Karat Packaging Q2 2023 Earnings Call Transcript

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August 9, 2023

There are 8 speakers on the call.

Operator

Welcome to the Care Packaging, Inc. 2nd Quarter 2023 Earnings Conference Call. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Roger Pondell with Pondell Wilkinson, Investor Relations for Care Packaging.

Operator

Please go ahead.

Speaker 1

Thank you, operator, and good afternoon, everyone. Welcome to Carrot Packaging's 2023 Second Quarter Earnings Call. I'm Roger Pondell with Pondell Wilkinson, Carrot Packaging's Investor Relations firm. It will be my pleasure momentarily to introduced to the company's Chief Executive Officer, Alan Yu and its Chief Financial Officer, Jan Go. 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 in the Securities Litigation Reform Act of 1995.

Speaker 1

Such forward looking statements are subject to numerous conditions, conducting a question and answer session. Please go ahead. 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 ks conducting a review of 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 conducting a question and answer session to the operator's call. Please also note that during this call, we will be discussing adjusted EBITDA, in the range of adjusted EBITDA margin and adjusted diluted earnings per share, which are non GAAP financial measures conducting a reconciliation of the most directly comparable GAAP measures joined.

Speaker 1

And with that, I will turn the call over to CEO, Alan Yu. Alan?

Speaker 2

Thank you, Roger. Good afternoon, everyone. Despite revenue being impacted by anticipated price reductions and lower revenue from logistics services and shipping charges, We achieved excellent second quarter results. Sales for our core disposable foodservice product grew during the quarter, be with volume increasing 5% over the prior year period, demand for our eco friendly product remains strong. Be Sales for the category grew 22% in the 2nd quarter over the prior year period.

Speaker 2

Our 2023 objective for the eco friendly product category be at about 35% of total sales. We were able to sustain record levels for the gross margin conducting a discussion of the company's financial results. Despite the industry wide deflationary environment and multiple price reduction that were implemented as well as write off of raw materials be associated with the disposal of certain machinery and equipment. We continue to implement our asset light growth initiatives focused on the

Speaker 1

business to focus more

Speaker 2

on import and distribution, drive margin expansion and improve inventory management and fill rates. We are working through some operational challenges in the opening of our Chicago and Houston warehouse, and we currently expect both warehouses to be fully operational conducting a number of questions before the end of September 2023. We are also looking for additional warehouse space in strategic locations be participating in the call to discuss the financial results such as Arizona and Florida. Together with the scaling back of manufacturing footprints in certain U. S.

Speaker 2

Locations substantially completed, Combined with the expansion of import items, we were able to achieve and maintain greater margin. I also want to mention that we completed the transaction of selling our portion of a joint venture project in Taiwan be receiving a full investment of $6,000,000 plus interest. Our current operating model and strategic initiative be producing strong operating cash flow. Accordingly, as we announced earlier today, our Board of Director declared a special dividend of $0.40 per share. The Board also approved the initiation of a regular quarterly cash dividend policy and they could declare a dividend of $0.10 per share.

Speaker 2

Be. These distribution demonstrate the Board's confidence in Carrot's future and commitment to returning value to our shareholder. I will now turn the call over to Jan Gao, our Chief Financial Officer to discuss the company financial results in greater detail. Jan?

Speaker 3

Thank you, Alan. Despite a challenging year over year revenue comparison, Q2 2023 results demonstrated our ability be able to implement our business strategies and we were again able to uphold enhanced margins be participating in the company's liquidity position. Net sales for the 2023 Q2 as anticipated

Speaker 1

be

Speaker 3

Sales to national and regional chains decreased 5.0%. Sales to the retail channel decreased 13.7% and sales from the online channel increased modestly. As Alan mentioned, Our core disposable foodservice product volume grew 5% over the prior year period and our eco friendly products be increased even more at 22% for the Q2. Carrot is a leading provider in this category based in part be participating on our enlarged sourcing network and expansion of our product offerings. Eco friendly products represented 32% of total sales in the 2023 Q2 compared with 25% a year ago.

Speaker 3

Gross profit increased conducting a reconciliation of $1,900,000 for the 2023 Second Quarter conducting a reconciliation of $34,000,000 in the prior year quarter. Our gross profit in this quarter includes a write off conducting a reconciliation of $1,700,000 of raw materials as we disposed of certain machinery and equipment in the U. S. Gross margin increased to 38.5% in the Q2 of 2023, in the range of $2,000,000 which amounted to 6.2 percent of net sales in the 2023 Q2 compared with 18.0 percent of net sales last year. Operating expenses in the 2023 Q2 were $28,500,000 conducting a question and answer session or 26.2 percent of net sales compared with $26,200,000 or 22.8 percent of net sales conducting a reconciliation of $2,500,000 in the prior year quarter.

