Karat Packaging Q3 2024 Earnings Call Transcript

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November 7, 2024

There are 8 speakers on the call.

Operator

Hello and thank you for standing by. At this time, I'd like to welcome everyone to the Carrot Packaging, Inc. 3rd Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

Operator

Session. As a reminder, this call is being recorded. I will now turn the conference over to Roger Pondell. Please go ahead, sir.

Speaker 1

Thank you, operator. Good afternoon, everyone, and welcome to Carrot Packaging's 2024 Q3 conference call. I'm Roger Pondell with Pondell Wilkinson, Carrot 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, 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 Securities Litigation Reform Act of 1995.

Speaker 1

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 ks as filed with the Securities and Exchange Commission and 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 Carrot Packaging undertakes no obligation to update any forward looking statements except as required by law. Please also note that during today's call, we will be discussing adjusted EBITDA, adjusted EBITDA margin and adjusted diluted earnings per share, 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, it is my pleasure to turn the call over to CEO, Allen Yu.

Speaker 1

Allen?

Speaker 2

Thank you, Roger. Good afternoon, everyone. We are encouraged by our 3rd quarter performance with net sales up nearly 7% and volume up approximately 10%. Despite some pricing pressure, we experienced growth in most of our sales channels. Our online business, which benefited from the inclusion of $3,000,000 online platform fees in the current quarter, achieved a 33% increase over the prior year period.

Speaker 2

Pierrot's recent expansion into the supermarket chain category is starting to generate positive results. After successful product sampling and trial orders, we began shipping customized bakery packaging containers for a major grocery chain customer in late September, followed by the initiation of shipments on utensils to another major grocery chain in mid October. We are now developing additional product offering and intensifying our sales effort in this sector. Sales of our eco friendly products increased 9% year over year and now represented 33.4% of total sales in the 3rd quarter. We believe demand for eco friendly and compostable single use disposable product will continue to increase and will contribute positively in the long term.

Speaker 2

We are focusing on new eco friendly product development to further enhance our competitive edge. By the end of Q4, we expect to launch a new line of RPET cut and lids to meet the rising demand that we're seeing in the marketplace. This new line of RPET product is made with more than 25% recycled PET material. Geographically, we continue to experience strong growth in the Midwest, Northwest and East Coast compared with last year. Additionally, we see sales stabilizing in California, which is our biggest market, following a sharp decline in the past few quarters.

Speaker 2

At the gross margin level, we achieved gross margin of 38.6% in the 3rd quarter versus 36.9% in the prior year period despite the impact from high ocean freight rate in the first half of the quarter. Heading into the 4th quarter, we are encouraged by the positive momentum and are focused on optimizing inventory sourcing and management, controlling expenses and enhancing warehouse capabilities. From an inventory perspective, we implemented procedures to optimize sourcing and inventory management. Even with reduced domestic production and increased sales, we expect to be able to reduce inventory import volume in the Q4 of 2024 compared to the prior year. Additionally, with decreased ocean freight rate and reduced vendor pricing in certain categories, we expect 4th quarter margin to remain at a higher level.

Speaker 2

Additionally, we recently implemented measures to further reduce labor and certain other operating costs, and we expect such measures to yield benefit in the 4th quarter. We are also actively looking for a new distribution center in the Southeast region to support anticipated business growth. With Carrot's strong operating cash flow as well as the company liquidity, solid balance sheet and positive long term outlook, our Board of Directors again approved an increase in the quarterly cash dividend payment to $0.40 per share on November 5 from $0.35 per share in the preceding quarter. I will now turn the call over to Jan Guo, our Chief Financial Officer, to discuss company's financial results in greater detail. Jan?

Speaker 3

Thank you, Alan. Net sales for the 2024 Q3 were $112,800,000 up 6.9% from $105,500,000 for the same quarter last year. As Alan mentioned, our sales volume grew nearly 10% compared with the 2023 Q3. Net sales also included a favorable impact from inclusion of $3,000,000 in online platform fees, partially offset by a $5,700,000 unfavorable year over year pricing comparison. By channel, compared with a year ago, online sales for the 2024 Q3 were up 32.8%, benefiting in part from the inclusion of online platform fees mentioned earlier.

