Karat Packaging Inc. (KRT) Earnings Call Transcript & Summary

Good afternoon, and welcome to Karat Packaging's 2025 First Quarter Conference Call.[Operator Instructions] Please also note that this event is being recorded today. I would now like to turn the conference over to Roger Pondel with PondelWilkinson. Please go ahead, sir.

Thank you, operator. Good afternoon, everyone, and welcome to Karat Packaging's 2025 First Quarter Conference Call. I'm Roger Pondel with PondelWilkinson, Karat Packaging's Investor Relations firm, and it will be my pleasure momentarily to introduce the company's Chief Executive Officer, Alan Yu; and its Chief Financial Officer, Jian Guo. Before I turn the call over to Alan, I want to remind all listeners that today's call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to numerous conditions, many of which are beyond the company's control, including those set forth in the Risk Factors section of the company's most recent Form 10-K as filed with the Securities and Exchange Commission, copies of which are available on the SEC's website at www.sec.gov, along with other company filings made with the SEC from time to time. Actual results could differ materially from those forward-looking statements, and Karat Packaging undertakes no obligation to update any forward-looking statements, except as required by law. Please also note that during this call, we will be discussing adjusted EBITDA, adjusted EBITDA margin, adjusted diluted earnings per share and free cash flow, which are non-GAAP financial measures as defined by SEC Regulation G. A reconciliation of the most directly comparable GAAP measures to the non-GAAP financial measures is included in today's press release, which is now posted on the company's website. And with that, I will turn the call over to CEO, Alan Yu. Alan?

Thank you, Roger. Good afternoon, everyone. We achieved another strong quarterly performance marked by the nearly 11% increase in sales volume and 8.4% growth in the net sales year-over-year. Our global strategy sourcing capabilities enabled us to take early action securing inventory from sources outside of China to countries with significantly lower tariffs and more favorable trade conditions. At the end of 2024, our sourcing from China was up approximately 20%, and it was down to 15% in March of this year. We're on track to further reduce imports from China to be under 10% by the end of second quarter. And due to the recent imposed extreme tariffs, we have temporarily suspended imports from most vendors in China starting mid-April. In addition to leveraging our diverse international supplier network, our ability to quickly scale up existing domestic manufacturing operation without significant incremental CapEx is allowing us to respond promptly and effectively to the evolving market dynamic. At the end of first quarter, we had approximately $80 million in inventory, and we are strategically managing sales to customers ahead of the anticipated supply chain disruption to ensure long-term reliability in meeting customers' need. We believe Karat is well positioned to address ongoing supply chain challenges and navigate an uncertain trade environment. As previously announced, we implemented price increases for certain products on April 1 with higher cost of goods anticipated from more recent global tariff development. We expect to implement additional price increases to most of our products in mid-May. Geographically, our strongest growth for the quarter came from Texas and the Midwest. Sales in California, our largest market, also continued to improve, particularly in the retail and distribution and chain sectors. We remain focused on expanding wallet and market share as well as growing our online businesses, which experienced a nearly 20% sales increase during the first quarter. We continue to strengthen our pipeline and anticipate that several large chain accounts will begin shipping in late June. Our new 187,000 square feet distribution center near our headquarters in Chino, which we expect to be fully operational this month, provides much more needed additional capacity to support anticipated growth, allowing us to add 500 new SKUs of products and additional inventory. The timing also coming at a pivotal moment with regards to the supply chain interruptions and general economic uncertainties. As mentioned on our last call, we continue to focus on lowering operating costs while growing our top line, including enhancing distribution efficiency, lowering third-party domestic shipping costs starting in March and reducing online selling expenses. Karat has consistently proven to be a reliable supplier to our customers, not only during the height of the COVID-19 period, but also post pandemic when there was widespread product shortages. Our ability to maintain steady inventory has reinforced our reputation and resilience. We continue to generate strong operating cash flow as well as liquidity. Our Board member remains committed to a balanced capital allocation strategy between shareholder returns and long-term growth investments. I will now turn the call over to Jian Guo, our Chief Financial Officer, to discuss the company financial results in greater detail. Jian?