Speaker 3

Operating expenses in the current quarter included impairment expense and loss on disposal of machinery Excluding this impact, our run rate operating expenses in the 2023 Q2 were $26,100,000 or 24.0 percent of net sales, which reflected reduced shipping and transportation costs and bedded expense, partially offset by workforce expansion, higher marketing expense to support online sales growth and higher rental expense participating from the additional leased warehouses. Net income for the 2023 Q2 rose 48.3% conducting a question and answer session to the financial results of the financial results. Please turn to Slide 10, please turn to Slide

Speaker 1

10, be conducting

Speaker 3

a reconciliation of $0.53 per diluted share from $6,300,000 or $0.32 per diluted share participating in the prior year quarter. Adjusted EBITDA, a non GAAP measure, increased to $21,100,000 in the 2023 Second Quarter from $11,800,000 in the prior year quarter. Consolidated adjusted EBITDA margin expanded to a company record of 19.4 percent of net sales from 10.3% conducting a question for the 2022 Q2. Adjusted diluted earnings per common share rose to $0.69 per share conducting a question from $0.34 per share a year ago. We finished the quarter with $110,300,000 conducting a number of key financial liquidity be receiving a $56,000,000 with another $28,000,000 in short term investment.

Speaker 3

Moving further into 2023, we're forecasting net sales for the 3rd quarter to be down approximately 3% to 4% year over year, and we are anticipating strong top line growth of 10% to be participating in the Q4. The overall market condition for our industry remains deflationary, but we believe we are towards at the tail end of the price cuts. The year over year expected decline in revenue in the 3rd quarter participating in the Q1 of 2019. This primarily reflects the delayed operation of our 2 new warehouses and unanticipated implementation delays notified by certain new chain account agreements that were signed earlier this year. That said, we anticipate a strong 4th quarter Accordingly, we expect net sales to be up by approximately 10% to 15% over the prior year quarter.

Speaker 3

We're also raising our 2023 full year gross margin goal to be at around 36 conducting a reconciliation of our business to 30 7% versus 31.2% for 2022 as our current operating and growth initiatives continue to benefit our performance. Anna and I will now be happy to answer your questions. And I'll turn the call back to the operator.

Operator

Be The first question today comes from Michael Hoffman with Stifel. Please go ahead.

Speaker 4

Hi, Alan and Jen. Just to be clear, the down 3Q is about delays And then incremental price pressures related to resetting of raw materials and freight. It's not a decline in activity, it's a delay in and an upside in activity?

Speaker 2

Yes. We do see The sales momentum is very strong, especially in the East Coast, Atlanta, Florida region, be Texas region, Oklahoma and Chicago, people are waiting for us to get the warehouse up and running, like and also the same as Houston. We were looking to have an operational mid July, but with the permitting delays and racking delays and training, So we're shooting for September and we're telling the customer to hang on tight and we'll get it ready. And because we don't have enough every one of our warehouse currently is It's overloaded already. South Carolina warehouse, we even have to stop shipping product because it's just overloaded.

Speaker 4

Okay. So I'll just repeat myself. You're not seeing be reduction in demand. This is a timing issue related to your ability to fulfill both of the warehousing

Speaker 2

Michael, I want to reemphasize, there is no reduction in

Speaker 4

And then just to do the quick math, are we and just so it helps us sort of level set models, are we settling in somewhere around $435,000,000 to $440,000,000 in sales, that gets you that sort of low single digit. And then if gross margins Play out the way you're describing it, that sort of $155,000,000 to $160,000,000 I'm assuming G and A, there's nothing unusual going on for the rest of the year. So be All of that upside in gross margin should come through in EBITDA as well?

Speaker 2

Jane, can you answer be.

Speaker 3

Yes, I can take that, Michael. So from the modeling perspective, if I hear your question correctly, the top line, be when we did a math, the total full year revenue is we will probably see a modest below single digit compared to last year. I think overall expect the full year SG and A leverage because it's going to be fairly consistent be seeing our adjusted EBITDA margin decline higher than last year.

Speaker 4

Right. So just to be clear that There's about $10,000,000 or $11,000,000 of incremental gross margin coming through the model based on the sales outlook. And We should expect most of that to translate into EBIT and EBITDA, but it's not

Speaker 5

a big Step up in SG

Speaker 4

and A is what I think I heard you say. And I apologize for the background noise.

