Karat Packaging Q3 2024 Earnings Call Transcript

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November 7, 2024

Key Takeaways

  • Carrot reported Q3 net sales of $112.8 million, up 6.9% year-over-year, with volumes rising nearly 10% and online sales jumping 33% (including $3 million in platform fees).
  • The company’s expansion into supermarket bakery packaging is underway, with initial shipments to two major chains forecast to generate $5–6 million annually and potential to reach $15 million for one account.
  • Gross margin improved to 38.6% in Q3 (versus 36.9% last year) and is guided to 39–40% in Q4, supported by lower ocean freight, reduced vendor pricing and optimized inventory sourcing.
  • Eco-friendly offerings grew 9% year-over-year and now represent 33.4% of sales, with a new line of RPET cups and lids (25%+ recycled PET) slated to launch by year-end.
  • Strong cash flow of $19.5 million in Q3, liquidity of $75.1 million and a solid balance sheet enabled a raised quarterly dividend to $0.40 per share, while mid-to-high single-digit Q4 sales growth and full-year guidance were reaffirmed.
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Earnings Conference Call
Karat Packaging Q3 2024
00:00 / 00:00

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Operator

Hello and thank you for standing by. At this time, I'd like to welcome everyone to the Karat Packaging Inc Q3 2024 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. Thank you. As a reminder, this call is being recorded. I will now turn the conference over to Roger Pondel. Please go ahead, sir.

Roger Pondel
Roger Pondel
Head of Investor Relations at Karat Packaging Inc

Thank you, Operator. Good afternoon, everyone, and welcome to Karat Packaging's third quarter 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 his 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 factor section of the company's most recent Form 10-K 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.

Roger Pondel
Roger Pondel
Head of Investor Relations at Karat Packaging Inc

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 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 Alan Yu. Alan.

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

Thank you, Roger. Good afternoon, everyone. We are encouraged by our Q3 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 million online platform fees in the current quarter, achieved a 33% increase over the prior year period. Karat'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.

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

Sales of our eco-friendly product increased 9% year-over-year and now represented 33.4% of total sales in the Q3. We believe demand for eco-friendly and compostable single-use disposable product will continue to increase and will contribute positively in the long term. 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 cups 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.

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

At the gross margin level, we achieved gross margin of 38.6% in the Q3 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 Q4, we are encouraged by the positive momentum and our focus 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 Q4 margin to remain at a higher level. Additionally, we recently implemented measures to further reduce labor and certain other operating costs, and we expect such measures to yield benefits in the Q4.

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

We are also actively looking for a new distribution center in the Southeast region to support anticipated business growth. With Karat's strong operating cash flow as well as the company's 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 5th from $0.35 per share in the preceding quarter. I will now turn the call over to Jian Guo, our Chief Financial Officer, to discuss the company's financial result in greater detail. Jian?

Jian Guo
Jian Guo
CFO at Karat Packaging Inc

Thank you, Alan. Net sales for the 2024 Q3 were $112.8 million, up 6.9% from $105.5 million 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 the inclusion of $3 million in online platform fees, partially offset by a $5.7 million 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. 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 $69.3 million compared with $66.6 million in the prior year quarter.

Jian Guo
Jian Guo
CFO at Karat Packaging Inc

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 Q4 increased 11.7% to $43.5 million from $38.9 million last year. Gross margin for the Q4 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 mixed, partially offset by higher ocean freight costs. Operating expenses in the Q4 were $32.2 million compared with $27.6 million in the prior year quarter.

Jian Guo
Jian Guo
CFO at Karat Packaging Inc

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 expenses. 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 the secondary offering during the 2023 Q3. Net income for the 2024 Q3 increased 1.3% to $9.3 million from $9.1 million for the prior year quarter. Net income margin was 8.2% in the Q4 compared with 8.7% a year ago. Net income attributable to Karat for the 2024 and 2023 Q3 was $9.1 million, or $0.45 per diluted share. Adjusted EBITDA was $14.7 million for the Q4 compared with $15.2 million for the prior year quarter.

Jian Guo
Jian Guo
CFO at Karat Packaging Inc

Adjusted EBITDA margin was 13.0% for the Q4 versus 14.4% in the prior year quarter. Adjusted diluted earnings per common share was $0.47 for both the Q4 and Q3. We generated operating cash flows of $19.5 million in the Q3 and ended the quarter with $115.6 million in working capital compared with $110.5 million at the end of 2023. As of September 30, 2024, we had financial liquidity of $75.1 million with another $21.5 million 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 million we returned to shareholders in the current year in regular and special dividends. We remain committed to a balanced capital allocation strategy between shareholder return and long-term growth investments.