Speaker 3

Retail and distributor channel sales increased 9.2% and 3.3% respectively from the prior year quarter as our investments in sales force started to come to fruition. Sales to national and regional chains were essentially flat. Cost of goods sold for the 2024 Q3 was $69,300,000 compared with $66,600,000 in the prior year quarter. The increase was primarily due to higher ocean freight and duty costs driven by elevated ocean freight rate primarily in the first half of the quarter, coupled with increased import volume, along with the inclusion of production expenses related to machinery repair and maintenance. Gross profit for the 2024 Q3 increased 11.7 percent to $43,500,000 from $38,900,000 last year.

Speaker 3

Gross margin for the 2024 Q3 increased 170 basis points to 38.6%, which included a net benefit contribution of 110 basis points from adjustments to net sales related to online platform fees and production expenses in cost of goods sold as discussed earlier. Gross margin also benefited from lower vendor pricing and increased imports as a percentage of total products mix, partially offset by higher ocean freight costs. Operating expenses in the 2024 Q3 was $32,200,000 compared with $27,600,000 in the prior year quarter. Operating expenses in the current quarter included online sales platform fees, higher rent and warehouse expense, increased shipping and transportation costs and higher online marketing expense. Such increases were partially offset by the inclusion of production expense in cost of goods sold as discussed earlier and a decrease in professional expenses due to transaction costs in connection with a secondary offering during the 2023 Q3.

Speaker 3

Net income for the 2024 Q3 increased 1.3 percent to $9,300,000 from $9,100,000 for the prior year quarter. Net income margin was 8.2% in the 2024 Q3 compared with 8.7 percent a year ago. Net income attributable to carats for both the 2024 and 2023 3rd quarters was $9,100,000 or $0.45 per diluted share. Adjusted EBITDA was $14,700,000 for the 2024 Q3 compared with $15,200,000 for the prior year quarter. Adjusted EBITDA margin was 13.0 percent for the 2024 Q3 versus 14.4% in the prior year quarter.

Speaker 3

Adjusted diluted earnings per common share was $0.47 for both the 2024 and 2023 3rd quarters. We generated operating cash flows of $19,500,000 in the 3rd quarter and ended the quarter with $115,600,000 in working capital compared with $110,500,000 at the end of 2023. As of September 30, 2024, we had financial liquidity of $75,100,000 with another $21,500,000 in short term investments. As Alan mentioned earlier, our Board of Directors just approved another increase of our quarterly dividend to $0.40 per share. This is on top of the $23,000,000 we returned to shareholders in the current year in regular and special dividends.

Speaker 3

We remain committed to a balanced capital allocation strategy between shareholder return and long term growth investments. We expect net sales for the 2024 Q4 to increase by mid to high single digit over the prior year quarter. Our gross margin goal for the 2024 Q4 is approximately 39% to 40%. We are also reaffirming our full year 2024 guidance today. Alan and I will now be happy to answer your questions.

Speaker 3

And I'll turn the call back to the operator.

Operator

Thank you. We will now begin the question and answer And your first question comes from the line of Ryan Mayers with Lake Street Capital Markets. Your line is open.

Speaker 4

Hey guys, thanks for taking my questions. Jan, just wanted to follow-up and get a good understanding of what you said in regard to the guidance. So thinking about the Q4 guide, you guys called out an increase in sales of mid to high single digit percent. But so I believe back to last quarter, sort of the implied Q4 number with the year guidance, I think was looking for a double digit growth rate. Just want to make sure I understand that correctly.

Speaker 4

If there's anything that I missed in comment, it'd be kind of helpful to walk through that.

Speaker 3

Yes. So Ryan, thank you for the question. Yes, that's correct. So at this point, we do expect the 4th quarter sales growth to be mid to high single digit. We are also reaffirming our full year guidance, as we mentioned in the prepared remarks.

Speaker 3

I do also wanted to call out, if you recall, Ryan, last Q4 2023 last year, our Q4 net sales amount actually included an accounting misclassification adjustment of a full year amount of a little over $6,000,000 So that was a benefit to Q4 2023. So that's going to cause a little bit of apple to orange comparison in this year. But with that impact, we are still expecting to see mid to high single digit year over year growth in Q4.

