans,” “potential,” “predicts,” “remain,” “should,” or “will” or the negative of these terms or other comparable terminology. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expect and, therefore, you should not unduly rely on such statements. The risks and uncertainties that could cause those actual results to differ materially from those expressed or implied by these forward-looking statements include but are not limited to:

•fluctuations in the demand for our products in light of changes in laws and regulations applicable to food and beverages and changes in consumer preferences;

•supply chain disruptions that could interrupt product manufacturing and increase product costs;

•our ability to source raw materials and navigate a shortage of available materials;

•our ability to compete successfully in our industry;

•the impact of earthquakes, fire, power outages, floods, pandemics and other catastrophic events, as well as the impact of any interruption by problems such as terrorism, cyberattacks, or failure of key information technology systems;

•our ability to accurately forecast demand for our products or our results of operations;

•the impact of problems relating to delays or disruptions in the shipment of our goods through operational ports;

•our ability to expand into additional foodservice and geographic markets;

•our ability to successfully design and develop new products;

•fluctuations in freight carrier costs related to the shipment of our products could have a material adverse impact on our results of operations;

•the effects of COVID-19 or other public health crises;

•our ability to attract and retain skilled personnel and senior management; and

•other risks and uncertainties described in “Risk Factors,”Factors" as discussedset forth in Item I, Part 1, Item 1A, “Risk Factors” of ourthe Annual Report on Form 10-K for the year ended December 31, 2021.2022 as filed with the Securities and Exchange Commission (the "SEC") on March 16, 2023 (the "2022 Form 10-K").

As used in this Quarterly Report on Form 10-Q, “we”, “us”, “our”, “Karat”, “the Company” or “our Company” refer to Karat Packaging Inc., a Delaware corporation, and, unless the context requires otherwise, our operating subsidiaries. References to “Global Wells” or “our variable interest entity” refer to Global Wells Investment Group LLC, a Texas limited liability company and our consolidated variable interest entity, in which the Company has an equity interest and which is controlled by one of our stockholders. References to “Lollicup” refer to Lollicup USA Inc., a California corporation, our wholly-owned subsidiary.

Due to rounding, numbers presented throughout this report may not add up precisely to totals we provide and percentages may not precisely reflect the absolute figures.
19

Overview
We are a rapidly-growing specialty distributor and select manufacturer of environmentally-friendly disposable foodservice products and related items. We are a nimble supplier of a wide range of products for the foodservice industry, including food and take outtake-out containers, bags, tableware, cups, lids, cutlery, straws, specialty beverage ingredients, equipment,

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gloves and other products. Our products are available in plastic, paper, biopolymer-based and other compostable forms. Our Karat Earth® line provides environmentally friendly options to our customers, who are increasingly focused on sustainability. We offer customized solutions to our customers, including new product development, design, printing and logistics services.

While a majority of our revenue is generated from the distribution of our vendors’ products, we have select manufacturing capabilities in the U.S., which allows us to provide customers broad product choices and customized offerings with short lead times. We operate our business strategically and with broad flexibility to provide both our large and small customers with the wide spectrum of products they need to successfully run and grow their businesses. We believe our ability to source products quickly on a cost-effective basis via a diversified global supplier network, complemented by our manufacturing capabilities for select products, has established us as a differentiated provider of high-quality products relative to our competitors and supported a superior margin profile.
We operate an approximately 500,000 square foot distribution center located in Rockwall, Texas, an approximately 300,000 square foot distribution center in Chino, California, and an approximately 76,000 square foot distribution center located in Kapolei, Hawaii. We have selected manufacturing capabilities in all of these facilities. In addition, we operate fiveseven other distribution centers located in Sumner, Washington; Summerville, South Carolina; Branchburg, New Jersey; Kapolei, Hawaii; and City of Industry, California.California; Aurora, Illinois; and Sugar Land, Texas. Our distribution centers are strategically located in proximity to major population centers, including the Los Angeles, Houston, Dallas, New York, Seattle, Atlanta, Chicago and Honolulu metro areas.
We manage and evaluate our operations in one reportable segment.
Business Highlights and Trends
•We recorded revenuesnet sales of $110.0$105.5 million duringand $310.1 million for the three and nine months ended September 30, 2022, which represents an increase of 7.1% compared2023, respectively.
•Our gross margin expanded to 36.9% and 38.4% for the three and nine months ended September 30, 2021,2023, respectively, a particularly strong quarter due to post COVID-19 re-openings.
•We achieved gross margin of 31.1% during the three months ended September 30, 2022, a 210580 and 740 basis points increase from the three and nine months ended September 30, 2021.2022, respectively. The gross margin for the nine months ended September 30, 2023 included the impact of 60 basis points due to the write-off $1.7 million of certain raw materials as we disposed of certain machinery and equipment in executing our plan to scale back production in certain locations.
•We recorded net income of $6.2$9.1 million duringand $29.0 million for the three and nine months ended September 30, 2023, respectively, an increase of 49% and 36% compared to three and nine months ended September 30, 2022, which represents an increaserespectively. We achieved net income margin of 51.1% compared to8.7% and 9.4% for the three and nine months ended September 30, 2021.
•We acquired over 4,000 new customers during2023, respectively, a 310 and 300 basis points increase from the three and nine months ended September 30, 2022, which consistedrespectively. Net income for the nine months ended September 30, 2023 included $2.1 million in impairment expense and loss, net, on disposal of customers through wholesale distributionmachinery as we executed our strategy to scale back manufacturing in certain locations, and e-commerce direct-to-consumer channels.$1.7 million in raw materials write-off, as discussed above.
•We generated record quarterlynet cash from operating activities of $20.2$12.0 million and repaid $11.6$43.1 million on our line of credit duringfor the three and nine months ended September 30, 2022.
•We had financial liquidity of $54.52023, respectively, compared to $20.2 million as ofand $12.5 million in the three and nine months ended September 30, 2022, and declared a special cash dividend of $0.35 per share on our common stock on November 8, 2022.respectively.
•We generated consolidated Adjusted EBITDA, a non-GAAP measure defined below, of $11.7$15.2 million duringand $51.6 million for the three and nine months ended September 30, 2023, respectively, a 30% and 41% increase from the three and nine months ended September 30, 2022, representing an increase of 30.1% comparedrespectively.
•Our Adjusted EBITDA margin, a non-GAAP measure defined below, expanded to 14.4% and 16.6% for the three and nine months ended September 30, 2021.2023, respectively, an increase of 370 and 550 basis points from the three and nine months ended September 30, 2022, respectively.
•We had financial liquidity of $64.4 million and additional short-term investments of $18.1 million as of September 30, 2023. On November 6, 2023, our Board of Directors declared the quarterly cash dividend and increased it to $0.20 per share on our common stock, which will be paid on or around November 30, 2023 to shareholders of record at the close of business on November 20, 2023.
•During the second quarter of 2023, we closed the sale of our equity interest in Bio Earth and had received total consideration of $6.1 million, which comprised of our original deposits plus accrued interest.

