Karat Packaging Inc. ($KRT)

Good afternoon, and welcome to the Karat Packaging Fourth Quarter 2025 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Roger Pondel, Investor Relations. Please go ahead.

Thank you, operator. Good afternoon, everyone, and welcome to Karat Packaging's Fourth Quarter and Full Year 2025 Conference Call. I'm Roger Pondel with PondelWilkinson, Karat Packaging's Investor Relations firm. 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 our 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 these 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. Despite ongoing trade volatility, Karat continues to deliver profitable growth demonstrating the strength and resilience of our business model. We closed 2025 with an increase of 13.7% net sales in the fourth quarter, fueled by strong double-digit volume growth across all major markets. Notably, pricing also turned positive for the first time since early 2023, adding further momentum to our performance. Our ongoing effort to diversify sourcing continued to deliver positive results. We have adjusted our import volume across sourcing countries following tariff and foreign currency development. During the fourth quarter, our import mix consisted of 46% from Taiwan, 14% from China, 13% from the United States, and 11% each from Vietnam and Malaysia. Our resilient global supply chain enabled us to maintain a solid 34% gross margin despite significantly higher tariff and duty costs during the quarter. Following the recent favorable global tariff developments and destabilization of favorable U.S. dollar and new Taiwan dollar exchange rates, we expect tailwinds on the margin to be realizing beginning in the second quarter of this year. Our new paper bag business product category continues to gain strong momentum, expanding steadily and driving meaningful revenue growth. In addition to supplying one of our largest national chain accounts, we are actively pursuing additional opportunities, some of which are at the final confirmation stage. We are also strengthening this category by supplying generic paper bags to smaller customer accounts in addition to custom paper bags, and we expect to continue gaining market shares in this category in the years ahead. Our eco-friendly product sales boosted in part by paper bags grew to 37.3% of total revenue in the fourth quarter of 2025, up from 34.5% in the same quarter of 2024. As our paper bag category business continued to expand, we are further strengthening our position as a leading provider of sustainable, eco-friendly disposable foodservice product. In today's consistently shifting trade environment, we believe that Karat global sourcing flexibility and efficient logistic capabilities position us well to support continued growth and the margin improvement. We are also maintaining our focus on operating efficiency reflected in the improvement of our operating cost leverage to 26.7% in the fourth quarter of 2025 from 32% in the prior year quarter. Together, these efforts provide a solid foundation as we look forward to another strong year. I will now turn the call to Jian Guo, our Chief Financial Officer, to discuss the company's financial results in greater detail. Jian?