Speaker 4

Okay, got it. That makes sense. And then just thinking about the national and regional chain segment, looks like revenue was flat year over year. Is most of that pricing or is there anything else kind of to call out there? It looks like volume across the business is pretty strong, but just to get an understanding of kind of that segment itself would be helpful.

Speaker 3

You're talking about the chain segment?

Speaker 4

Yes, correct. Because I know over the past handful of quarters, you guys have obviously made some emphasis of rolling out into new regional chains, whether it's salespeople or additional products, but just kind of get a good feel for that line item.

Speaker 3

Yes, sure. I can start. I'm sure Alan can add additional detail there. So for some of the chain accounts, I mean, that is right, what you said, Ryan, as far as the pricing adjustments. We wanted to make sure that we remain competitive in our value propositions with our customers.

Speaker 3

So we do have we did have some price adjustment in the past quarter. I also wanted to point out, as we mentioned in our prepared remarks, we started shipping in some of the for a major supermarket chain customer, we started shipping to this particular customer in the very last week of September, which was a little later than what we previously anticipated. However, we are at a full annualized volume with this particular customer now, and we do expect to get a benefit in the 4th quarter in the chain segment. Alan, anything else you want to add?

Speaker 5

Sure. First of all, Brian, to your first earlier question about the double digit growth that we expected it. If you look at the as Jen mentioned that, if you were to take out the $6,000,000 from last year Q4, our revenue would have been $89,000,000 total, but we added $6,000,000 so $95,000,000 Now if we were to take out the $96,000,000 with $89,000,000 compared to what we're guiding right now, it's a little bit over 14%, which is double digit growth year over year. That's what Jen said, if we were to compare it apple to apple, our real growth will be double digit in 14%. Now in terms of what Jen just mentioned to you, in terms of additional national chain account, yes, we just started the supermarket chain accounts, which is very it's a very recognizable reputable company in Texas as well as another national supermarket chain that we're focusing and we started shipping.

Speaker 5

Of course, there are other national chain that we're working on that we are hopeful that we'll start shipping in the Q4, maybe later of Q4 of this year or earlier 1st quarters. That is our goal. And in terms of additional growth that we're seeing is online sales, we're seeing strong online sales. As I mentioned earlier in our conference call, we're already seeing a 33% growth year over year, which in the Q4, which we will rely heavily on online sales because we're going to be promoting more marketing towards that. And the Q3, we actually invested a lot more in terms of online marketing advertisement, which will come to fruition in the Q4.

Speaker 4

Okay, got it. That makes sense. Yes, the commentary on the guidance and that $6,000,000 impact from last year is helpful and kind of gets us into a good spot. So awesome. Thanks for taking my questions.

Speaker 5

Thank you, Ryan. Thanks, Ryan.

Operator

Next question comes from the line of Jake Bartlett with Tuohy Securities. Your line is open.

Speaker 6

Great. Thanks for taking the questions. My first one is just on the supermarket opportunity. Alan, you mentioned this new account that you've or 2 new accounts you've brought on. My question is how big an opportunity this is?

Speaker 6

You're obviously focusing on the press release and the call today. But how much of an opportunity really is it for Carrot, maybe in the near and then also the long term? And then also what makes Carrot well suited for this business? It seems like a business you hadn't pursued in the past or maybe you hadn't just hadn't had success with it, but what makes this a good business for Carrot to be getting into at this point?

Speaker 5

Well, with the initial number of forecast projected by the customers, our initial annualized revenue will be around $5,000,000 or a little bit over $5,000,000 to $6,000,000 And we are currently working on additional project with the same accounts that should bring us to an annualized revenue of $15,000,000 for this one account. And also for another supermarket chain, it's about around $500,000 to $1,000,000 to start with and they can grow even larger. What is special about these going after the supermarket chain is that we realized supermarkets have they have less SKUs and they use higher volume. And this is more catering toward the bakery product section. I mean, in our past, our focus would have been in the cup business, in the restaurant business, in the drinking business.