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Trends in Our Business
The following trends have contributed to the results of our operations, and we anticipate that they will continue to affect our future results:
•There is a growing trend towards at home dining and mobility-oriented e-commerce, food delivery and take-out dining. We believe this trend will continue to have a positive impact on our results of operations, as more of our customers will require packaging and containers to meet the demands of their increased food delivery and take-out dining consumers.
•Environmental concerns regarding disposable products, broadly, have resulted in a number of significant changes that are specific to the food-service industry, including regulations applicable to our customers. We believe this trend will have a positive long-lasting impact on our results of operations, as we expect there will be an increased demand for eco-friendly and compostable single-use disposable products. Sale of eco-friendly products represented approximately 33% of total sales in the third quarter of 2023, compared to 27% in the prior year quarter.
•Changes in freight carrier costs related to the shipmentMost of our products especially relating toare sourced from vendors abroad and as a result we incur freight costs from these overseas import shipments. The freight and duty costs totaled $16.3 million, or 14.8% of net sales, during the three months ended September 30, 2022, compared to $14.4 million, or 14.1% of net sales during the three months ended September 30, 2021. We believe this trendfluctuations in freight cost can have either a positive or a negative impact on our results of operations, in the future, depending on whether such freight costs increase or decrease.
•U.S. foreign trade policy continues to evolve, such as the imposition of tariffs on a number of imported food-service disposable products, including those imported from China and other countries. We believe this trend will have either a positive or a negative impact on our results of operations, depending on whether we are able to source our raw materials or manufactured products from countries where tariffs have not been imposed by the current U.S. administration and whether the previously imposed tariffs are removed.
•Inflation and theThe cost of raw materials used to manufacture our products, including polyethylene terephthalate, or PET, plastic resin, aluminum and paper boards may continue to fluctuate. Since negotiated sales contracts and the market largely determine the pricing for our products, we are, at times, limited in our ability to raise prices and pass through any impacts of inflation to our costs. There can also be lags between cost inflation and the implementation of price increases, which could negatively impact our gross margin. We believe price fluctuations will have either a positive or a negative impact on our results of operations in the future, depending on whether raw material costs increase or decrease and whether we can successfully implement price increases to offset the impacts of inflation.
•Supplier chain disruptionseffectiveness could have a long-lasting impact on our operations and financial results. We believe this trend will have either a positive or a negative impact on our results of operations, depending on whether we are able to navigate the challenging environment and adjustmanage our operating modelsglobal supply chain effectively, including the accurate forecast of demand, the successful procurement of raw materials and products and the effective management of our inventory, production and distribution.
•Fluctuations in foreign currency exchange rates could impact either positively or negatively various aspects of our business activities, including but not limited to our purchasing power and capacity to source inventory.

•We have recently made a strategic business decision to pivot into a more asset-light growth model by increasing import and scaling back manufacturing in certain locations. We believe this will have either a positive or a negative impact on our results of operations, depending on whether we can successfully source and import finished goods at a price that is more favorable than domestically manufacturer products, and effectively realize savings from reduced manufacturing capabilities.
COVID-19 Update
Information regarding COVID-19 update is contained in Note 16 — COVID-19 in the Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

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Critical Accounting Policies and Estimates

The following discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with US GAAP. The preparation of these financial statements in accordance with US GAAP requires us to make estimates and judgments.

There have been no material changes in our critical accounting policies, or in the estimates and assumptions underlying those policies, from those described under the heading “Critical Accounting Policies and Estimates” in Item 7 of Part II of our 20212022 Form 10-K filed on March 31, 2022.10-K.
Results of Operations
Three Months Ended September 30,Nine Months Ended September 30,
2022202120222021
(in thousands)(in thousands)
Net sales$109,996$102,711$330,290$272,910
Cost of goods sold75,82872,918227,869193,393
Gross profit34,16829,793102,42179,517
Operating expenses26,25824,42877,21863,511
Operating income7,9105,36525,20316,006
Other income (expense)143(24)2,4164,456
Provision for income taxes1,9001,2686,3234,001
Net income$6,153$4,073$21,296$16,461
The amount and percentage changes calculated in the discussion below were based on numbers rounded to the nearest thousands.
21

Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
(in thousands)(in thousands)
Net sales$105,528$109,996$310,069$330,290
Cost of goods sold66,58475,828191,120227,869
Gross profit38,94434,168118,949102,421
Operating expenses27,56426,25881,49877,218
Operating income11,3807,91037,45125,203
Other income6641435972,416
Provision for income taxes2,9041,9009,0456,323
Net income$9,140$6,153$29,003$21,296
Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022 Compared to the Three Months Ended September 30, 2021
Net sales
Net sales were $105.5 million for the three months ended September 30, 2023 compared to $110.0 million for the three months ended September 30, 2022, compareda decrease of $4.5 million, or 4%. This decrease is primarily made up of $10.4 million from unfavorable year-over-year pricing comparison, as we actively passed on savings from ocean freight and raw materials costs to $102.7customers and $1.8 million from lower logistic services and shipping revenue, partially offset by $7.7 million from an increase in volume and change in product mix.
Cost of goods sold
Cost of goods sold was $66.6 million for the three months ended September 30, 2021, an increase of $7.3 million, or 7.1%. The increase in net sales was driven by an increase of $2.8 million in product sales to our existing customers, and incremental net sales of $4.5 million from more than 4,000 new customers in the three months ended September 30, 2022. Of the total net sales increase of $7.3 million2023 compared to the three months ended September 30, 2021, $12.2 million was primarily attributable to favorable pricing partially offset by a decrease of $4.6 million primarily due to volume and change in product mix as compared to strong prior year volumes due to post-COVID re-openings.
Cost of goods sold

Cost of goods sold was $75.8 million for the three months ended September 30, 2022, compared to $72.9 million for the three months ended September 30, 2021, an increase of $2.9 million, or 4.0%. The increase in cost of goods sold was primarily due to an increase of $1.9 million in freight and duty costs to acquire inventory from overseas and an increase of $1.0 million in product costs driven by the general increase in raw materials and labor costs. The increase was partially offset by efficiencies and productivity improvements realized and the favorable foreign currency exchange rate impact from the strengthening of the US Dollar against Taiwan New Dollar.
Gross profit