Thank you, Alan. I'll begin with a summary of our fourth quarter performance followed by an update on our guidance. Net sales for the 2025 4th quarter increased to $115.6 million, up 13.7% from $101.6 million in the prior year quarter. The increase primarily reflected $8.2 million in volume and a $6.3 million favorable impact from pricing and product mix. Sales to chain accounts and distributors, our biggest sales channel, were up by 17.5% in the 2025 4th quarter. Online sales rose 1.9% over the prior year quarter, and sales to the retail channel declined 4.8% from the 2024 4th quarter. As part of our initiative to optimize margin, we continued to shift away from online sales fulfilled by Amazon and focused more on driving traffic through our own Lollicup store and fulfilling our own orders on third-party platforms. We achieved significantly higher contribution margin in our online sales with reduced online platform fees and market costs. Cost of goods sold for the 2025 4th quarter increased 23.4% to $76.3 million from $61.8 million in the prior year quarter. Product costs increased $6.1 million due to sales growth, partially offset by more favorable vendor pricing and product mix. Within import costs, duty and tariff costs increased $8.4 million due to higher tariff rates and a $0.4 million adjustment to the duty reserve previously recorded on certain imports. Gross profit for the 2025 4th quarter was $39.3 million compared with $39.8 million in the prior year quarter. Gross margin for the 2025 4th quarter was 34.0% compared with 39.2% in the prior year quarter. Gross margin was impacted by higher import costs, which included ocean freight and import duty and tariffs. As a percentage of net sales, import costs increased to 14.5% from 8.3% in the prior year quarter. However, we were able to partially offset the headwind on margin by reducing product costs as a percentage of net sales due to more favorable vendor pricing and product mix as well as lower logistics expenses as a percentage of net sales. Operating expenses in the 2025 4th quarter decreased to $30.9 million from $32.5 million in the prior year quarter. As Alan mentioned, our focus on cost containment yield significant results here. Compared to the prior year quarter, we reduced online platform fees by $1.6 million while maintaining our sales growth trajectory, lower marketing expense by $0.5 million and reduced professional services expense by $0.4 million. At the same time, our rent expense increased $0.5 million primarily due to the opening of a new Chino distribution center in 2025. Operating income in the 2025 4th quarter increased 16.0% to $8.5 million from $7.3 million in the prior year quarter. Total other income net increased 17.7% to $1.2 million for the 2025 4th quarter from $1.0 million in the prior year quarter. Net income for the 2025 4th quarter increased 22.8% to $7.2 million from $5.9 million for the prior year quarter. Net income margin rose to 6.2% in the 2025 4th quarter from 5.8% in the prior year quarter. Net income attributable to Karat for the 2025 4th quarter increased 21.3% to $6.8 million or $0.34 per diluted share from $5.6 million or $0.28 per diluted share in the prior year quarter. Adjusted EBITDA for the 2025 4th quarter rose to $12.5 million from $11.3 million for the prior year quarter. Adjusted EBITDA margin was 10.8% compared with 11.1% for the prior year quarter. Adjusted diluted earnings per common share increased to $0.34 a per share for the 2025 4th quarter from $0.29 per share in the prior year quarter. We executed strong working capital management during the fourth quarter, generating operating cash flow of $15.4 million and free cash flow of $14.6 million despite continued heavy duty and tariff payments. During the fourth quarter, we also made an early loan repayment of $8.0 million for our consolidated variable interest entities term loan. In addition to our regular quarterly dividend of $0.45 per share paid to shareholders on November 28, 2025, we further utilized our newly approved share repurchase program and repurchased 137,374 shares of our common stock at an average share price of $21.74 per share for a total amount of $3.0 million. As of March 11, 2026, approximately $12.0 million remained available for repurchase under the authorized repurchase program. We ended 2025 with $91.0 million in working capital and maintained financial liquidity of $45.6 million. On February 5, 2026, our Board of Directors approved a regular quarterly dividend of $0.45 per share payable February 27, 2026, to shareholders of record as of February 20, 2026. Looking ahead to the 2026 1st quarter, we expect net sales to increase by approximately 8% to 10% from the prior year quarter. Sales for the first quarter are typically subject to weather conditions. Although we experienced facility shutdowns due to inclement weather this January and February, we are seeing strong sales growth momentum. We expect gross margin for the 2026 1st quarter to be within 34% to 36% and adjusted EBITDA margin to be within 9% to 11%. For the full year 2026, we expect net sales to grow in the low double-digit range over the prior year, and we anticipate continued improvements in both gross margin and adjusted EBITDA margin compared with the prior year under the current global tariff import environment. As Alan mentioned earlier, we are seeing accelerated growth in our pipeline, supported by the continued expansion of our paper bags category and the addition of several key customer accounts. We remain committed to accelerating top line growth while continuing to improve operational efficiency and cost management. Alan and I will now be happy to answer your questions, and I'll turn the call back to the operator.

[Operator Instructions] Our first question today comes from Ryan Merkel with William Blair.

I wanted to start with the outlook for '26, the up double digits. Alan, what are you assuming for the market in that outlook? I was thinking something like flat in that most of your sales growth is going to be market share gains, but tell me how you're thinking about that.

Well, I do see the environment for our competitive -- it's a very competitive environment right now. And I see numbers coming out from our competitors are negative growth to maybe low single-digit growth. While we are seeing -- foreseeing our company to have a low double-digit growth, I think that has been conservative. The way I see that is, yes, market share gain, mainly on the new categories that we're offering on the paper bag, the SOS back, we're adding -- for example, we have about maybe perhaps 40 SKUs on the paper bag. We're going to add additional 50 or more SKUs just on the paper bag category. Maybe we can have a complete line of SOS bags. We're adding all of it. Paper shopping bag, we're adding more of that, and we're adding more custom printing. We're doing a lot of things to add -- addition to the -- our line offering to increase our revenue.

Got it. Okay. That's great. And then I wanted to ask on 1Q. Kind of up 9% year-over-year for revenue, that's a bit of a slowdown from the up 14% this quarter. Jian, you mentioned weather. So I guess my question is, is it just weather that's causing the slowdown in 1Q. And now that the weather has cleared a bit, have you seen the trends pick back up?

Yes. Texas is one of our major hub. We had a shutdown over a week. We couldn't work in -- it was like a snowstorm. And also East Coast had several weather issues, New Jersey and South Carolina, but mainly it was Texas that we had entire week that we couldn't do anything. So that really slowed us down for the month of January, some part of February. But we do see that, whether it's getting better now in March, so we're seeing strong momentum coming back from the March and onward.

[Operator Instructions] The next question is from Ryan Meyers with Lake Street Capital Markets.

Congrats on a solid fourth quarter. First question for me, just thinking about the full year revenue guidance, do you guys factor in any of these business opportunities that you commented on that are in the final confirmation stages? Or is this full year revenue guidance just based on the business that you guys have already signed and visibility to already?