Speaker 5

But now our focus is going to the bakery business. So it's from the supermarket, we're also wanting to get into the deli business. There's a lot of paper opportunities in the delis and supermarket and bakeries, like the paper containers, the paper bags. So these are the things that we really want to move shift into the business that we haven't been focused in the past. In the past, it's always the hot cup, the cold cup, the paper cold cup, the PET cup, the portion cup.

Speaker 5

Now as we shift into this business, we see that the opportunities are much greater and the potential is a lot higher than what we have been doing and selling in the past with the cup business.

Speaker 6

Okay, great. And on the Eco Friendly side, nice to see the continued growth there. I'm trying to understand what the implications are for the new product or products that you're going to be launching in the Q4? I mean, how big a deal is that? How much could that be adding to the eco friendly product growth in 2025 and beyond?

Speaker 5

Well, we're actually starting to add the corrugated box takeout container business. If you were to go out into bakery stores and some of these chains, just trying to switch away from the plastic takeout container into the corrugated board box and as well as the bakeries. They have you can see all these little corrugated boxes, bakery container, paper containers with the plastic openings. Before it was all plastic or styrofoam. Paperback, SOS bag, those are the things that we want to get into.

Speaker 5

And there's different sizes of SOS bag. It's not just the shopping bag we're looking to. The RPET business is that we've been asked by a lot of our some of our chains that they want us to reduce the use of virgin material. How can we utilize the use of the recycled material so that it's we use less plastic as well as more recycled material? In Europe, basically, they ban all plastic effectively if you were to mix with 25% or more of the recycled content material.

Speaker 5

So this is more of a future, just how we started the PLA cut business back in 2007. If we have to if the company still have to use plastic, which is more functionable, they want us to at least they want the company to start using less version material and more recycled content material. That's part of that. As far as the corrugated box business, it's not just for the packaging, it's now for the food container takeout as well.

Speaker 6

Okay. And then my last question, maybe I'll jump back in with another later. But is the gross margins obviously, the gross margins have been much stronger than initially expected maybe a couple of years ago. My question is, and then also continue to remain very strong obviously with the guidance in the Q4. My question is how sustainable that is?

Speaker 6

What portion of this margin expansion versus the 31% you were running 2 years ago? Now you're looking on pace for 39% in 2024. So of the gains, what should we think about as a long term gain? What's sustainable for this business long term from a gross margin perspective?

Speaker 5

Well, as Jen just mentioned earlier in our call, we're seeing our I'm not sure if we mentioned that our gross margin guidance for the Q4, we're looking at 39% to 40% versus our last quarter 38.5%. So we're still seeing this margin in the high 30s and the low 40s. Is this sustainable? Well, we believe it is because we're as we mentioned earlier, we're focusing more on online sales, online revenue. Online revenue generally has carry a larger, higher amount of the margin, basically profit margin.

Speaker 5

And we're already at 33% growth, which is about 17% to 18% of our overall revenue. We do I do expect that to continue to grow into the 20s or the low 20s overall revenue on the online sales, possibly 25% or more for the online sales compared to our overall revenues. That's going to help us to boost our overall margin as well as ocean freight. We do continue to see that ocean freight is not going to spike up. We're seeing it stabilizing, it's dropping for the remaining of the year and possibly very likely the Q1.

Speaker 5

So these will also help in terms of reducing our costs and increase our gross margin. So we're doing everything we can in terms of selling online, which online would generate more higher margin for us. That is going to offset us in terms of growing our volume in the distribution side of the business. There is pricing pressure on the distribution side of the business, but that is helping us with the sales volume. We're looking at volume potentially up to year over year 20% growth in volume wise overall volume wise in the Q4.

Speaker 6

Sorry, the volume just that last comment, the volume from the distributors in the Q4 or overall you expect the mix to be very high for volume in terms of what's driving sales?

Speaker 5

Overall volume to 20% higher.

Speaker 6

In the Q4?

Speaker 2

In the Q4, yes.

Speaker 6

Okay. Got it. Thanks a lot. Appreciate it.