Gross profit was $34.2 million for the three months ended September 30, 2022 compared to $29.8 million for the three months ended September 30, 2021, an increase of $4.4 million, or 14.7%. Gross margin was 31.1% for the three months ended September 30, 2022 compared to 29.0% for the three months ended September 30, 2021. Despite the higher freight and duty costs, which as a percentage of net sales increased from 14.1% in three months ended September 30, 2021 to 14.8% in three months ended September 30, 2022, the gross margin increased primarily due to margin expanding factors including a shift to higher margin products such as environmentally-friendly items, price increases implemented previously to partially offset increased product, ocean freight and labor costs, favorable foreign currency exchange rate from the strengthening of the US Dollar against Taiwan New Dollar and improved operating efficiencies and leverage.
Operating expenses
Operating expenses for the three months ended September 30, 2022 were $26.3 million compared to $24.4 million for the three months ended September 30, 2021, an increase of $1.9 million, or 7.8%. The increase was primarily due to an increase of $1.3 million in payroll-related costs due to workforce expansion and higher labor costs, an increase of $0.8 million in rental expense as we expanded our distribution network, and an increase of $0.6 million in production expenses due to higher repair and maintenance costs incurred, partially offset by a decrease of $0.5 million in professional service expense.
Operating income
Operating income for the three months ended September 30, 2022 was $7.9 million compared to $5.4 million for the three months ended September 30, 2021, an increase of $2.5$9.2 million, or 47.4%12%. The increase was primarily due to an increase in gross profit of $4.4 million partially offset by the increase in operating expenses of $1.9 million, as discussed above.
Other income
Other income for the three months ended September 30, 2022 was $0.1 million, compared to other expense of $0.0 million for the three months ended September 30, 2021. The $0.1 million other income for the three months ended September 30, 2022 consisted primarily of a gain on foreign currency transactions of $0.4 million, rental income of $0.2 million, partially offset by a net interest expense of $0.5 million. The $0.0 million other expense for the three months ended September 30, 2021 primarily consisted of rental income of $0.2 million, partially offset by a net interest expense of $0.3 million.
Provision for income taxes
Provision for income taxes was $1.9 million and $1.3 million for the three months ended September 30, 2022 and 2021, respectively. The Company’s effective tax rate for the three months ended September 30, 2022 and 2021 was 23.6% and 23.7%, respectively. The effective tax rate was consistent between the two periods.
Net income
Net income for the three months ended September 30, 2022 was $6.2 million, compared to $4.1 million for the three months ended September 30, 2021, an increase of $2.1 million, or 51.1%. The increase was primarily driven by an increase in operating income of $2.5 million and an increase in other income of $0.2 million, partially offset by an increase in the provision for income taxes of $0.6 million, as discussed above.
Nine Months Ended September 30, 2022 Compared to the Nine Months Ended September 30, 2021
Net sales
Net sales were $330.3 million for the nine months ended September 30, 2022 compared to $272.9 million for the nine months ended September 30, 2021, an increase of $57.4 million, or 21.0%. The increase in net sales was primarily driven by an increase of $48.1 million in product sales to our existing customers, and incremental net sales of $9.3 million from more than 13,000 new customers acquired in the nine months ended September 30, 2022. Of the total net sales increase of $57.4 million compared to nine months ended September 30, 2022, $41.5 milliondecrease was primarily attributable to favorable pricing, $13.6 million was primarily related to the increase in volume and change in product mix as compared to strong prior year volumes due to post-COVID re-openings, and $2.2 million as a resultreduction of an increase in logistic services and shipping revenue.
Cost of goods sold

Cost of goods sold was $227.9 million for the nine months ended September 30, 2022 compared to $193.4 million for the nine months ended September 30, 2021, an increase of $34.5 million, or 17.8%. The increase in cost of goods sold was primarily due to an increase of $21.5$8.0 million in freight and duty costs to acquire inventory from overseas as a result of elevatedlower ocean freight ratesrate, and an increasea decrease of $12.7$1.9 million in product costs driven bydue to lower sales in the general increase incurrent period combined with reduced pricing on certain raw materials and labor costsused in production as well as some imported finished goods, partially offset by efficiencies and productivity improvements realized and the favorable foreign currency exchange rate impact from the strengtheningan increase of the US Dollar against Taiwan New Dollar.$0.5 million in inventory reserves adjustments.
Gross profit

Gross profit was $102.4$38.9 million for the ninethree months ended September 30, 2023 compared to $34.2 million for the three months ended September 30, 2022, comparedan increase of $4.8 million, or 14%. Gross margin increased to $79.5 million36.9% for the ninethree months ended September 30, 2021, an increase of $22.9 million, or 28.8%. Gross profit margin was 31.0%2023, compared to 31.1% for the ninethree months ended September 30, 2022 compared to 29.1% for2022. Despite the nine months ended September 30, 2021. The margin expansion resulted primarily from the shift to higher margin products, such as our environmentally-friendly products, price increases implemented previously to partially offset increased product, ocean freight and labor costs, favorable foreign currency exchange rateunfavorable impact from the strengthening of the US Dollar against Taiwan New Dollar, and improved operating efficiencies and fixed cost leverage. Such favorable impacts on theprice reductions, gross margin were partially offset by higherbenefited from a significant decrease in ocean freight and duty costs, which as a percentage of net sales increased from 11.2% inwas 7.9% during the ninethree months ended September 30, 2021 to 15.8% in2023, down from 14.8% during the ninethree months ended September 30, 2022. Additional margin expansion factors also included strong United States Dollar against Taiwan New Dollar, and our efforts to scale back manufacturing in the U.S. in favor of imports which carry higher margin.
Operating expenses

Operating expenses were $27.6 million for the ninethree months ended September 30, 2023 compared to $26.3 million for the three months ended September 30, 2022, were $77.2 million compared to $63.5 million for the nine months ended September 30, 2021, an increase of $13.7$1.3 million, or 21.6%5%. The increase was primarily due to an increase of $5.5$1.4 million in labor costs primarily due to workforce expansion and the shift towards import as we reduced production but increased warehouse headcount, an increase of $0.6 million in marketing expense as we increased online marketing efforts to grow our e-commerce sales channel, an increase of $0.6 million in professional expenses primarily due to transaction costs incurred in connection with the secondary offering, and an increase of $0.3 million in rental expense primarily due to additional leased warehouses as we continued to expand our distribution capabilities. These increases were partially offset by a decrease of $1.7 million in shipping and transportation costs to transfer inventory among our warehouses and to deliver products to our customers, an increase of $4.4 million in payroll-related costs due to workforce expansion and costs incurredlower shipping rates. See Note 18 - Secondary Offering for temporary labor to cover COVID-19 related illness, an increase of $1.6 million in rental expense as we expanded our distribution network, an increase of $1.2 million in production expenses due to higher repair and maintenance costs incurred, an increase of $0.5 million in bad debt expense, and an increase of $0.7 million in stock-based compensation expense, partially offset by a decrease of $0.9 million in professional service expense.further information.

Operating income

22

Operating income was $11.4 million for the ninethree months ended September 30, 2023 compared to $7.9 million for the three months ended September 30, 2022, was $25.2 million compared to $16.0 million for the nine months ended September 30, 2021, an increase of $9.2$3.5 million, or 57.5%44%. The increase was primarily due to an increase in gross profit of $22.9$4.8 million, partially offset by thean increase in operating expenses of $13.7$1.3 million, as discussed above.
Other income, net