Jian Guo
Jian Guo
CFO at Karat Packaging Inc

We expect net sales for the Q4 to increase by mid- to high single digit over the prior year quarter. Our gross margin goal for the Q4 is approximately 39%-40%. We are also reaffirming our full-year 2024 guidance today. Alan and I will now be happy to answer your questions, and I'll turn the call back to the operator.

Operator

Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad to raise your hand and join the queue. If you would like to withdraw your question, simply press star 1 again. And your first question comes from the line of Ryan Meyers with Lake Street Capital Markets. Your line is open.

Ryan Meyers
Senior Research Analyst at Lake Street Capital Markets

Hey, guys. Thanks for taking my questions. Jian, I 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 %. But if I recall back to last quarter, sort of the implied Q4 number with the full-year guidance, I think was looking for a double-digit % growth rate. Just want to make sure I understand that correctly. If there's anything that I missed, it'd be kind of helpful to walk through that.

Jian Guo
Jian Guo
CFO at Karat Packaging Inc

Yeah. So, Ryan, thank you for the question. Yes, that's correct. So at this point, we do expect the Q4 sales growth to be mid- to high-single-digit. We are also reaffirming our full-year guidance, as we mentioned in the prepared remarks. 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 million. So that was a benefit to Q4 2023. So that's going to cause a little bit of an 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.

Ryan Meyers
Senior Research Analyst at Lake Street Capital Markets

Okay. Got it. That makes sense. Then just thinking about the national and regional chain segment, it looks like revenue was flat sort of 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.

Jian Guo
Jian Guo
CFO at Karat Packaging Inc

You're talking about the chain segment?

Ryan Meyers
Senior Research Analyst at Lake Street Capital Markets

Yeah, 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 with salespeople or additional products. But just kind of get a good feel for that line item.

Jian Guo
Jian Guo
CFO at Karat Packaging Inc

Yeah, 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. So we do have some price adjustment in the past quarter. I also wanted to point out, as we mentioned in our prepared remarks, we started shipping some of the bakery packaging containers 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 Q4 in the chain segment. Alan, anything else you want to add?

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

Sure. First of all, Ryan, to your first earlier question about the double-digit growth that we expected, if you look at what I mentioned that if you were to take out the $6 million from last year Q4, our revenue would have been $89 million total, but we added $6 million, so it's $95 million. Now, if we were to take out the $6 million with $89 million compared to what we're guiding right now, it's a little bit over 14%, which is double-digit growth year-over-year. And that's what Jian said. If we were to compare it apples to apples, our real growth will be double-digit, 14%.

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

Now, in terms of what Jian just mentioned too, 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 in, and we started shipping. Of course, there are other national chains that we're working on that we are hopeful that we'll start shipping in the Q4, maybe later of the Q4 this year or earlier Q1s. 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 we will rely heavily on online sales because we're going to be promoting more marketing towards that.

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

And the Q3, we actually invested a lot more in terms of online marketing advertisement, which will come to fruition in the Q4.

Ryan Meyers
Senior Research Analyst at Lake Street Capital Markets

Okay. Got it. That makes sense. Yeah, the commentary on the guidance and that $6 million impact from last year is helpful and kind of gets us in a good spot. So awesome. Thank you for taking my questions.

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

Thank you, Ryan.

Jian Guo
Jian Guo
CFO at Karat Packaging Inc

Thanks, Ryan.

Operator

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

Jake Bartlett
Jake Bartlett
Senior Equity Research Analyst at Truist Securities

Great. Thanks for taking the questions. My first one is just on this supermarket opportunity. Alan, you mentioned this new account that you've won or two new accounts you've brought on. My question is how big an opportunity this is. You're obviously focusing on the press release and the call today. But how much of an opportunity really is it for Karat, maybe in the near and also the long term? And then also, what makes Karat well-suited for this business? It seems to be a business you hadn't pursued in the past, or maybe you just hadn't had success with it. But what makes this a good business for Karat to be getting into at this point?

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

With the initial number and forecast projected by the customers, our initial annualized revenue will be around $5 million or a little bit over $5 million-$6 million. We are currently working on an additional project with the same account that should bring us to an annualized revenue of $15 million for this one account. Also for another supermarket chain, it's about around $500,000-$1 million to start with, and it can grow even larger. What is special about going after the supermarket chain is that we realized supermarkets, they have less SKUs, and they use higher volume. 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. Now our focus is going to the bakery business.

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

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 shift into a business that we hadn't been focused on in the past. In the past, it was always the hot cup, the cold cup, the paper cold cup, the PET cup, the portion cup. 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.

Jake Bartlett
Jake Bartlett
Senior Equity Research Analyst at Truist Securities

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?