Thank you, Allan. I will first provide an overview of our Q1 performance and then close with the guidance update. Net sales for the 2025 first quarter were $103.6 million, up 8.4% from $95.6 million in the prior year quarter. As Alan mentioned, volume grew 10.9% year-over-year. Pricing was unfavorable by $3.9 million year-over-year. In terms of sales by category, over the past couple of quarters, we have observed an increasing shift in some ordering pattern from our chain accounts from direct delivery by Karat through third-party carriers to fulfillment through distribution partners. This change has increasingly blurred the distinction between sales to chains and distributors. Accordingly, starting this quarter, we're combining net sales to chain accounts and distributors into a single category and have recast the comparative period as well. Sales to our chain accounts and distributors were up by 7.1%. Online sales increased 19.6% over the prior year quarter, reflecting our continued focus on expanding this high-margin category. Sales to the retail channel decreased 3.2%. Cost of goods sold for the 2025 first quarter was $62.9 million compared with $58.0 million in the 2024 first quarter. The increase was primarily driven by a $3.0 million of higher product cost as a result of the increase in sales volume, partially offset by more favorable vendor pricing as well as higher ocean freight and duty costs of $2.0 million, reflecting a 15.5% increase in import volume and a 4.3% increase in ocean freight container rates. Gross profit for the 2025 first quarter increased 8.4% to $40.8 million from $37.6 million in the prior year quarter. Gross margin remained consistent at 39.3% for the first quarter of both 2025 and 2024. Gross margin benefited from lower product costs as a percentage of net sales, mainly due to a more favorable vendor pricing, increased imports as a percentage of total product mix and foreign currency gain, partially offset by a higher freight and duty costs as a percentage of net sales. Operating expenses for the 2025 first quarter increased 11.6% to $32.9 million from $29.5 million in the prior year quarter. The increase was primarily due to a $3.4 million increase in shipping and transportation costs from higher sales volume and an increase in online sales packages as a percentage of total shipments as well as a $0.9 million increase in rent expense due to the opening of our new distribution center and lease extension in Chino. Additionally, marketing expense and professional service expense also increased $0.4 million and $0.3 million compared with the prior year quarter, respectively. The increases were partially offset by a $2.0 million noncash impairment of a right-of-use asset during the prior year quarter, resulting from the sublease of a warehouse in the City of Industry, California. Operating income for the 2025 first quarter was $7.8 million versus $8.1 million in the prior year quarter. Net income for the 2025 first quarter increased 5.2% to $6.8 million from $6.5 million in the prior year quarter. Net income margin was 6.6% in the 2025 first quarter compared with 6.8% in the prior year quarter. Net income attributable to Karat for the 2025 first quarter was $6.4 million or $0.32 per diluted share compared with $6.2 million in the prior year quarter or $0.31 per diluted share. Adjusted EBITDA for the 2025 first quarter was $11.9 million compared with $13.5 million for the prior year quarter. Adjusted EBITDA margin was 11.5% of net sales for the 2025 first quarter compared with 14.2% for the prior year quarter. Adjusted diluted earnings per common share was $0.33 for the 2025 first quarter compared with $0.40 for the same quarter last year. We generated operating cash flow of $7.7 million in the first quarter and ended the quarter with $111.9 million in working capital. Our free cash flow was $6.6 million in the first quarter, -- as of March 31, 2025, we have financial liquidity of $46.7 million with another $23.8 million in short-term investments. On May 6, 2025, our Board of Directors approved the quarterly dividend of $0.45 per share payable May 23, 2025, to stockholders of record as of May 16, 2025. Looking ahead, we expect net sales for the 2025 second quarter to increase by high single digits to low double digits over the prior year quarter. We expect our gross margin for the 2025 second quarter to be in line with the first quarter and adjusted EBITDA margin to be in the mid-teens. Currently, we are reiterating our 2025 full year guidance on net sales, gross margin and adjusted EBITDA margin. Alan and I now will be happy to answer your questions, and I'll turn the call back to the operator.