Speaker 3

That's correct.

Speaker 4

I'm in a public setting. Okay. Okay. All right. That's what I needed, those two things.

Speaker 4

Thanks.

Speaker 2

Thank you, Michael.

Operator

The next question comes from Ryan Myers with Lake Street Capital. Please go ahead.

Speaker 6

Hey guys, thanks for taking my questions. First one for me, I know investment in the sales team has been a priority in the past. So just kind curious what the sales team looks like right now, and how that ramp up has gone as we look to accelerate growth here in Q4?

Speaker 2

Yes. We have recently just hired actually 3 sales reps in the Midwest be And we are looking 2 more, 2 to 3 more in the East Coast and also the Northwest. So we are on track on the additional sales rep be

Speaker 6

Got it. That's helpful. And then some of the weakness that you're seeing on the West Coast, just wondering if you could unpack that be a little bit more. Is that kind of broad based across the business? Is Eco Products performing well

Speaker 4

on the West Coast? Just kind of help

Speaker 2

What I'm seeing through The Street, in the West Coast, we are seeing some softness in the in the distribution channel, especially those that are catering to the mom and pop restaurants. We walked the streets in Los Angeles and we heard at the Street of San Francisco, Northern California, restaurants are closing at 8 o'clock versus they were closing at 10, 11 p. M. Be and after 6 p. M.

Speaker 2

People are not going out eating anymore and dining. And also there's many restaurants have basically shut the doors be in the West Coast region, especially California. We're seeing a lot of decline in activity in that part. But the chain stores, be they have remained strong. So basically, this is where we're seeing the support at.

Speaker 2

Even the West Coast, the mom and pop restaurants are closing, they're raising prices, their cost The rental has gone up, but the chain store has been able to maintain the strength in terms of growing their sales numbers.

Speaker 6

Be Got it. That's super helpful. Thanks for taking my questions.

Speaker 2

Thank you, Ryan.

Operator

The next question comes from Ryan Merkel with William Blair. Please go ahead.

Speaker 7

Yes. Hey, thanks. I wanted to ask about the change in sales in the second half. Alan, is the delay at the national chain accounts and your warehouse delay, are those the same things? Are those separate issues?

Speaker 2

These are separate issues. Normally, we understand dealing with the national chain account. There's always the setting up the item codes, be the timing also, if there is switching over from another vendors and there might be some leftover inventory they need to deplete. Be There's always an issue like that for the chains. So even though if we were anticipating the like for example on August 1, be the start date, it might be pushed back to October 1 or September 15.

Speaker 2

Now with the warehouse, that's a key another key problem is that, We're seeing that because our warehouse is so overloaded, this is the same issue we had last year. That's why we increased our warehouse base in California and also be adding new spaces in the other locations is that when the warehouse is overloaded, we tend to be shorting customer items be delaying shipment to the product because or we have to move like change the location of the product to ship from be originally versus South Carolina or to Texas. We have to shut down a couple of days of shipments because we have to move around the product be able to organize it and also transfer our product into different warehouses. So right now, we're using Chicago and Houston as a storage facility be waiting for the overloaded warehouse in South Carolina and in California and New Jersey. We're waiting for the rack to be racking up the entire warehouse for The existing warehouse as well as the new warehouse, Chicago is just fully racked and they're getting started to begin operation next week.

Speaker 2

But Houston, we have racking delays because, the ocean freight from the vendors, they have delays in that. So, this is be interested in getting another warehouse in Florida and SLS Arizona because we know even though that was originally part of the end of the year ago objective, But we're kind of pushing forward because we know that even if we start looking now, it might be end of the year when that really happens.

Speaker 7

Yes. Okay, got it. And then you mentioned that expanding import items has helped gross margins. Are you primarily talking about be California and shutting down the facilities there and just replacing it with imports. Is that how we should be thinking about it?

Speaker 2

Well, in California, we scaled back in manufacturing, with the increase in labor, increase in electricity costs in rental facilities. So we scaled back in California already and we moved a lot of these products into overseas be as well as we'll bring actually new items, eco friendly items. For example, people are looking for different type of a gas product. They're looking for different type of PLA lit. And also, we are just about to introduce our 1 and only first and only paper lids in place of PLA.

Speaker 2

A lot of Cities are considering PLA as still part of the plastic. You can't decompose it until with a unless you have a commercial compost site. Be So with the paper, lid, it can basically decompose, just put on the ground, it will decompose. So we're looking at new different items that are responsible and eco friendly. And also we're looking at going through the even with the plastic, we're looking to start using the recycled content be using plastic added to our existing version of plastic, so that the cups or the finished container are made at least with 25% recycle be So these are the things that we're focusing in moving forward to new items.