Other income, net was $0.7 million for the ninethree months ended September 30, 2023 compared to $0.1 million for the three months ended September 30, 2022. The increase of $0.5 million was primarily due to an increase in interest income of $0.5 million.
Provision for income taxes
Provision for income taxes was $2.9 million for the three months ended September 30, 2023 compared to $1.9 million for the three months ended September 30, 2022, an increase of $1.0 million, or 53%. The Company’s effective tax rate was $2.4 million, compared to $4.5 million24.1% for the ninethree months ended September 30, 2021, a decrease of $2.1 million, or 47.1%. The $2.4 million other income2023 compared to 23.6% for the ninethree months ended September 30, 2022 consisted primarily of a gain on foreign currency transactions of $1.4due to the change in the non-taxable non-controlling interest income.
Net income
Net income was $9.1 million rental income of $0.7 million, and a net interest income of $0.6 million, which was made up of a gain associated with the interest swap of $2.2 million partially offset by interest expense on the Line of Credit and term loans totaling $1.6 million. The $4.5 million other income for the ninethree months ended September 30, 2021 consisted primarily of gain on forgiveness of debt of $5.0 million and rental income of $0.7 million, partially offset by a net interest expense of $1.2 million, which represented interest expense on the Line of Credit and term loans totaling $2.3 million partially offset by the change in the interest swap fair value of $1.1 million.
Provision for income taxes
Provision for income taxes was $6.3 million and $4.02023 compared to $6.2 million for the nine months ended September 30, 2022 and 2021, respectively. The Company’s effective tax rate for the nine months ended September 30, 2022 and 2021 was 22.9% and 19.6%, respectively. The effective tax rate was lower for the nine months ended September 30, 2021, primarily due to the gain on forgiveness of debt of $5.0 million, which was a discrete item not presented in the nine months ended September 30, 2022.
Net income
Net income for the ninethree months ended September 30, 2022, was $21.3 million compared to $16.5 million for the nine months ended September 30, 2021, an increase of $4.8$3.0 million, or 29.4%49%. The increase was primarily driven by an increase in operating income of $9.2$3.5 million, and an increase in other income, net of $0.5 million, partially offset by an increase in the provision for income taxes of approximately $1.0 million, as discussed above.
Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022
Net sales
Net sales were $310.1 million for the nine months ended September 30, 2023 compared to $330.3 million for the nine months ended September 30, 2022, a decrease of $20.2 million, or 6%. This decrease is primarily made up of $22.6 million from unfavorable year-over-year pricing comparison, as we actively passed on savings from ocean freight and raw materials costs to customers and $6.2 million from lower logistic services and shipping revenue, partially offset by $8.6 million from an increase in volume and change in product mix.
Cost of goods sold
Cost of goods sold was $191.1 million for the nine months ended September 30, 2023 compared to $227.9 million for the nine months ended September 30, 2022, a decrease of $36.7 million, or 16%. The decrease was primarily attributable to a reduction of $31.4 million in freight and duty costs to acquire inventory from overseas as a result of lower ocean freight rate, and a decrease of $8.0 million in product costs due to lower sales in the current period combined with reduced pricing on certain raw materials used in production as well as some imported finished goods. These decreases were partially offset by a $1.7 million write-off of raw materials in 2023 as we disposed of certain machinery and equipment in executing the plan to scale back production in the U.S.
Gross profit

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

Operating expenses were $81.5 million for the nine months ended September 30, 2023 compared to $77.2 million for the nine months ended September 30, 2022, an increase of $4.3 million, or 6%. The operating expenses for the nine months
23

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

Operating income

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

Other income, net was $0.6 million for the nine months ended September 30, 2023 compared to $2.4 million for the nine months ended September 30, 2022. The decrease of $1.8 million was primarily due to a decrease in the gain on foreign currency transactions of $1.0 million and a decrease in interest income of $1.1 million. Interest income was $1.0 million during the nine months ended September 30, 2023, which was primarily earned on cash and cash equivalents and short-term investments. Interest income during the nine months ended September 30, 2022 represented a gain associated with an interest rate swap of $2.2 million.
Provision for income taxes
Provision for income taxes was $9.0 million for the nine months ended September 30, 2023 compared to $6.3 million for the nine months ended September 30, 2022, an increase of $2.7 million, or 43%. The Company’s effective tax rate was 23.8% for the nine months ended September 30, 2023 compared to 22.9% for the nine months ended September 30, 2022 primarily due to the change in the non-taxable non-controlling interest income.
Net income
Net income was $29.0 million for the nine months ended September 30, 2023 compared to $21.3 million for the nine months ended September 30, 2022, an increase of $7.7 million, or 36%. The increase was primarily driven by an increase in operating income of $12.2 million, partially offset by a decrease in other income, net of $2.1$1.8 million and an increase in the provision for income taxes of approximately $2.3$2.7 million, as discussed above.









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Non-GAAP Financial Measure
We use certain non-GAAP financial measures to assess our financial and operating performance that are not defined by, or calculated in accordance with US GAAP. A non-GAAP financial measure is defined as a numerical measure of a company’s financial performance that (i) excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the comparable measure calculated and presented in accordance with US GAAP in the Consolidated Statements of Income; or (ii) includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the comparable measure so calculated and presented.
Our primary non-GAAP financial measures are listed below and reflect how we evaluate our operating results.
Adjusted EBITDA and Adjusted EBITDA Margin
Adjusted EBITDA is a financial measure which beginning in the fourth quarter of fiscal 2021, is calculated as net income excluding (i) interest (income)income, (ii) interest expense, net, (ii)(iii) provision for income taxes, (iii)(iv) depreciation and amortization, (iv) IPO related expenses, (v) stock-based compensation expense, (vi) secondary offering transaction costs, (vii) write-off of certain inventory items outside the normal course of business, and (vi) gain(viii) impairment expense and (gain) loss, net, on forgivenessdisposal of debt.machinery outside the normal course of business. Adjusted EBITDA margin is calculated by dividing Adjusted EBITDA by revenue. The prior period Adjusted EBITDA has been revised to conform to this definition.net sales.
We present Adjusted EBITDA and Adjusted EBITDA margin as supplemental measures of our financial performance. Adjusted EBITDA and Adjusted EBITDA margin assist management in assessing our core operating performance. We also believe these measures provide investors with useful perspective on underlying business results and trends and facilitate a comparison of our performance from period to period.
Adjusted EBITDA and Adjusted EBITDA margin should not be considered in isolation or as alternatives to net income or cash flows from operating activities and net income margin or other measures determined in accordance with US GAAP. Also, Adjusted EBITDA and Adjusted EBITDA margin are not necessarily comparable to similarly titled measures presented by other companies.
Set forth below is a reconciliation of net income to Adjusted EBITDA and net income margin to Adjusted EBITDA margin.
Three Months Ended September 30,
20222021
(in thousands, except percentages)
Amount% of RevenueAmount% of Revenue
Net income:$6,153 5.6%$4,073 4.0%
Add:
Interest expense, net4930.43080.3
Provision for income taxes1,9001.71,2681.2
Depreciation and amortization2,6042.52,5342.5
Stock-based compensation expense5980.58480.8
Adjusted EBITDA$11,74810.7%$9,0318.8%

Three Months Ended September 30,
Reconciliation of Adjusted EBITDA and Adjusted EBITDA Margin (Unaudited)20232022
(in thousands, except percentages)
Amount% of Net SalesAmount% of Net Sales
Net income:$9,140 8.7 %$6,153 5.6 %
Add (deduct):
Interest income(454)(0.4)— — 
Interest expense5360.54930.4
Provision for income taxes2,9042.81,9001.7
Depreciation and amortization2,7082.62,6042.5
Stock-based compensation expense2500.25980.5
Secondary offering transaction costs (2)4530.4— — 
Gain on disposal of machinery (1)(310)(0.4)— — 
Adjusted EBITDA$15,227 14.4 %$11,748 10.7 %