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

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, they're trying to switch away from the plastic takeout container into the corrugated board box, as well as the bakeries. You can see all these little corrugated boxes, bakery containers, paper containers with the plastic openings. Before, it was all plastic or Styrofoam. Paper bag, SOS bag, those are the things that we want to get into. And there's different sizes of the SOS bag. It's not just the shopping bag we're looking to. The RPET business is that we've been asked by 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 we use less plastic as well as more recycled material?

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

In Europe, basically, they ban all plastic, especially if you were to mix with 25% or more of the recycled content material. So this is more of the future, just how we started the PLA cup business back in 2007. If companies still have to use plastic, which is more functional, they want us to at least they want the company to start using less virgin 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.

Jake Bartlett
Jake Bartlett
Senior Equity Research Analyst at Truist Securities

Okay. My last question, maybe I'll jump back in with another later. But are the gross margins obviously, the gross margins have been much stronger than initially expected, maybe a couple of years ago? They also continue to remain very strong, obviously, with the guidance in the Q4. My question is how sustainable that is. What portion of this margin expansion versus the 31% you were running two 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 is sustainable for this business long-term from a gross margin perspective?

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

As Jian 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%-40% versus our last quarter, 38.5%. We're still seeing this margin in the high 30s and the low 40s. Is it sustainable? We believe it is because, as we mentioned earlier, we're focusing more on online sales, online revenue. Online revenue generally has to carry a larger, higher amount of the margin, basically profit margin. We're already at 33% growth, which is about 17%-18% of our overall revenue. 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.

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

As well as Ocean Freight, we do continue to see that Ocean Freight is not going to spike up. We're seeing it's stabilizing. It's dropping for the remaining of the year and very likely the first quarter. 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 will generate a 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.

Jake Bartlett
Jake Bartlett
Senior Equity Research Analyst at Truist Securities

Sorry, 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?

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

Overall, volume to be 20% higher.

Jake Bartlett
Jake Bartlett
Senior Equity Research Analyst at Truist Securities

In the Q4?

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

In the Q4, yes.

Jake Bartlett
Jake Bartlett
Senior Equity Research Analyst at Truist Securities

Got it. Thanks a lot. Appreciate it.

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

Oh, 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 going forward.

Operator

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

Brian Butler
Brian Butler
Analyst at Stifel

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, it looks like very good momentum, and it seems like the market's improved with California kind of flattening, at least not being down more, and then you're moving to supermarkets as well as new products. How do we think about Q4 being high, our mid-single-digit revenue growth? When you look at 2025, 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?

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

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

Brian Butler
Brian Butler
Analyst at Stifel

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

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

We are going to invest. I would call that this is more of an investment in terms of advertisement for future additional sales online. For online business, in order to continue growth, we're basically acquiring, paying, spending advertisement to acquire a new business so they can continue to recur and buy our product on a recurring basis. So if basically our goal is to grow our business, increase by 50% from currently this year of $70 million-$75 million-$125 million next year, we are going to see more expenses spent on the advertisement for the online expense. But at the same time, it's definitely going to help us increase our revenue faster than it was in the past 12 months.

Brian Butler
Brian Butler
Analyst at Stifel

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 outlaid to support kind of that double-digit growth? Can you give some color there?

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

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've been pushing a little bit higher, but we're not going to go crazy on that, and 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 to support our growth. It could be in the millions on that part, but definitely we have the cash flow on hand to support that already.

Brian Butler
Brian Butler
Analyst at Stifel

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?

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

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 employees. They clicked on the attachment, which where the hacker were able to hack into our email system. At the same time, we hired a third-party investigator to investigate. Initial investigation came out that there were no material data breach. We're continuing to follow through and see if there's any issue on that part. In terms of monetary damages, there were no monetary damages. The amount spent is very nominal, very not material.

Brian Butler
Brian Butler
Analyst at Stifel

Great. Thanks for taking the questions.

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

Thank you. Thank you.

Operator

Again, if you would like to ask a question, press star one on your telephone keypad. There are no questions at this time. I will turn the call back over to Alan Yu for closing remarks.

Alan Yu
Alan Yu
CEO at Karat Packaging Inc

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

Operator

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

Executives
    • Jian Guo
      Jian Guo
      CFO
    • Roger Pondel
      Roger Pondel
      Head of Investor Relations
    • Alan Yu
      Alan Yu
      CEO
Analysts
    • Brian Butler
      Analyst at Stifel
    • Jake Bartlett
      Senior Equity Research Analyst at Truist Securities
    • Ryan Meyers
      Senior Research Analyst at Lake Street Capital Markets
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