[Operator Instructions] And our first question here will come from Jake Bartlett with Truist Securities.

This is Larson on for Jake. Congrats on a strong quarter. I just had a few here if we could get through. The first one, I just wanted to touch on, I know you mentioned that you're working towards getting that China exposure down to 10%. I was wondering if you could just give any sort of color on that as far as some of the countries that you might be looking through. I know it's for competitive reasons, might be a little bit muted, but anything you could add there, that would be great. Just wondering if it's sort of a near-term thing where you might see an impact longer term or anything you could add for context there?

Sure, Larson. Let me answer that question. As Jian mentioned earlier, we are -- we were at about 10% as of first quarter. Our goal is actually, we're expected to be at no more than 1% or maybe 1% or a little bit more than that by August of this year, shipment out of China. And where we move to, we're moving them majority into Malaysia, Indonesia, Vietnam, and we're adding more product into Thailand. That's where we're moving majority of the product to.

Great. Appreciate the color there.

And then I do want to add one more thing -- I'm sorry Larson.I do want to add one more thing. We're actually looking into getting product from Middle East as well. So basically, it will be -- we want to diversify out of not just 100% out of Asia and moving to other part of the continent. That's part of our goal for this year, too.

Great. On the pricing, how do you view the balance between -- are you guys expecting to pass the full impact of the tariffs on to customers? Are you going to absorb some of that in margins? Or how are you sort of thinking about that?

Well, we have implemented a price increase April 1 on certain items. And we're -- we've already announced across-the-board increase May 19, that's on every item. it's ranging from 5% to somewhere 15%, 20% different depending on the product itself. So that's what we're looking to do. In terms of are we absorbing all of the costs, we don't -- it's not 100%. But one thing for sure is our product basically is in high demand right now. We're seeing a lot of our competitors or importers stop importing 100%, and they're coming to us for everything. And there is -- there has been already a major shortage of product already in certain category.

And I just wanted to add on to that just real quick. So in terms of the pricing, obviously, we have been and we remain to be very competitive on the pricing side. To add a little color to Alan's point, we did announce we are expecting to implement some price increases, but we are also looking internally aggressively at areas where we can gain more efficiency to save cost to be able to absorb, to your point, some of the price increases as well.

Great. Appreciate that. And then on -- how do you guys think about reciprocal tariffs? Is that factored into guidance? Or what do you think that means for the business?

Right. Well, currently, we're just doing business as we go because as everyone knows that the situation changes not by the month or by the quarter. The situations are being changed by the days. So we -- it's hard for anybody to prepare anything to think of any reciprocal tariff because we don't even know that's going to happen. And if it happens, we don't know what's going to happen. So it's not just us. Basically, it's really hard to plan anything like this at this point.

Yes, fair point. And then just a few more here. So would you say -- do you think it's fair to say that you are in a position where the tariffs are almost a net benefit because you guys are actually -- have been, let's say, quicker to the ball on getting the sourcing outside of China compared to competitors where you might be able to take share now?

Yes. I think that we have been prepared. It's just that it came earlier than we planned it. That's all.

Yes. Fair enough. And the last one here. Just how much -- so did you say that the freight costs that you're seeing in the quarter were actually higher this past quarter? Or was that lower?

Again, everything changes. Last quarter, the first quarter, the freight was lower than the fourth quarter. Upcoming quarter, second quarter, the freight is looking higher than the first quarter, but this is only this month. We don't know if something is going to change because all the shipments are delayed or actually they stop shipping and it's going to get very competitive. So price may come down next week. So everything is so fluctuating right now. Yes.

Yes. Yes, fair point. And then just to wrap up here. You mentioned before that there is some cost-saving initiatives that you're looking at internally. Is there anything that you could share as an example, something like that, that would be good to contextualize?

Yes. I think Jian can go over it on the cost-saving initiatives that we have.