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Nine Months Ended September 30,Nine Months Ended September 30,
20222021
Reconciliation of Adjusted EBITDA and Adjusted EBITDA Margin (Unaudited)Reconciliation of Adjusted EBITDA and Adjusted EBITDA Margin (Unaudited)20232022
(in thousands, except percentages)(in thousands, except percentages)
Amount% of RevenueAmount% of RevenueAmount% of Net SalesAmount% of Net Sales
Net income:Net income:$21,296 6.4%$16,4616.0%Net income:$29,003 9.4 %$21,296 6.4 %
Add (deduct):Add (deduct):Add (deduct):
Interest (income) expense, net(584)(0.2)1,1580.4
Interest incomeInterest income(1,040)(0.3)(2,160)(0.7)
Interest expenseInterest expense1,5160.51,5760.5
Provision for income taxesProvision for income taxes6,3231.94,001 1.5Provision for income taxes9,0452.96,3231.9
Depreciation and amortizationDepreciation and amortization7,7522.47,477 2.7Depreciation and amortization8,0582.67,7522.4
Stock-based compensation expenseStock-based compensation expense1,7740.61,0880.4Stock-based compensation expense7430.21,7740.6
IPO related expenses——9970.4
Gain on forgiveness of debt——(5,000)(1.8)
Secondary offering transaction costs (2)Secondary offering transaction costs (2)4530.1— — 
Write-off of inventory (1)Write-off of inventory (1)1,7100.6— — 
Impairment expense and loss, net, on disposal of machinery (1)Impairment expense and loss, net, on disposal of machinery (1)2,1350.6— — 
Adjusted EBITDAAdjusted EBITDA$36,56111.1%$26,1829.6%Adjusted EBITDA$51,623 16.6 %$36,561 11.1 %

(1) The write-off of inventory and impairment expense and (gain) loss, net, on disposal of machinery represent costs incurred in connection with the scaling back of production in the U.S. As part of the execution of this strategy, certain machinery and equipment was disposed of or impaired, and raw materials associated with those machinery and equipment were written-off.
(2) Secondary offering transaction costs represent legal and professional fees incurred in connection with the completion of the secondary offering, which were directly related to the offering and were incremental to our normal operating expenses.









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Liquidity and Capital Resources
Sources and Uses of Funds
Our primary sources of liquidity are cash provided by operations, borrowings under our line of credit with the Hanmi Bank (the “Line of Credit”), and promissory notes, and during the year ended December 31, 2021, net proceeds of our IPO offering totaling $67.6 million.notes. On an annual basis, we have typically generated positive cash flows from operations. Our ability to generate positive cash flow from operations in the future will be, at least in part, dependent on global economic conditions and our ability to navigate challenging macro environment at times.
As described in Note 7 — Line of Credit to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q,condensed consolidated financial statements, the Line of Credit is available for working capital and general corporate purposes, and is secured by our assets. It consists of a $40.0 million revolving loan facility which also includesand a standby letter of credit sublimit, that was amended and increased to $2,000,000 on August 18, 2022.sublimit. We are not required to pay a commitment (unused) fee on the undrawn portion of the Line of Credit and interest is payable monthly. On March 14, 2023, we amended the Line of Credit. Prior to March 14, 2023, interest accrued at the annual rate of prime less 0.25% with a minimum floor of 3.25%. The amendment on March 14, 2023, among other things, (1) extended the maturity date to March 14, 2025, and (2) revised the interest on any Line of Credit borrowings to an annual rate of one month term Secured Overnight Financing Rate ("SOFR") plus 2.50%, with a SOFR floor of 1.0%. On June 20, 2023, we amended the Line of Credit which increased the standby letter of credit sublimit from $2 million to $5 million. As of September 30, 2022,2023, the amount issued under the standby letter of credit was $1.1$3.7 million, and the maximum remaining amount that could be borrowed under the Line of Credit was $38.9$36.3 million.
As described in Note 9 — Long-Term Debtto the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q,condensed consolidated financial statements, on June 17, 2022, we entered into a $28.7 million term loan agreement which matures July 1, 2027 (the “2027 Term Loan”). The 2027 Term Loan hashad an initial balance of $20.7 million and an option to request for additional advances up to a maximum of $8.0 million through June 30, 2023, which we have not exercised as of September 30, 2022.in March 2023. Interest accrues at a fixed rate of 4.375% per annum, and principalannum. Principal and interest payments of $0.1 million are due monthly throughout the term of the loan, with the remaining principal balance due at maturity. The 2027 Term Loan is collateralized by substantially all of Global Wells’ assets and is guaranteed by one of the Company’sour stockholders. In accordance with the loan agreement, Global Wells is required to comply with certain financial covenants, including a minimum debt service coverage ratio. Proceeds from the 2027 Term Loan were used to pay down an existing term loan with the same lender, which was set to mature in May 2029 with interest accruing at prime rate less 0.25%, and had an outstanding balance of $20.6 million as of the repayment date.
Additionally, as of September 30, 2022,2023, we have a $23.0 million term loan that matures in September 30, 2026 (the “2026 Term Loan”). The 2026 Term Loan had an initial balance of $16.1 million and an option to request for additional advances up to a maximum of $6.9 million through September 2022, which we exercised in February 2022. Interest accrues at a fixed rate of 3.50% per annum. Principal and interest payments of $0.1 million are due monthly throughout the term of the loan, with the remaining principal balance due at maturity. The loan2026 Term Loan is collateralized by substantially all of Global Wells’ assets and is guaranteed by Global Wells and one of our stockholders. In accordance with the loan agreement, Global Wells is required to comply with certain financial covenants, including a minimum debt service coverage ratio.
As of September 30, 2022,2023, we were in compliance with the financial covenants under all of our loan agreements, and do not expect material uncertainties in our continued ability to be in compliance with all financial covenants through the remaining term of all of our loan agreements. As of September 30, 2022,2023, we had $0.0 million inno outstanding balance on the Line of Credit, bearing an interest per annum of prime rate less 0.25% (6% as of September 30, 2022), $20.6$28.3 million in outstanding balance under the 2027 Term Loan, and $22.3$21.7 million in outstanding balance under the 2026 Term Loan.
As described in Note 4 —Joint Venture in the Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, ourcondensed consolidated financial statements, we entered into a joint venture agreement (the "JV Agreement") in April 2022 to establish a new corporation, Bio Earth, to build thea bagasse factory in Taiwan requires significant investments.Taiwan. Through March 31, 2023, we had made net payments totaling $6.0 million as stipulated in the JV Agreement. In May 2023, we entered into a share transfer agreement to sell all of our equity interest in Bio Earth to Keary Global. Concurrent with the share transfer agreement, the Company also entered into an agreement with Keary Global, Bio Earth and Happiness Moon Co., Ltd. (“Happiness Moon”) pursuant to which (i) Lollicup agreed to transfer all Bio Earth shares, as well as its rights and obligations under the JV Agreement to Keary Global, (ii) Happiness Moon and Bio Earth agree to foregoing and (iii) Bio Earth shall manage the regulatory and registration requirements related to the share transfer. As of September 30, 2022,the end of the second quarter of 2023, the share transfer to Keary Global had been completed and we made paymentsreceived the full amount of the total consideration owed to us in connection with the sale of our equity interest in Bio Earth of $6.1 million, representing the original deposits totaling $4.0$6.0 million plus interest which accrued at 5% per annum.
27
towards this investment. As
Additionally, as described in Note 1719 — Subsequent Events in the Notes to the Condensed Consolidated Financial Statements included in this Quarter Report on Form 10-Q, we made the final remaining investment payment of $1.88 million pursuant to the JV Agreementcondensed consolidated financial statements, on November 9, 2022. Additionally,6, 2023, our Board of Directors declared a special cashregular quarterly dividend of $0.35$0.20 per share on our common share,stock, which will be paid on or around November 30, 20222023 to shareholders of record at the close of business on November 21, 2022.20, 2023. Prior to this, we paid out special and regular quarterly dividend totaling $16.9 million in the current fiscal year.
As described in Note 14 — Impairment Expense and (Gain) Loss, Net, on Disposal of Machinery, in February 2023, management started to pivot into a more asset-light growth model by increasing import and scaling back manufacturing in certain locations. As part of the execution of this strategy, management reached an agreement with two unrelated third-party vendors in Taiwan to sell them certain of our manufacturing machinery and equipment. We also cancelled certain equipment purchase commitments that we had previously paid deposits towards. We expanded our efforts to scale back manufacturing across all U.S. manufacturing facilities in the third and fourth quarter of 2023. As of September 30, 2023, we had received $0.5 million in deposit refunds and $0.6 million from sale of the machinery and equipment. We expect to receive approximately $1.9 million in additional net cash proceeds from sale of the various manufacturing equipment in the next 12 months.
As described in Note 16 — Income Taxes, in March 2023, the Internal Revenue Service ("IRS"), under the Winter Storm Relief, announced that taxpayers in California affected by severe winter storms, flooding, landslides, and mudslides have until November 15, 2023, to file various individual and business tax returns and make tax payments. We took advantage of this tax relief and deferred current year quarterly estimate tax payment until October 2023 when we made a tax payment of approximately $9.6 million.
Our ongoing operations and growth strategy may require us to continue to make investments in our logistics and manufacturing infrastructure and our e-commerce platform. In addition, we may consider making strategic acquisitions and investments which could require significant liquidity. The COVID-19 pandemic and the rapidly changing macroeconomic and geopolitical dynamics created significant uncertainty in the global economy and capital markets, and long-lasting disruptions in the global supply chain, which could have long-lasting adverse effects beyond 2022.2023. We currently believe that our cash on hand, ongoing cash flows from our operations and funding available under our borrowings will be adequate to meet our