Speaker 7

Okay. All right. Thank you.

Speaker 2

Thank you, Ryan.

Operator

Be the next question comes from Jake Bartlett with Truist Securities. Please go ahead.

Speaker 5

Great. Thank you so much for taking the question. Your line is open on the gross margins and the guidance. I believe I'm just kind of backing into it here. I think that implies about a little over 34 Percent gross margins in the back half of the year.

Speaker 5

One, just correct me if I'm wrong on that. But also, is that the right level to Going forward or is that still benefiting from unusually low freight costs for instance or ocean freight costs? Trying to figure out kind of what be the gross margins have sort of diverged so much from kind of original expectations, trying to figure out what the right normalized gross margins are kind of going forward. And then I have a follow-up.

Speaker 2

Well, Jake, here's the thing. We mentioned earlier in our report that we're benefiting from a super low ocean freight in the past in the second quarter. But we're seeing the ocean freight coming back up pretty fast, but not as much as it was back in 2022, but it has gone up 30 be we're anticipating the ocean freight to go up even more starting August 2015. That's what we've been told. For example, We were paying $1100 ocean freight and it is going to go up to be $2,000 to $2,500 nearly double in certain areas.

Speaker 2

So basically, we don't know how long that's going to sustain, because in the 3, 4 months ago, the cost of ocean freight went up. And for just 2 weeks, It was not sustainable and it fell down again. So we're still in a really sensitive manner of timing things that we don't know where the ocean freight is going to be, which Also it's a big chunk of our cost of goods sold. So there's really not much who can say where it's going to be the normalization right now.

Speaker 5

Got it. Okay. And I think given that commentary, we should expect higher gross margins in the Q3 and then it comes down in the 4th be From that level, is that the right way to think about the cadence here?

Speaker 2

At this current moment, yes, Q3, we should see a higher gross margin. 4th quarter is unknown.

Speaker 5

Okay. And then I wanted to dig in on the comments about volumes. And I think you mentioned that the core foodservice, disposable packaging volumes were up 5%. What was the overall volume just up across the business? I'm trying to kind of figure out what else might have been kind of dragging the volume down?

Speaker 1

Well,

Speaker 2

here's the thing. Our core business is our packaging, disposable packaging as well as food items. Be. That segment has gone up 5%. The segment that has dragged our number down is the shipping And also logistics service, the service that we had in the past pulling containers from the port for other nearby neighbors, that has dropped significantly

Speaker 5

Okay. And you've talked about, I think for a A couple of quarters now, you've had visibility on the chain accounts that you've signed on. And this is a matter of kind of getting those up and running and Some delays there, but it's going to happen, which is encouraging. My question is whether there's more be in kind of process like you've signed, I mean, have you signed additional chain accounts that we might expect in 2024? Just trying to be understand the pipeline of new business that you've been generating.

Speaker 2

Yes. We have a list of pipeline that we generated beginning of this year and also in the Q2 and we are seeing more and more in our pipeline, not just the national chain account, also supermarket. We are targeting convenience stores after during the starting the Q4 this year. But first thing we need to do is we need to increase in terms of warehouse storage. We understand that without the warehouse storage, we will not be able to service our customer in the correct manner.

Speaker 5

Okay. And then last question, is you initiated a dividend, you are a growth company as well. Be is this the kind of maybe an indication that you're not actively seeking to acquire another company maybe to generate impacted that way. How should we look at your returning to cash to shareholders, but at the same time being a pretty fast be.

Speaker 2

Yes. We're returning dividends to the shareholder. One is that we're accumulating a lot of cash. And one of the reasons we're accumulating cash is that we have decided not to invest more in equipment to manufacture product. In the past 2 years, we invested over $50,000,000 or more the past 2 years consecutively.

Speaker 2

This year, we mentioned earlier in the Q1. In the Q1, our CapEx expense is going to drop significantly. But with that even with the returning be in deposit account as well as we have line of credit we can utilize anytime if there is a a strategic partner that could become available that we can acquire. That could be a warehouse distribution center or

Operator

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

Speaker 2

Thank you everyone for joining our carrier packaging conference call be in 2nd quarters and we look forward to be sharing from all of you again in the 3rd quarter conference call. Again, thank you very much for your participation. Have a nice day. Bye bye.

Operator

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

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Karat Packaging Q2 2023
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