Yes, sure. So one good example is when we look at our controllable variable cost, one big component is shipping and transportation cost. So basically, the cost that we incur that we spend with our third-party carrier, the partners to distribute products to our customers. So this is one area that we have been looking very aggressively in terms of negotiating with our vendors. We recently launched a project where we are getting some savings. We are seeing some initial savings starting in the month of March by switching out some of our third-party carriers. So we've seen encouraging results from the month of March already, and we'll be prepared to provide another update in our next quarter's call.

[Operator Instructions] Our next question will come from Ryan Meyers with Lake Street.

First one for me. I just want to make sure I get a good understanding of the gross margins for the year. So you commented that you expect the second quarter gross margins to be largely flat with the first quarter. But if we look at the second half, that obviously implies sort of a step down in gross margins just to get to the range of the guidance that you gave. Just any dynamics that you want to call out there as far as what you can potentially see in the second half of the year on the gross margin side?

Jian, can you answer that question?

Yes, I can take that. Ryan, thanks for the question. So you are absolutely right. So at this point, we do expect our second quarter gross margin to be consistent with the first quarter. we are saying that because we have good visibility into our gross margin even with -- I know, obviously, we've been talking about the tariff and the freight cost. And obviously, we're sitting in early part of May. I'd say we have good visibility because our inventory turns roughly about -- it takes about roughly 60 days to turn. That's the reason why we have a good idea just based on all the freight costs, what we have paid over the past couple of months. I mean that gives us a good idea of what the second quarter gross margin looks like. So that's on the second quarter. In terms of the full year, yes, you are right. We -- at this point, obviously, tariff is open, right, a little up in the air, but we did build some cushion, some -- we have some scenario analysis in terms of kind of how margin is going to be compressed a little bit in the second half of the year because of the duties, the tariffs that we would expect to pay and depending on, obviously, how the negotiations go. So you're absolutely right. We do have -- we're building some conservatism in the second half of -- in the model for the gross margin in the second half.

Got it. That makes sense. And then my next question, I was curious to see that you guys ramped up domestic manufacturing. Can you maybe give us what the mix of the revenue during the quarter came from domestic manufacturing and then maybe how you expect that to play out through the year?

In the first quarter, we didn't actually ramp up much of the domestic manufacturing was pretty much stable. But in starting recently, we've seen that there is a shortage in the household increase in demand, overwhelmingly increase in demand on our products. So we're turning out machines that we didn't have them on before. And also, we're adding -- asking our employees to cut work over time to produce more product because we are -- as I mentioned earlier, there has been shortages in the market already. And basically, our products are being really -- we're actually telling customers not to stock up inventories and we're not allowing people to buy for. So this will not disrupt our inventory level. but we do need to build additional inventory because we are seeing more and more customers giving us a forecast that they will be taking inventory from us by stopping importing from what they've been doing. So that's where we're at right now. But in terms of percentage-wise, we actually don't have that yet.

Got it. That makes sense. And then the last question for me, this is more of a bigger picture industry type question. When you think about the volume that you guys have continued to drive over the last couple of quarters, I would assume that you've continued to take a significant amount of market share. So Alan, what would you attribute that to? Is that just really your guys' ability to get your customers the inventory they want? Or is there anything else that's worth noting there?

Well, one thing is credibility. We built a great relationship during the COVID period that we're a stable company and reliable. -- we will make sure that we're prepared for anything happens. And good thing is that because of our additional warehouse in Chino that we signed up in March, we were able to build additional inventory cushion just for the upcoming summer. And that's when our new President Trump announced the tariff in April, early April, everybody start to scramble, but that's too late. But we started to gear up back in March. Didn't expect it's going to be this much the tariff, then much is going to be -- the volume increase in our sales part is going to be that much. But the good thing is we're ready and our customers are happy that we're ready. And -- and because we built an existing relationship with a lot of these clients, now they're in need and they've come to us. And basically, we're doing our best to help whatever we can.

And this concludes our question-and-answer session. I'd like to turn the conference back over to Alan Yu for any closing remarks.

Well, thank you, everybody, for joining our earnings conference call in the first quarter 2025. We look forward to seeing all of you on the next quarterly meeting. Thank you very much. Have a nice day. Bye-bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.