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working capital needs, service our debt, make lease payments, and fund for capital expenditures to further enhance our manufacturing and logisticsoperating infrastructure and our e-commerce platform for at least the next 12 months. We continue to explore other options to further expand our liquidity to support the business growth and enhance shareholder value.
Beyond the next 12 months, if we require additional capital resources to grow our business, either organically or through acquisition, we may seek to sell additional equity securities, increase use of the Line of Credit, and raiseacquire additional debt. The sale of additional equity securities or certain forms of debt financing could result in additional dilution to our stockholders. We may not be able to obtain financing arrangements in amounts or on terms acceptable to us in the future. In the event we are unable to obtain additional financing when needed, we may be compelled to delay or curtail our plans to develop our business, which could have a material adverse effect on our operations, market position and competitiveness. Notwithstanding the potential liquidity challenges described above, we expect to meet our long-term liquidity needs with cash flows from operations and financing arrangements.
Liquidity Position
The following table summarizes total current assets, liabilities and working capital at September 30, 20222023 compared to December 31, 2021:2022:
September 30, 2022December 31, 2021IncreaseSeptember 30, 2023December 31, 2022Increase/(Decrease)
(in thousands)(in thousands)
Current assetsCurrent assets$124,807$102,872$21,935 Current assets$158,689$123,800$34,889
Current liabilitiesCurrent liabilities34,82830,7644,064Current liabilities45,69739,2536,444
Working capitalWorking capital$89,979$72,108$17,871 Working capital$112,992$84,547$28,445
As of September 30, 2022,2023, we had a working capital of $90.0$113.0 million as compared to working capital of $72.1$84.5 million atas of December 31, 2021,2022, representing an increase of $17.9$28.4 million, or 24.8%34%. The improvement in working capital from December 31, 2021 was driven by an increase of $21.9$34.9 million in current assets including an increase of $4.0 million in accounts receivable primarily resulting from the sales growth during the third quarter, an increase in inventory of $14.8 million to accommodate higher sale demand, and an increase in prepaid expense of $2.1 million. These improvements were partially offset by an increase of $4.1$6.4 million in current liabilities. The increase in current assets was primarily driven by an increase in cash and cash equivalents and short-term investments of $30.2 million and an increase in account receivable of $4.1 million. The increase in current liabilities mainly fromwas primarily driven
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by an increase of $3.3$8.0 million in income taxes payable primarily due to the deferral of federal and California state income taxes under the Winter Storm Relief declared by the Internal Revenue Service partially offset by a decrease of $1.6 million in accounts payable and relaterelated party payable primarily resulting from increased inventory purchase, and an increase of $0.7 million in accrual expense.payables.
Cash Flows
The following table summarizes cash flow for the nine months ended September 30, 20222023 and 2021:2022:
Nine Months Ended
September 30,		Nine Months Ended September 30,
2022202120232022
(in thousands)(in thousands)
Net cash provided by (used in) operating activities$12,499 $(1,246)
Net cash provided by operating activitiesNet cash provided by operating activities$43,088 $12,499 
Net cash used in investing activitiesNet cash used in investing activities(16,577)(8,639)Net cash used in investing activities(21,341)(16,577)
Net cash provided by financing activities5,12611,116
Net cash (used in) provided by financing activitiesNet cash (used in) provided by financing activities(9,626)5,126 
Net change in cash and cash equivalentsNet change in cash and cash equivalents$1,048 $1,231 Net change in cash and cash equivalents$12,121 $1,048 
Cash flows provided by (used in) operating activities. activitiesFor. Net cash provided by operating activities was $43.1 million for the nine months ended September 30, 2022,2023, primarily the result of net income of $29.0 million, adjusted for certain non-cash items totaling $17.2 million, consisting mainly of depreciation and amortization of fixed assets and operating right-of-use assets, write-off of inventory, loss, net, on disposal of machinery, stock-based compensation, adjustments to allowance for doubtful accounts, and impairment of deposit. In addition, cash decreased $3.1 million, primarily as a result of changes in working capital, which included a decrease of $3.6 million from inventory build-up, a decrease of $3.4 million from an increase in accounts receivable, a decrease of $3.3 million from a reduction in operating lease liabilities, and a decrease of $0.7 million from lower accounts and related party payables, partially offset by an increase of $8.0 million from the deferral of federal and California state income taxes under the Winter Storm Relief declared by the IRS. Net cash provided by operating activities was $12.5 million for the nine months ended September 30, 2022, primarily the result of net income of $21.3 million, adjusted for certain non-cash items totaling $8.9$11.8 million, consisting mainly of depreciation and amortization of fixed assets and operating right-of-use assets, change in fair value of interest rate swap, stock-based compensation, and adjustments to allowance for doubtful accounts receivable and inventory reserves, and stock-based compensation partially offset by the gain on the interest rate swap.reserves. In addition, cash decreased $17.7$20.6 million, primarily as a result of changes in working capital, which includes an increaseincluded a decrease of $15.3 million infrom inventory buildup to accommodate higher sales volume, an increasebuild-up, a decrease of $5.1 million from an increase in accounts receivable, stemminga decrease of $2.9 million from higher sales,a reduction in operating lease liabilities, and an increase in prepaid expensea decrease of $2.3 million from a higher balance of prepaid expenses and other current assets, partially offset by an increase in account payable and accrual expense totaling $1.6of $3.3 million from higher accounts and related party payablepayables, and an increase of $2.9 million. For the nine months ended September 30, 2021, net cash used by operating activities was $1.2$1.1 million primarily as a result of net income of $16.5 million, adjusted for certain non-cash items of an aggregate $2.4 million consisting of changes in fair value of interest rate swaps, gain on forgiveness of debt,