Well, a part of it. The one that we're adding in is that we know we have a lot of pipeline that we are confirming on the final stages. The key part is, in most cases, it is chain account, even with their -- after they confirm, there's a testing phase, and they might just delay and drag for 6 months to 9 months. So we want to be conservative. Of course, we don't just have 1 or 2 or 3 or maybe -- we have more than a dozen -- several dozen potentially accounts that we're adding in. They're either existing customer or the new accounts. So we're adding that, and that's why we're forecasting single digit -- single double -- low double-digit growth, but my goal is actually mid or higher -- high double-digit growth. That's our ultimate goal.

Okay. Got it. That's helpful.

So upside if we can -- if some of those opportunities can materialize.

Yes. Okay. Makes sense. And then I just want to make sure I'm understanding the gross margin guidance correctly. So Jian, are you expecting an increase from the 36.8% full year 2025 number in 2026? Or are you expecting an increase from what you guys reported in the fourth quarter? Just one clarification there.

We are expecting year-over-year increase under the current tariff environment.

The next question is from George Staphos with Bank of America.

Got it. This is Kyle Benvenuto stepping in for George. Quick question for you. You discussed tariffs, FX and logistics as key margin drivers, and in the past, you've talked about transportation. Can you comment on whether energy costs are baked into your margin outlook, your margin guidance?

Yes, we have because this is not the first time we've seen the energy crisis like the oil crisis. We've seen the -- in 2022, the ocean freightliner, the shipping ocean freight skyrocketed from $1,500 to $10,000 containers. But we do not foresee the price will be incrementally high. We are foreseeing a little bit of an increase. And I mean, the past 3 months, basically, the ocean freight carrier, they tried to increase the prices of the ocean freight cost. And for the past 3 times, they failed. It went up for just merely 2 or 3 weeks and they dropped back down. But mainly, we normally sign in the full year agreement, which normally are signed in the month of April, which is, next month, we'll be able to sign that. And so far, the guidance is just about 10%, 15% increase year-over-year on the ocean freight shipping costs. And for locally, domestic diesel gases, it's been up and down throughout the year. So these have been accounted for.

And then just one more question. In regard to the online sales, we saw some positive growth this quarter. Back in Q2, I believe you mentioned double-digit growth potentially in the back half of this year. I guess I was just wondering what's the progress on that maybe going forward into '26 and how -- a little bit more detail about how that's evolving.

Yes. No problem. We -- I do -- we do foresee 2026, we will have a double-digit growth online because we're adding additional platform where, currently, we have our own Shopify store. We have Amazon. We added sysco.com platform. We'll be adding target.com, and there's a cheneybrothers.com. And there's other platform we're adding our product into those platforms. That will increase our sales. And also, we're driving our sales by increasing bulk sale from our own stores and our Amazon stores. What I mean bulk sales is we're encouraging customers to buy not just 1 cases, 1 pieces but like 5 cases and 10 cases. That increases our volume. Not only volume, it increases our revenue and also profit margin because we do get a bulk discount from the carrier. If we ship more product to the same location, our shipping costs come down. So we're optimizing that and passing that savings to the customer to increase revenue. So we do foresee that our 2026 online growth will be double digit.

Next question is from Joshua Axel with KTF Investments.

I have a question for you on -- really 2 questions. Number one, can you expand a little bit on the demand you're seeing for the eco-friendly business maybe outside of the paper bag? Just curious as if you're still seeing high demand with the current environment. And then secondly, can you comment a little bit on what you're seeing in the California market?

Sure. The first question, demand in eco products has never dropped and mainly on the molded fiber product and on the paper bag due to regulatory regulation. And we're seeing more and more chains are moving away from Styrofoam into paper products. So we're seeing more of that. On the compostable product, PLA items, we also see a growth of that due to the price decrease. They used to be pretty expensive to buy a compostable PLA cup. But now as price comes down, it's become more affordable, and more and more customers are actually looking to that. We're seeing newly opened restaurants are trying out with eco-friendly products because they want to perceive themselves with the consumer as being part of the initiative to save the environment. So I would say that more and more going to that. That's driving the demand from the consumer perspective. Now in California market, we're seeing a slowdown in the California market overall. In general, restaurants are shutting down, and it's becoming a very competitive environment. But in our aspect, our company, we're seeing a double -- we have seen recently a double-digit growth in our companies. We're seeing, due to the tariff containment, some of the importers stopped importing product because they went out of business, and so it's definitely driving the business to our company as well as other larger companies with more inventory on hand. That's what we're seeing in the California market.

This concludes our question-and-answer session. I would like to turn the conference back over to Alan Yu for any closing remarks.

Thank you, operator. Thank you, everyone. It has been a wonderful quarter, and I look forward to hearing from you all in the next quarter. Thank you all. Bye-bye.

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