Speaker 5

Last comment, Jake, while I have you on the phone. We have not seen a double digit growth for the past 18 months. And basically, we're seeing that as a very hopeful sign that our goal is we do want to continue this to be the double digit growth in the future.

Operator

Next question comes from the line of Brian Butler with Stifel. Your line is open.

Speaker 7

Good afternoon. Thank you for taking the question. I guess, Alan, just to kind of follow-up on that double digit growth kind of in the future. You have it looks like very good momentum and it seems like the markets improved with California kind of flattening, at least not being down more. And then you're moving to supermarkets as well as new products.

Speaker 7

How do we think about 4th quarter being high or mid single digit revenue growth? When you look at 25, what's the early thoughts on where that can be? Could that be double digits again? Or is it really more of a mid single digit until maybe some of the macro kind of gets more of a tailwind?

Speaker 5

Well, Brian, as I mentioned earlier and to answer today's question, Q4, if we're comparing to Aqua to Aqua, it's already double digit growth in revenue wise. If we take out the $6,000,000 that was we added the $6,000,000 from online platform fee from the January to December. So that's why we're expecting to see hopefully, we're expecting to see actually we are expecting to see a double digit growth in the Q1 of 2025 based on that trajectory right now. And our goal is historically, in the past year prior to the COVID, we have been growing double digit year over year. And this is basically where it seems like we're on the right track back to our trajectory double digit growth organically.

Speaker 7

Okay, great. And then on the cost side, operating cost, again, you had the operating cost included the platform fees. When do we anniversary that? And when you think about 2025, how much how fast should that grow if you're growing top line kind of double digits?

Speaker 5

We are going to invest. I would call that this is more of an investment in terms of advertisement for future additional sales online. If for online business, in order to continue growth, we're basically acquiring paying spending advertisement to acquire new business for that so they can continue to recur and buy our product on a recurring basis. So basically, our goal is to grow our business, increase by 50% from currently this year of $70,000,000 to $75,000,000 to $125,000,000 next year. We are going to see more expenses spent on the advertisement for the online expense.

Speaker 5

But at the same time, it's definitely going to help us increase our revenue faster than it was in the past 12 months.

Speaker 7

Okay. And then on kind of generating that growth, what type of capital expectations do you have from a spending perspective on what has to be outlayed to support kind of that double digit growth. Can you give some color there?

Speaker 5

In terms of capital expenditure, we won't be spending that as much. Basically, we do set a budget in terms of how much online growth and how much we spend on the online advertisement. We have been pushing a little bit higher, but we're not going to go crazy on that. So that's why I don't see a big capital expansion on that part, except for the exception that we are looking to expand additional warehouse space. That is where we're going to see the capital expenditure on additional warehouse space in the Southeast region, where we definitely want to build a mega center for the to support our growth.

Speaker 5

It could be in the millions on that part. But definitely, we have the cash flow on hand to support that already.

Speaker 7

Okay. And then my last one, just you had reported a data breach in the Q3. Do you have an update on where that kind of stands and what that impact might have been or might be in the future here?

Speaker 5

We actually based on our initial investigation, there were no material data breach. We were a little bit more cautious in terms of some it was more of an employee or a couple of employee, they click on the attachment, which were the hacker were able to hack into our email system. And at the same time, we hired a 3rd party investigator to investigate. Initial investigation came out that there were no material data breach. We'll continue following through and see if there's any issue on that part.

Speaker 5

In terms of monetary damages, there were no monetary damages and the amount spent is very nominal, very nonmaterial.

Speaker 7

Great. Thanks for taking the questions.

Speaker 5

Thank you. Thank

Operator

There are no questions at this time. I will turn the call back over to Alan Yu for closing remarks.

Speaker 5

Thank you, operator, and thanks to all of you for joining us today. We appreciate your continued support. We remain confident about Carrot's future and we look forward to keeping you appraise of our progress. Have a great evening and a wonderful Thanksgiving holiday season. Thank you all.

Speaker 5

Bye bye.

Operator

And this concludes the meeting. We thank you all for your participation. You may now disconnect.

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Karat Packaging Q3 2024
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