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depreciation and amortization, reserve for inventory obsolescence, and stock-based compensation partially offset by a decrease in cash of $20.1 million due to changes in working capital.from higher accrued expenses.
Cash flows used in investing activities. Net cash used in investing activities for nine months ended September 30, 2022 was $16.6 million, which included the purchase of manufacturing equipment for our facilities totaling $2.0 million, deposits paid for additional manufacturing equipment of $11.5 million, and investment pursuant to the JV Agreement of $4.0 million. Net cash used in investing activities was $21.3 million for the nine months ended September 30, 2021 was $8.62023, which primarily included $18.0 million which consistedin net purchases of short-term investments, $5.4 million of deposits paid for the purchase of manufacturingproperty and equipment, totaling $3.9and $2.9 million paid to directly purchase property and equipment, partially offset by $4.0 million of net refund from the joint venture investment, $0.6 million of proceeds from the sale of machinery and equipment, and $0.5 million of deposits paid for additional manufacturing equipment of $3.8 million, and net cash paid of $0.9 million for our acquisition of Pacific Cup.
Cash flows provided by financing activities. refunded from cancelled machinery orders. Net cash provided by financingused in investing activities was $16.6 million for the nine months ended September 30, 2022, which included $11.5 million of deposits paid for the purchase of property and equipment, $4.0 million of investment made pursuant to the JV Agreement, and $2.0 million paid to purchase property and equipment, partially offset by proceeds of $0.8 million for the settlement of the interest rate swap.
Cash flows (used in) provided by financing activities. Net cash used in financing activities was $9.6 million for the nine months ended September 30, 2023, which primarily included $16.9 million of cash dividends paid to shareholders, and $0.7 million of term loan repayments, partially offset by $8.0 million of additional borrowings under the 2027 Term Loan. Net cash provided by financing activities was $5.1 million for the nine months ended September 30, 2022, which primarily included an additional borrowing under the 2026 Term Loan of $6.9 million, and a borrowingborrowings under the 2027 Term Loan of $20.6 million, partially offset by $21.3 million of term loan repayments, and $1.1 million of noncontrolling interest tax withholding payment of $1.1 million. The company also withdrew $21.1 million under the Line of Credit, and paid off this amount during nine months ended September 30, 2022. Net cash provided by financing activities for the nine months ended September 30, 2021 was $11.1 million, which primarily consisted of net proceeds from the issuance of common stock in connection with our initial public offering of $67.6 million, partially offset by net payments on the Line of Credit of $33.2 million, net payments under the term loans of 23.0 million, and payments on capital lease obligations of $0.3 million.payment.
Related Party Transactions
For a description of significant related party transactions, see Note 1415 — Related Party Transactions in the Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
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Recent Accounting Pronouncements
Information regarding recent accounting pronouncements is contained in Note 2 — Summary of Significant Accounting Policies in the Notes to the Consolidated Financial Statementscondensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
ItemITEM 3.Quantitative and Qualitative Disclosure About Market Risk QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This item is not applicable as we are currently considered arequired for smaller reporting company.companies.

ItemITEM 4.Controls and Procedures CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

In connection with the preparation of this Quarterly Report on Form 10-Q, ourthe Company's management, with the participation of ourits Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of ourits disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of September 30, 2022.2023. Based on this evaluation, managementthe Company's Chief Executive Officer and Chief Financial Officer concluded that certain material weaknesses in our internal control over financial reporting identified in our Annual Report on Form 10-K for the year ended December 31, 2021 were under ongoing remediation and therefore continued to exist, and as such, our disclosure controls and procedures were not effective as of September 30, 20222023 due to the material weaknesses described in Part II—Item 9A of the Form 10-K for the following reasons:year ended December 31, 2022 filed with the SEC on March 16, 2023.

Material Weaknesses in Internal Control Environment, Risk Assessmentover Financial Reporting

Management did not maintain appropriately designed entity-level controls impacting the control environment and risk assessment procedures to preventA material weakness is a deficiency, or detect material misstatements to the consolidated financial statements. Thesea combination of deficiencies, were attributed to: (i) lack of structure and responsibility, insufficient number of qualified resources and inadequate oversight and accountability over the performance of controls, including retention of control evidence, and (ii) ineffective identification and assessment of risks impactingin internal control over financial reporting.reporting such that there is a reasonable possibility that a material misstatement of the registrant's annual or interim financial statements will not be prevented or detected on a timely basis.

Control Activities and Information and Communication

TheseRefer to the management report on internal control over financial reporting for the material weaknesses contributed toin Part II—Item 9A of the following additionalForm 10-K for the year ended December 31, 2022 filed with the SEC on March 16, 2023. The same material weaknesses within certain business processes andcontinue to exist as of September 30, 2023. Each of the information technology environment:









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•Management did not design and implement controls over the completeness and accuracy of underlying data usedmaterial weaknesses could result in the operationa misstatement of certain controls within its financial reporting process.

•Management did not design and implement review controls at a sufficient precision level to detectaccount balances or disclosures that would result in a material misstatement in financial statement areas including income taxes, valuation of accounts receivable, and valuation of inventory.

As set forth below, management has taken and will continue to take steps to remediate the control deficiencies identified above. Notwithstanding such control deficiencies, management concludes that theannual or interim consolidated financial statements includedthat would not be prevented or detected. The material weaknesses identified did not result in this Quarterly Reportthe restatement of any previously reported financial statements or any related financial disclosure, nor does management believe that they had any effect on Form 10-Q fairly represent, in all material aspects, ourthe accuracy of the Company’s financial condition, results of operations and cash flowsstatements for the periods presented.current reporting period.

Management’s Remediation Plan

As reported in the Annual Report on2022 Form 10-K, for the year ended December 31, 2021, we are engaged in remedial actions in response to the deficiencies discussed above, and we plan to continue efforts underway to improve internal control over financial reporting.

Actions Taken During the Year Ended December 31, 2022

The following remedial actions were implemented duringtaken in the first quarter of 2022 to remediate the material weakness related to the failure of management to design and maintain effective general controls over information systems that support the financial reporting process:prior fiscal year:

•We performedPerformed a thorough review of users’ access rights to our significant information technology systems and implemented restrictions to user accesscertain updates to allow for appropriate segregation of duties.

•We implementedIncreased the number of personnel with the appropriate level of knowledge related to accounting transactions, accounting matters, and relevant systems, including the addition of a policy to restrict and monitor NetSuite user and access to financial applications and data to appropriate Company personnel.

In addition to the remediation of the material weakness described above, the following additional remedial actions were implemented during the first nine months of 2022:

•We hired our new Chief Financial Officer in February 2022, who brings a strong background in accounting, financial reporting and business operations in the public company marketplace.Controller.

•We hiredEngaged a Corporate Controller in June 2022, whose primary responsibilities include improvingthird-party service provider to assist management with the design and implementation execution, and supervision of our internal controls.

•We adopted a process to identify and assess our disclosure controls and procedures, including the preparation of presentation and disclosure requirement checklists to be reviewed by management.

•Under the supervision of our Audit Committee, Chief Executive Officer and Chief Financial Officer, we initiated a project to implement a Sarbanes-Oxley compliance program underStarted an initial risk assessment based on the criteria set forthestablished by the Committee of Sponsoring Organizations of the Treadway Commission in its 2013 Internal Control – Integrated Framework, completed an enterprise risk assessment("COSO") to identify internal control over financial reporting ("ICFR") risks and established reporting objectives and material weakness remediation plan.control objectives.

•We engaged aWith the assistance from the third-party service provider, to assist withand under the supervision of the Company's Audit Committee, Chief Executive Officer and Chief Financial Officer, started the design and preparation of an internal controls compliance plan and perform testing of the effectiveness of internal controls. We have completed the design and documentation
30

implementation of significant process transaction flows and key controls in ourthe Company's business processes, including revenue, inventory, income taxes, and overall IT environment,environment.

•Management started to adopt a process to identify and assess the Company's disclosure controls and procedures, including the identificationpreparation and review of potential control gapspresentation and disclosure requirement checklists.

Actions Taken During the implementationThree Months Ended March 31, 2023

The following remedial actions were taken in the first quarter of controls to mitigate such risks. We are inthe current fiscal year:

•Improved the process of performing an internal control design effectiveness assessment.retaining evidence of sales arrangements with customers including adopting a required retention period for applicable customer purchase orders.

•We provided extensiveManagement held additional training for warehouse employees to existingappropriately perform and new employees in order to enhancedocument the level of communicationthree-way match between sales orders, shipping documents, and understanding of controls withsales invoices.

•Enhanced training programs for personnel that provide key information and perform key roles.roles associated with ICFR. Management designed such training programs in order to improve the level of understanding of the design and proper implementation of controls by the control owners and to instruct such individuals on appropriate level of documentation practices for evidencing review, especially over the completeness and accuracy of underlying data and the precision level used in the review.

•We added accountingManagement enhanced controls requiring inventory adjustments to be reviewed and information technology employees withapproved by the appropriate experience, certification, education and training to the organization to strengthen our internal accounting team, to provide oversight, structure and reporting lines,level of management and to provide additional review over our disclosures. We expectbe appropriately recorded and inventory costing analysis to continue evaluating our needs for additional personnel.be appropriately reviewed.

•Management adopted a Company-wide approval matrix that establishes clear guidelines on authority levels for all types of cash disbursement transactions.

36Actions Taken During the Three Months Ended June 30, 2023
Table
The following remedial actions were taken in the second quarter of Contentsthe current fiscal year:

•We reallocated resourcesEnhanced policies and reassigned job roles in orderprocedures to improve Information Technology General Controls and the Company's overall IT environment. Examples of some of management's efforts include:

◦Adopted the policy and procedure to regularly perform a thorough review of user's access rights relating to the Company's significant information technology systems;
◦Maintained and monitored restrictions to user access where needed to allow for appropriate segregation of duties; and
◦Maintained and enforced procedures and controls around system development and change management.

•Management has reviewed user access and established appropriate reporting lines within the accounts payable department to ensure proper segregation of duties.duties for and performance of controls and procedures including vendor master file changes and the three-way match between purchase orders, receiving documents, and vendor invoices.

WeActions Taken During the Three Months Ended September 30, 2023

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

•Updated and enhanced the standard operating procedures of year-end physical counts to ensure all inventory items are counted at all warehouses in a consistent manner.

•Developed and adopted IT policies around software development and implementation, information security, data backup, and change management.

•Continued to update the risk assessment, objectives, processes and control design and documentation, including such design and documentation as related to the completeness and accuracy of underlying data and a sufficient precision level in management review controls to detect material misstatement across all financial statement areas.

Ongoing Remediation Efforts

31

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

•Continue to evaluate the Company's needs for additional personnel and add, as needed, additional headcount primarily within the accounting and information technology departments. Management continues to onboard individuals with the appropriate education, experience, certifications, and training. The hiring of new employees is expected to create and ensure proper reporting lines and segregation of duties, while also providing additional oversight and structure to the organization.

Management is committed to continuingremediating the material weaknesses in a timely fashion and to improve ourmaking continuous improvements to the Company's internal control processes and will continue to review, optimize and enhance ourover financial reporting controls and procedures. We believereporting. Management believes the measures described above have strengthened ourthe Company's internal control over financial reporting, however,Management will continually assess the remainingeffectiveness of the remediation efforts and may determine to take additional measures to address control deficiencies or modify the remediation plan described above. The material weaknesses will not be considered remediated until a sustained period of time has passed to allow for continued operation of the new controls and for management to test the operational effectiveness of the new controls. Testing is expected to continue during the year endingended December 31, 20222023 and management will continue to provide an update on the status of our remediation activities on a quarterly basis.

Changes in Internal Control Over Financial Reporting

Other than the changes notedthose described above, to remediate the previously reported material weaknesses, there werehave been no changes in our internal control over financial reporting that occurred during our most recent fiscalthe quarter ended September 30, 2023, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

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PART II - OTHER INFORMATION

Item 1.Legal Proceedings.

WeFrom time to time, we are not a party to any materialinvolved in various legal proceedings. Although no assurance can be given, we do not believe that any of our currently pending proceedings will have a material adverse effect on our financial condition, cash flows or results of operations.
Item 1A.Risk Factors.

There have been no material changes to the Risk Factors previously disclosed in our Annual Report onthe 2022 Form 10-K, for the year ended December 31, 2021, which are incorporated herein by reference.
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3.Defaults Upon Senior Securities.

None.
Item 4.Mine Safety Disclosures.
Not applicable.
Item 5.Other Information.

None.On November 6, 2023, the Company's Board of Directors declared the quarterly cash dividend and increased it to$0.20 per share on the Company's common stock, which will be paid on or around November 30, 2023 to shareholders of record at the close of business on November 20, 2023. A copy of the press release announcing the dividend is attached as Exhibit 99.1 to this Form 10-Q.

On November 6, 2023, upon the recommendation of the Company’s Compensation Committee, the Company’s Board of Directors approved and ratified compensation to the Company’s executive directors per Board meeting commensurate with the compensation paid to the Company’s non-employee directors.
Item 6. Exhibits.
Exhibits.
Exhibit No.Description
10.1*10.1+
Change In TermsSeparation Agreement and General Release, dated August 30, 2023 (incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K filed with the Securities and Exchange Commission on August 31, 2023).
10.2+
Employment Agreement, dated October 5, 2023, between Karat Packaging Inc. and Daniel Quire, Chief Revenue Officer (incorporated by August 18, 2022, byreference to Exhibit 10.1 of the Current Report on Form 8-K filed with the Securities and Exchange Commission on October 11, 2023).
10.3*
Business Loan Agreement between Lollicup USA IncGlobal Wells Investment Group LLC and Hanmi Bank, dated September 30, 2021.
31.1*
Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2*
Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32.1**
Certifications of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
33

32.2**
Certifications of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1*
Press release, dated November 7, 2023
101.INS*XBRL Instance Document
101.SCH*XBRL Taxonomy Extension Schema Document
101.CAL*XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*XBRL Taxonomy Extension Labels Linkbase Document
101.PRE*XBRL Taxonomy Extension Presentation Linkbase Document
104*Cover Page Interactive File (formatted as inline XBRL and contained in Exhibit 101)
*
* Filed herewith.
** Furnished herewith.
+ Indicates management compensatory agreement.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

DATE: November 9, 2023KARAT PACKAGING INC.
Date: November 14, 2022
By:/s/ Alan Yu
Alan Yu
Chief Executive Officer
(Principal Executive Officer)
Date: November 14, 2022
By:/s/ Jian Guo
Jian Guo
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)


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